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LGT Beacon: Moving toward a neutral positioning

August 17, 2018

The S&P 500 nearly reclaimed its historic January high over the past six weeks. Strong corporate earnings and good economic data helped investors to forget the trade conflict for a while. Then, the escalating Turkish lira crisis highlighted how quickly a continued rise in US interest rates and tariffs can hurt some economies and weigh on global market sentiment.

We have recently noted that certain risks have started to cloud the broader market outlook, which should have been a very bullish one otherwise. To recapitulate, these include:

  • Rising trade protectionism, which can hurt productivity and boost inflation 
  • Monetary tightening, especially in the US, which de-creases US dollar liquidity    
  • Political divisions within important policy institutions, e.g. in the European Union (EU), following the recent formation of a populist government in Italy

Of course, risks are always matched with potential opportunities, which could include: 

  • Continued economic growth, driven by pent up demand for capital investment and domestic consumption
  • An extended period with low real interest rates, if gains in nominal interest rates lag behind inflation, which supports credit creation, consumption and risk-taking
  • Reasonable and in some cases increasingly attractive asset valuations, which raises long-term expected re-turns
  • A further liberalization of global trade and investment as a result of US pressure, (at least) among nations that are allied and/or share strategic interests with the US

Strategy: gradually moving toward a neutral positioning

Such bifurcated, contrasting and uncertain prospects reaffirm the validity of our active counter-cyclical investment approach – i.e. selling into meaningful market strength and buying into exaggerated weakness. At the same time, recent developments make us increasingly inclined to gradually move toward a neutral positioning in equities, from a moderate overweight at present. A neutral starting point would be more appropriate to opportunistically shift the asset class weights as and when needed. Indeed, over the last several weeks, we took steps toward a more balanced positioning.

First, we added some exposure to hard currency-denominated debt of issuers from emerging markets (EM). We also trimmed our European equity holdings somewhat, following a comparative rebound: by early this month, the Euro Stoxx 50 had recovered about 5.5% from June's low, being the first among major non-US indices to approach previous highs. We thus felt these levels were appropriate for a sale. We should add that we remain inclined to reduce EM equities once they recover, while maintaining a preference for US assets, given the relative strength of the US economy. 

Still valid: sell on strength, buy on exaggerated weakness 

The sale of European equities was in line with our sell-on-strength approach, while the purchases in the fixed income space also came after long periods of weakness, which we deemed exaggerated given fundamentals.

EM bonds had suffered markedly with the start of the trade conflict on March, when the US announced steel and aluminum import tariffs. This slide was mainly the result of depreciating currencies. Tariffs tend to add strength to the USD, partly as an offsetting market mechanism. Nevertheless, the EM hard currency segment has begun to stabilize more recently, so we took the opportunity to increase our exposure in this space. Most EM remain in a good shape economically, and their bonds offer a good yield-pick over developed market government bonds.

Read more in the LGT Beacon

Read about the resulting investment positioning changes in our portfolios in the LGT Beacon below. To subscribe to a weekly newsletter, go to subscriptions.

Note: The next edition of the LGT Beacon is scheduled for mid September 2018.

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