2019 Mid-Year Outlook: Cash is Not King. Stay Diversified!
As summer is here (or endless summer in South-east Asia), we thought it would be timely to perform a “portfolio health check” to ensure investments are in rude health heading into 2H 2019.
A HEALTHY PORTFOLIO
The first and most fundamental step towards a healthy portfolio is robustly reviewing the asset allocation as it is the most important decision for long-term terms investors, in particularly with the recent re-emergence of trade tensions amidst a moderately challenged growth environment.
However, unlike last year, financial conditions have eased considerably with most major central banks having an easing bias. This has acted to cushion financial markets. In addition, China has been more proactive in utilizing monetary and fiscal stimulus as well.
The G20 meeting between the US and China in late June was in-line with our “base case” expectations that existing tariffs remain and there are no new tariffs by the US on China goods.
In short, it is a little bit of déjà vu as this is similar to the G20 meeting in November 2018 where further tariffs were put on hold which will allow time for trade negotiations to begin again.
One small positive is the news on any temporary loosening of US components to Huawei. There could be a mild relief rally given the better sentiment characterizing current talks.
However, the extent of any equity rally may be limited as in November, as there is no new information on the key US issues on the trade dispute:
(1) Enforcement of IP protections,
(2) Forced joint ventures and technology transfer,
(3) And the role of state owned companies just to name a few.
These topics are complex and difficult to bridge in the short-term. To what degree that these issues will China regard as an infringement of their sovereignty? Will the upcoming US elections increase the chance of a sustainable truce or jeopardize the talks?
The one area where US Congress is united is enforcement on China trade and national security issues.
POTENTIAL TRADE NEGOTIATION SCENARIOS
It is positive that the two countries avoided further measures for trade escalation but investors face uncertainty as the trade talks could falter again. Our base case is a circa 50% probability that negotiations could last up to six months.
The other scenarios are a 30% probability of a deal in a shorter-time period, and a 20% probability of a no-deal and further escalation.
However, investors should always remember to retain their core asset allocation, stay invested and adjust their tactical allocation accordingly to scenarios. Don’t let the tail wag the dog.
WHAT IS OUR INVESTMENT STRATEGY OUTLOOK?
We began the year with an overweight equities position after the year-end sell-off, taking advantage of the buying opportunities with multiple thematic calls.
Given the strong performance in 1Q, we had already downgraded global equities to short-term neutral in 2Q and had advised investors to diversify since May ahead of the sell-off. In light of the re-escalation of trade tensions in May, we have now turned tactically short-term negative for equities where the pro-longed trade uncertainty will pose risks on capex plans and economic confidence.
Earnings expectations would then be under further downward revision risks.
In the medium term, the asset allocation has turned to neutral from positive for global equities as we find the risk-reward relationship unattractive amid the current downward trends of leading indicators and earnings revisions.
Having said that, major downside risks should prove limited, thanks to a monetary policy background that stays moderately supportive and the cautious positioning of investors.
Where to invest?
We are medium-term overweight Europe, Japan, and neutral US and EM equities. In addition, we are positive on real estate, health-care, European oil majors, and Asian consumer discretionary, consumer staples, and communications sectors.
Fixed Income Outlook
We benefited from the overweight in investment grade bonds and short-term Treasuries in 1H 2019.
We expect two rate cuts from the Fed this year in July and September, and one more cut in mid-2020. Our 12-month targets for US yields are not far from current levels with US 2-year yield at 1.75% and 10-year yield at 2.25%.
Cash continues to be a major drag for portfolios. Where to go with the search for yield with falling rates? We retain our overweight on higher quality investment grade corporates with moderate duration, short-end of the sovereign curve for US, as well as local currency and selected hard currency EM/Asia bonds.
The dollar is expected to consolidate in the near-term after recent weakness, while medium-term we expect moderate dollar weakness.
In conclusion, a healthy portfolio diversification is essential as volatility could be higher for a period of months.
Don’t hesitate to diversify the tactical portion of your portfolio with ideas including: cross-asset ideas implemented via structured products with principle protection, selected fixed-income structures, gold as a portfolio hedge, FX derivative instruments, and equity switch ideas to keep the portfolios fresh.