Global outlook – Q2: A multi-asset solutions PM weighs-in
The recently released Global Market Outlook – Q2 Update provides valuable insights on global capital markets. Having been among the original members of the firm’s investment strategists and still benefiting from participating in some of their meetings, this outlook is a resource my multi-asset team leverages in our portfolio management decisions. From my read, key takeaways include:
- Valuations: From a pure valuation perspective the U.S. looks relatively more expensive than other developed equity markets. It is important to note, however, that the U.S. looks more attractive from a recessionary risk perspective. In my portfolios, for example, we have been dynamically weighting regional equity, currently with a neutral weight between U.S. and non-U.S. developed equities.
- Business Cycle: Neutral for U.S. equities given the risks around Q1 2016 earnings-per-share growth, impacted by the strong U.S. dollar in the first quarter and uncertainty around the pace and timing of further U.S. Federal Reserve tightening.
- Sentiment: Europe and Japan look oversold relative to the U.S, while emerging markets have attractive valuations married with some concerns from a cycle perspective.
Considering this outlook, I’m looking at the following in terms of opportunities and risks:
Regional equities present different opportunities from both a return and risk perspective. There is an asymmetry of opportunity, with downside risks outweighing the potential of modest upside gains. It is important to be cautious around risk assets, but opportunistic should markets present a mis-valuation between asset classes, as they did in Q1 2016. Our strategists's views suggest overweighting non-U.S. developed market equities relative to the United States (fully hedged), and this makes sense to me currently from a valuation perspective, but investors should also keep in mind that should volatility resurface, the U.S. will benefit from lower beta relative to non-domestic alternatives.
- Fixed Income
Diversification into higher yielding parts of the fixed income market will be important for the balance of 2016. Just as high yield spreads presented an opportunity in Q1 2016 when spreads approached levels not seen since the 2008 financial crisis, we are likely to see other opportunities in diversified fixed income.
From a PM perspective, while the strategists’ global forecasts are a critical part of the our mosaic of information, we also dive deeper and mix in additional research from our sub-advisors and third-party research to get a detailed view that we apply to the different portfolios we manage. We make judgments based on this information and other inputs to help meet our clients’ risk-adjusted portfolio goals. For example, we might find compelling investment opportunities due to an overvaluation or an undervaluation of a specific asset class pair that, when analyzed, with the potential risk, still suits a specific portfolio’s risk-adjusted goals. Taking a multi-asset total portfolio management approach to each client’s solution is central to how I think about each portfolio I am responsible for.
When I see, for example, that the strategists have slightly lowered their expectation for equity returns to low-single digits for 2016, my take-away is a sharpened focus on an established belief; there is a premium on diversification as well as dynamic asset allocation. The volatility we anticipate from divergent monetary policy going forward presents opportunities for mis-valuations we can take advantage of though nimble asset allocation within a strict risk management framework.
An illustrative example would be the tightening monetary environment in the U.S., as detailed in the latest quarterly report. We find it prudent to have very limited positions in long duration sovereign assets, but see the advantage of the risk hedging impact of fixed income in the portfolio. High yield deployments within our diversified fixed income positions have the opportunity to outperform should option adjusted spreads widen as they did earlier in the year, and they can in some cases provide material return with fewer risks than equities. Wholesale, we think opportunistic deployments, taking advantage of volatility in equity markets to incrementally deploy to regional equities as well as U.S. equities funded through our fixed income positions, will be rewarded.
Speaking of rewards, keep in mind, while we generalize last year’s tactic as ‘buying the dip’ and suggest this year’s is ‘selling the rally.’ It is important to remember that you had to have ‘bought the dip’ when the market overshoots to be in position to benefit from ‘selling the rally.’
For our latest forecast, see the 2016 Global Market Outlook- Q2 Update.