More defensive positioning

Investment Policy, February 2019

More defensive positioning

The latest equity recovery is at odds with recent indications of an economic slowdown. On the other hand, equity valuations have been depressed for months. Earnings growth will therefore be a decisive factor, although political factors remain important too. In the event of any further economic slowdown, a lot speaks for a more defensive stance involving less economic sensitivity, lower market sensitivity (lower betas) and relative stability for both equities and bonds.

There are occasions when markets can deviate dramatically from the fundamentals. This is particularly true when political events dominate the headlines. The last few weeks have been a good example of this – and in both directions. First of all, there was an excessive downward movement at the end of December due to low market liquidity and an intensification of the trade conflict. Then there was a market recovery driven by political hopes, e.g. that there might be a second referendum in the United Kingdom in which Brexit would be rejected. But we prefer to put our faith in facts rather than hopes. The fundamental facts of the last few weeks do not point to a recession, but they do suggest a significant global economic slowdown. This is why the US central bank (Fed) has now clearly changed its choice of words. Whereas back in December references to multiple further interest rate increases sounded like a "communication strategy on autopilot", the Fed is now  contemplating that it might hold back from further rate hikes for the time being. This has given a boost to higher-risk investments such as high-yield bonds and equities.

In an economic slowdown, a more defensive stance involving less economic sensitivity, relative income stability and, above all, less volatility make sense.

Gérard Piasko, Chief Investment Officer


For equity markets, an improvement in the various political uncertainties – such as the US-China trade conflict or the polarization between the Democrat-controlled House of Representatives and the Republican-controlled Senate – would be a good thing. On the positive side, it is difficult to overlook the low valuation of equities right now: Based on the MSCI World Index, the price/earnings valuation of the equity market is some 20% lower than it was this time last year. But on the other hand, there are enough indications of a noticeable economic slowdown in many of the world's key countries – including in Europe, but also in China and the US. For example, US consumer sentiment has now slipped back to the levels of early 2016. Particularly if the economy were to weaken further, it would make sense to adopt a more defensive stance within the equity portfolio – i.e. less cyclical sensitivity and less market sensitivity (market beta of less than 1) coupled with relatively stable dividend and income growth. For equities as an asset class generally, the various factors are currently pointing to a neutral allocation, i.e. the positive and negative factors are more or less cancelling each other out. However, political factors could drive equity markets in either direction at any time.


Following the Fed's recent hints that it may pause before pushing ahead with further interest rate increases, the market consensus now is that there will not be any rate hikes over the next twelve months. This appears to be a rather optimistic view, and would require two things to happen: Firstly, no rise in US inflation. Although this is not backed up by data on US wage growth, which continues to rise, sideways movement in the oil price can be expected to reduce the overall rate of US inflation due to the higher oil price levels witnessed a year ago. Wage growth is also accelerating in the Eurozone, but here too the overall rate of inflation is likely to be restrained by subdued energy prices. Moreover, the bond market is now itself anticipating an economic slowdown. Given the aggregation of recently published data, this appears to be a plausible scenario, and one that would have consequences. In view of low market liquidity and the dependence of more volatile corporate bonds with lower credit ratings on economic developments, we consider this segment of the fixed income market to be much riskier than government bonds and corporate bonds with higher credit ratings. Given the evident slowdown in the global economy, we now also prefer these two types of investment grade bond to so-called "unconstrained" funds, which have failed to convince in recent months and are quite volatile.


For the euro, the slowing of the European economy is not a positive. In year-on-year terms, industrial production in the Eurozone has fallen back to levels last seen during the summer of 2013. But with the US economy showing signs of cooling too, the euro has actually managed to regain some ground against the US dollar and the Swiss franc. Its future performance will primarily depend on statements by the Fed and on US economic data. And given the state of the European economy, it seems unlikely that the European Central Bank (ECB) will raise interest rates: since the Eurozone economy has had already had to contend with the curtailment of the ECB's bond purchases since December, it would probably now need stimulus rather than further restrictive measures. We are expecting volatile sideways movements in the EUR/USD and EUR/CHF exchange rates over the next few months. 


Demand for gold picked up in December against a backdrop of political uncertainties and share price falls. Any further recovery in equities could lead to gold consoli-dating around the level of USD 1,250 per ounce. But a renewed escalation of the trade conflict between the US and China could prove enough of catalyst to push gold up to the technical resistance zone of USD 1,300-1,350 per ounce. Where oil is concerned, further highly volatile fluctuations should be expected. For one thing, it is not clear what will happen in the spring to the special exceptions granted to certain countries to import oil from Iran – here too, everything depends on the actions of President Trump. He approved these waivers in order to punish Saudi Arabia following the death of journalist Jamal Kashoggi. But Saudi Arabia and indeed Russia then ratcheted up their oil production massively, which in turn triggered an oil price slump at the year-end. As an additional factor, the likelihood of economic demand increasing over the next few months is not so strong like what it was a year ago. Volatile movements in the range of USD 55-65 would be no surprise for Brent over the next few weeks.

Gérard Piasko

Gérard Piasko

Gérard Piasko is CIO and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years CIO of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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Editorial deadline: 25 January 2019

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