Questions we're tracking

Each month we will answer five of the top questions on investors' minds and on our minds as we determine our House View positioning.

Should investors consider portfolio insurance?

As the bull market grows older—it is now in its 10th year—investors are increasingly focused on preparing for the next bear market. While there are potential geopolitical tail risks, solid economic and earnings growth should allow equities to grind higher. Investors should stay risk-on but consider hedging strategies that protect against tail risks without sacrificing significant gains from rising markets.

Did you know?

The New York Federal Reserve estimates a 9.1% chance that the US economy will enter a recession in the next 12 months. A normal (non-recessionary) reading is 12.7%, while this gauge hits an average reading of 23.4% in the 12 months before a recession.

The S&P 500 gained 18% and 22% in the 12 months before the 2007 and 2000 market turns.

Can markets regain their composure?

During February's equity market correction, the VIX index rose as high as 50.3—an extreme level that was only previously seen during the depths of the global financial crisis and was briefly touched during the 2015 market correction. Volatility has since subsided but is not back to the extreme low levels of 2017; ongoing US-China trade tensions have also caused further market swings. The period of abnormal calm may be over, but we don't believe the surge in market volatility is a fundamental risk.

Did you know?

Sharp sell-offs tend to be good buying opportunities. In previous episodes where the VIX index traded above its 90th percentile, the S&P 500 posted 12-month gains 87% of the time, with a median return of 22%.

The maximum intra-year drawdown in 2017 was –2.6%, and the VIX level averaged only 11.1, making it the calmest year on record.

Will the threat of a trade war derail markets?

The Trump administration has followed tariffs on steel and aluminum imports with trade action against China. China has announced retaliatory tariffs of its own, with US and Chinese officials trading jabs even as they express openness to negotiations. While US actions have reawakened fears of a global trade war, we believe the US and China will reach a resolution before their tariffs go into effect in several months' time. While we are watchful for signs of escalation, our base case is that simmering trade frictions won't boil over into a full-on trade war.

Did you know?

Among Chinese listed companies, international sales make up a low-teens percentage of total sales; of this the US accounts for close to 20%. This implies that Chinese listed companies’ direct exposure to the US is around 3% of total sales.

The three largest sectors within MSCI China—IT (mainly internet), financials, and consumer Discretionary—account for over 70% of the index weight and are largely driven by domestic demand, not exports.

Should the US fiscal deficit worry investors?

The US Congress recently passed tax reform and significantly increased government spending. But while these changes have provided a boost to economic and earnings growth, they have also raised concerns about the US budget deficit. Even under strong economic conditions, the deficit will exceed 5% of GDP by 2019. In the long run, the rising US debt burden likely will mean higher taxes or entitlement spending cuts, especially on medical care. But unless Congress generates another "debt ceiling" crisis or a sustained government shutdown, we don't anticipate an acute short-term crisis. The US Treasury should still be able to find buyers for its debt.

Did you know?

Higher debt burdens don't necessarily translate into a higher borrowing cost. At 106% of GDP, total US government debt is at its highest level since the 1950s. But Japan's debt-to-GDP ratio is twice as large and its 10-year  government bond yield remains near 0%.

Almost half of US Treasuries—USD 8 trillion—are owned by foreigners.

Can emerging markets power ahead in 2018?

Emerging market (EM) stocks were a star asset class in 2017, returning 37%. 2018 has been far choppier but many of their supportive performance drivers remain intact. Against a backdrop of strong global growth, a revival in earnings, and relatively gradual monetary tightening, we recommend an overweight to EM equities.

Did you know?

China, the largest emerging economy, expanded by 6.9% last year—its first
acceleration in seven years.

EM equities (ex. Chinese A-shares) have attracted inflows of more than USD 26bn since the start of the year, according to Morgan Stanley. Recent volatility has seen inflows slow but not reverse.

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