Note Précis Oct 15,2020: Q4/2020 – Outlook Paper Thin Not Iron Clad Or Gilt Edged: In the U.S., Japan and Europe exist central bank and political tussles including flux in policy. Solvency and deficits appear getting little attention from many authorities. In finance as in the science of fluid mechanics, the wanton opening of floodgates rather than metered sluice guidance increases risks of harmful eddies. Perspective appears from different vantage classic writings by titans like Benjamin Graham, William Sharpe and Peter Drucker.
Post a bitter November 3, 2020 U.S. election, there lie significant global decisions; not least about fiscal spending for growth and deficits and trade; China appears flexing a more aggressive political posture; the European Union has many internal political, trade and financial stresses.Further, regional hostilities appear rising into outright conflict in many parts of the world. At present, policy efficacy seems paper thin and not iron clad or gilt edged.
The prongs of Covid-19 pandemic and irredentist territorial claims have been sharpening. In the movements of gold, the Swiss Franc, the Renminbi and many G-7 currencies versus the U.S. dollar and notwithstanding relative liquidity, we see ratcheting of tensions and volatility. The currency markets are diverse by participant and at $6.8 trillion in daily trading, not easily tamed. We expect resurgence by participants like hedge funds in strategies such as convertible arbitrage, paired trading and currency arbitrage.
Due to high valuation and solvency risk among other factors, volatility in equities and fixed income is likely to be elevated. Rebalance between valuation and momentum appears overdue. it is likely to include currency volatility. Our earnings expectations are lower and recovery profile longer than consensus appears to espouse. It would mean that the quality of restructuring delivery is crucial as a differentiator.
In fixed income both of the government and private variety, yield compression appears mandated by central banks but solvency is a consideration. Albeit with U.S. dollar denominations dominant, it supports diversification, including Yen denominations and strong emerging economy segments. We espouse short duration in fixed income and precious metals like gold bullion instruments in asset mix.
In emerging equity markets, the advantages likely lie with stronger growth in Asia. Overall, sector leadership likely resides in the United States but we also see opportunities to overweight Japan on restructuring. Smaller companies likely present vulnerabilities worldwide. We favor quality differentiation of the strong balance sheet variety and that related to operating management. It contrasts in markets with wholesale reliance on ETFs that has appeared for a prolonged period amid massive quantitative ease.
With Information Technology weightings on the S&P 500 having reached close to 29% in momentum markets, portfolio diversification and not just index benchmarking appear considerations. In growth, we suggest strong balance sheet Healthcare at overweight, Information Technology at market with Consumer Staples and concept social media at underweight. In cyclicals, rather than an early cycle tradition of overweighting Consumer Discretionary, currently we overweight Industrials related segments and for diversification, we also overweight Materials as well as strong balance sheet, severely out-of-favor Energy. Performance in the Financials sector remains crucial for market direction. We favor banks where less excess may reside as a result of continued, severe restructuring.