The UBS House View Monthly presents the latest version of the UBS Investment House View, assessing the impact of current economic trends on asset classes and portfolio allocation.
Entering choppier waters
Investors who kept calm, stayed invested, and rebalanced through the recent correction look set to be rewarded in a month that highlighted the difficulty, and potential costs, of trying to time the market. The worst week since 2016 was followed by the best week since 2015, and global equities are now just about 5% short of their all-time highs. Investors who sold out any more than three weeks too early and bought back any more than a week too late would still be worse off than a buy-and-hold investor.
Calmer market conditions, including the VIX volatility index returning to its long-run average, suggest that extreme investor positioning has reset, which should make markets more resilient. Importantly, the economic backdrop remains broadly unchanged, and positive. Growth is strong – services purchasing manager indices this month broke multi-year highs in both the US and China. Corporate earnings rose by around 15% in the fourth quarter, the fastest pace since 2011, and we project earnings growth in the low teens for global equities in 2018. And only limited moves in credit spreads suggest that the recent stock market sell-off should not harm the growth of the real economy.
We believe markets will continue to recover, see this as a good time for investors to look for opportunities, and add a number of new positions to our global tactical asset allocation. These include an overweight position in EM sovereign bonds in US dollars (USD) relative to US government bonds, in US 10-year Treasury bonds relative to cash, and within our FX strategy an overweight in the euro relative to the USD, in the British pound relative to the Swiss franc, and in the Japanese yen relative to the New Zealand dollar. Furthermore, we see this as a good time for all investors to review their portfolios and rebalance their equity holdings back to their strategic asset allocation targets.
But while we believe the worst of the volatility is likely behind us for now, we acknowledge that we are entering choppier waters, in which fears of higher inflation and interest rates could start to compete with, or even overwhelm, hopes for higher growth. So while we still see opportunities in today’s market, we also think it's time to prepare for the new environment by considering counter-cyclical positions to our tactical asset allocation. For investors who can buy option securities, we recommend put option strategies on the S&P 500 to provide protection in the event of an even larger correction. As always, please contact your financial advisor for additional details and risk discussions.
Should vour base case of modestly higher inflation, measured Fed interest rate rises (one per quarter), and rising equity markets materialize, we do not expect such counter-cyclical positions to be profitable. Yet we think it can be prudent to potentially sacrifice some of our expected returns in order to boost portfolio stability if fears of higher interest rates continue to impact markets.
Global Chief Investment Officer Wealth Management
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