Note Précis October 15,2018: Q4/2018 – A Time for Reappraisal not Jingoism: Our asset mix focal point in this cycle has been on the unusual nature and extent of quantitative ease with the collateral side effects potentially obscure but likely to unfold with the passage of time. Hence, we have suggested above benchmark cash reserves, fixed income investments at below benchmark especially in long dated instruments , a quality focus in equities with diversification focused on sectors rather than simply on geography and last but not least, inclusion of alternate investments like precious metals as well as direct and private investment vehicles. Incorporating recent developments in particular in fixed income markets, we see aspects of foggy clarity as being at work in global political and business discourse. We favor quality, better balance between value and momentum as well as need for cash reserve accumulation for redeployment later. It is a time for reappraisal not jingoism.
Capital markets have until recently been ignoring myriad risk adjustment signals like geopolitical stress, violent conflagration the rise of populism worldwide with the U.S. mid-term elections imminent on November 6, 2018 and trade friction. Meanwhile, deficit reduction planning of the type suggested by the bipartisan Simpson-Bowles Commission back in 2011 have been skimmed over, not just by the politicians in the United States but elsewhere. In marked-to-market investment portfolios, the capital decline of close to 10% even in 10 year U.S. Treasury Notes from yield lows to the present is likely to be uncomfortable for pure fixed income and even for multi asset portfolios especially were equities to also turn volatile as has recently been the case. We maintain a low duration focus for fixed income and a quality bent appears as also appropriate. In a tougher capital market, supra-agency like IMF and World Bank backed foreign currency fixed income may yet again come back in vogue.
In equities, the primary factors since 2009 and into 2017 appeared to be momentum linked with quantitative ease, share buybacks especially in the United States, recovery in the earnings cycle and concomitant valuation expansion with scant focus on quality as was also seen in junk bond fixed income markets. The first signs of change came early in 2018 in that the cycle extension did not come to pass (and which many appeared to expect) namely rotation into Japan and Europe ostensibly on lower valuation as well as broad based outperformance in emerging market equities including China and India, ostensibly backed by higher than global growth.
In our opinion and despite global economic growth continuing but in the lower end of a 3 ¾ – 4% annual band, withdrawal of quantitative ease led by the Federal Reserve and higher fixed income yields are likely to constrain valuation expansion and fervor for concept while a more likely upcoming 2019 environment of traditional 7% per year earnings growth for the S&P 500 drives increased focus on quality as well as better balance between value and momentum.
Furthermore and unlike recent equity behavior, we would expect the Financials sector to resume its critical role of leadership but with those most ruthless in restructuring still at the forefront, even after a decade of such restructuring. This aspect appears to have been underappreciated in many geographic rotation strategies. Overall, we also anticipate that more so than experienced recently, a diversification role exists for direct and private equity investing as well as for exposure to precious metals, hitherto U.S. dollar strength notwithstanding.
StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e