Finding value and managing risk

Markets remain volatile following one of the worst single months since the bull market began in 2009. The sell-off was driven by investors beginning to question the sustainability of three of the key assumptions that have supported equities in recent years – supportive monetary policy, strong earnings growth, and solid economic data.

Global equities remain 7% shy of their peak in local currency teams, and we believe this creates a value opportunity. After having removed some equity risk in July because we thought that macro headwinds were underestimated, we have now added it back to our risk exposure following the October decline.

Read it in full

Download the monthly letter.


Economics and valuation support equities

We think that the recent sell-off provides investors with a good entry point and recently increased our overweight allocation to global equities due to the following reasoning:

Downturn isn’t imminent
The cycle is maturing, but economic data in the three biggest developed market economies is not pointing to an imminent peak in the business cycle.

Valuations are attractive
Even with our below-consensus estimates for 2019 earnings, Emerging Market, Eurozone and US equities look attractive relative to high quality bonds.


Watching for positive surprises

We are also watching closely for potential positive surprises, such as the below, which could lead to a further rally in risky assets:

China stimulus

The Chinese government has started to take a proactive approach toward slowing growth and is using fiscal and monetary policy to offset the negative effects of tariffs. There are signs it is starting to have an impact. The sharp fall in fixed asset investment growth this year has shown early signs of stabilizing, and the latest PMI survey data was better than expected.

US-China trade tensions

The G20 meeting in Buenos Aires could prove an upside catalyst as markets seem to expect little progress on trade issues. There is some room for trade tensions to stabilize even if a meeting of the Chinese and US presidents does not quickly resolve all of the trade issues.

European growth

While recent economic data has weakened, there are signs that this was due to one-off effects such as the introduction of new emission test procedures, which led to a sharp decline in German car production. If one-off causes were indeed the reason for the soft patch, there is a good chance that economic momentum will pick up again.


Managing risks

While we think there is opportunity to capture value in risky assets, we also acknowledge that the economic environment will become more difficult as we head into 2019 and there is also potential for negative surprises:

Faster rate hikes
Our base case is for four interest rate hikes by the end of 2019, but if US wage growth accelerates the Fed could become more hawkish.

US-China trade tensions
Our base case does not include the imposition of another round of tariffs on Chinese products, but if incorrect, any additional US tariffs would be disproportionately more disruptive than those imposed so far.


Investment conclusion

Nuanced but navigable
With the right strategies in place, we believe this nuanced and challenging investment environment is navigable. In our Tactical Asset Allocation we overweight global equities and emerging market dollar-denominated sovereign debt to benefit from good economic data, favorable valuations, and the potential for positive surprises.

But we also hold a number of counter-cyclical positions, which can help protect portfolios in case of a sharper economic slowdown than we expect, or in case of our downside risk scenarios materializing. This includes an overweight to US 10-yr Treasuries, and, for investors who can invest in options, a put option on the S&P 500.

Stay up to date

Sign up for our newsletter