By Tom Elliott, deVere Group International Investment Strategist
Near-term market sentiment: Apprehensive. The benefits of a broadly diversified multi-asset portfolio were highlighted last week, as investors rushed into defensive assets. This was in reaction to a bellicose response from the White House in response to North Korea’s latest testing of its missile technology. Core government bonds rallied, global stock markets fell with growth-orientated (ie, higher risk) stocks falling further than value stocks. The Swiss franc and the Japanese yen, traditionally defensive currencies, rallied. By the close of U.S trading on Friday, however, there was however a sense that megaphone diplomacy from Trump was being tempered – not least by comments from China – and a recovery began in risk assets. This may continue into early next week, assuming Trump withholds from Tweeting on the issue. All of which demonstrates why, as we wrote last week, investors should remain diversified with exposure to both defensive assets as well as risk assets (eg, stocks and high yield bonds), given the unpredictability of market movements. The model portfolio below offers a guide as to how to achieve this.
Longer-term views: as has been written before in this note, we believe that the current equity bull market is fundamentally sound, supported as it is by low interest rates and bond yields. As long as these remain low, there is little likelihood of an end to the’ hunt for yield’ that is driving stock markets high yield debt prices ever higher. Demographic factors, weak public and private sector investment in the West, and a surplus of household savings in Asia, all suggest low yields across the maturity spectrum could be with us for a prolonged period of time.
The most likely risk to stock markets probably comes not from a sharp rise in interest rates and bond yields, but from themes that might drag down corporate earnings of stocks – and/or raise their volatility. This would reduce their attractiveness relative to bonds, creating more demand for fixed income. In this way a diversified multi-asset portfolio is partly protected from such a shock. Would such a shock trigger a bear market for stocks? It would depend on the extent of the shock, but global stock markets are likely to be more resilient than when the credit crunch occurred in 2008, or the dot.com bubble burst in 2000 and investors had much higher bank account cash and Treasury yields to run to. The most likely scenario is that any correction will be met with a swift correction as investors tire of negative real returns from ‘safe’ assets.
What are the themes that could cause a stock market shock? The risk of nuclear war developing on the Korean peninsula is the current most highly rated risk. Others themes include the risk of a credit-crunch in China triggering a recession – with a further devaluation of the renminbi. There is also the risk of a sell-off of U.S tech stocks, as valuations begin to look stretched relative to future earnings potential.
A balanced fund for the long term. A typical long-term balanced portfolio is based around 60% global equities and 40% global bonds. Financial history shows this combination to offer good returns relative to risk (ie, volatility). Investors should try to be as diversified as possible, perhaps using the 60/40 model as their guide. Multi-asset funds based on this principle are available, often with different ratios of bonds and equities depending on the level of risk suitable for an investor. Note that the chart shows neutral weightings for the long-term investor, it does not incorporate the near-term weighting suggestions of the previous paragraph.