Volatility returned in 2018 and likely will continue into 2019. It’s late in the cycle but we still see opportunities. Taking advantage of them will require discipline and a strong decision-making process.
Is the juice worth the squeeze?
It’s a question that often gets asked in our investment meetings and one that should have added emphasis in 2019. Do the potential returns justify the risks? It’s the most fundamental investment question. With the U.S. Federal Reserve (Fed) now comfortably ensconced in a quarterly rate hike groove, the risks are getting larger. It’s not hard to feel that the last return drops are being extracted.
There are no easy choices. Cash returns are low everywhere, the U.S. equity market is overvalued, credit spreads are narrow and profit expectations are dangerously optimistic. Government bond yields are under threat from late-cycle inflation pressures.
It’s a challenging environment for managing portfolios. We know the long-term return outlook is poor, so we need to make the most of opportunities. But it’s unwise to think that we can time the market well enough to get out at the top.
The best response is to focus on the three essential aspects of portfolio management: (1) diversification, (2) implementation and (3) decision-making process. We believe investors need to maintain exposure to a wide range of return sources, have effective implementation that saves basis points, and use a dynamic process that leans out as risks accumulate.
Our cycle, value and sentiment (CVS) decision-making process for every investment decision asks:
- Is the investment cheap or expensive?
- Is the cycle a tailwind or a headwind?
- Is market sentiment overconfident or overpessimistic?
Our CVS process has served as a reasonable guide. We like cheap asset classes over expensive ones, but we have been prepared to hold expensive ones, like U.S. equities and credit, if the cycle is providing support. And sentiment has helped us take advantage of market corrections. We identified a good buy signal from our oversold contrarian sentiment indicators in February and we’re watching for another to develop in late 2018.
For 2019, our strategists think it is too early to become overtly defensive given that 2020 seems to be the recession danger zone for the United States. They are moderately bearish on government bonds as late-cycle inflation pressures emerge, more so outside of the U.S. given the low yields in the rest of the world.
The challenge is to make the most of late-cycle returns while preparing for the inevitable downturn. It means relying on a structured and disciplined process. Ultimately, it’s about assessing the value of the squeeze.
Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.
The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.
The information on this website is only intended for use by professional clients, regulated financial advisers and intermediaries who are knowledgeable and experienced in the financial services market and in investment products of this nature. If you are a retail or individual investor then please leave this website immediately and consult your financial adviser.
You should not use this website unless you understand its nature and the extent of your exposure to risk. You should also be satisfied that the website and investments are suitable for your client in light of their circumstances and financial position.
The information contained on this website is for information purposes only and you should not take it as constituting an offer, solicitation, inducement, commitment or invitation to subscribe for or to purchase, sell or hold any interest in any of the investments mentioned herein.
This website is not intended for distribution or use by anyone in any jurisdiction in which such distribution or use would be prohibited. Nothing on this website or in the materials referred to therein constitutes, or is intended to constitute, financial, tax, legal or other advice.
The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested. Any past performance figures are not necessarily a guide to future performance.
The website may contain forward-looking statements, which are based on a number of assumptions regarding present and future business strategies, which may or may not prove to be correct. By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. Forward-looking statements are not guarantees of future performance.
Issued by Russell Investments Limited. Company No. 02086230 and Russell Investments Implementation Services Limited Company No. 3049880. Registered in England and Wales with registered office at: Rex House, 10 Regent Street, London SW1Y 4PE. Telephone +44 (0)20 7024 6000. Authorised and regulated by the Financial Conduct Authority, 12 Endeavour Square, London E20 1JN.
All reasonable care has been taken by us to ensure that the information contained on this website is accurate at the time of publication. However, we accept no responsibility for the accuracy, adequacy or completeness of the information and materials contained on this website and expressly disclaim liability for errors or omissions in such information and materials. We and our respective affiliates do not have any obligation to update the information contained in this website and reserve the right to change these terms and conditions at any time, without notice.
We will not regard you or any person who accesses this website as our client in relation to any of the investment products or services detailed therein, unless expressly agreed.