From the studio

Podcast: Investors Club: How investors should address rising geopolitical risks with CIO's Dirk Effenberger

Thought of the day

Investors returning from vacations may struggle to believe market volatility reports when they look at how their portfolios have changed. Over the past month, global equity markets are roughly unchanged, 10-year US Treasury yields are down by around 40 basis points, and the US dollar has depreciated by around 2% against the euro. This masks much bigger moves—August saw both the largest one-day points decline in Japanese market history and the VIX volatility index spike to its highest level since the onset of the pandemic.

But we also argue that three major market drivers have experienced significant shifts this month, meaning investors may need to catch up on the narrative changes and get ready to reflect the latest developments in their portfolios:

The probability that Vice President Harris becomes US president is rising. National polls (according to FiveThirtyEight.com) now give Harris around a three-point advantage over former President Donald Trump. We recently adjusted our election probabilities to reflect this momentum shift, assigning a 40% probability to a Harris win with a divided Congress and a 15% probability to a “blue sweep.” While investors should avoid making outsized portfolio moves based on election outcomes, we do see scope to review portfolio hedges, consider adding exposure to gold and the Swiss franc as so-called “safe-haven” assets, and look again at portfolio overexposure to election-sensitive sectors and currencies.

Federal Reserve rate cuts are likely not far away. The outlook for Fed rate cuts has shifted, with a more mixed set of labor data showing the Fed now has both the imperative and the leeway to cut interest rates. Indeed, the Philadelphia and Boston Fed Presidents Patrick Harker and Susan Collins have both endorsed a rate cut at September's Fed meeting. Kansas City Fed President Jeff Schmid has also expressed openness to a September rate cut, provided economic data in the run-up to the meeting support it. We now expect the Fed to cut interest rates at each of its three remaining meetings in 2024, but think market fears of a US recession are overdone. As returns on cash are eroded, we believe investors should consider diversified fixed income and equity income strategies as alternatives to cash.

Growth uncertainty, geopolitics, and quant investing could drive further turbulence. The rise of quantitative trading has added complexity to market dynamics, amplifying market movements. We estimate that systematic quant funds likely contributed to nearly USD 300-400 billion of trading equity selling volume in early August. An uncertain final quarter of the year may augur more market turbulence. Investors should keep a long-term perspective and avoid overreacting to price action. Historical data shows that staying: invested in the market yields better returns than attempting market timing. Diversification is crucial: Our analysis shows a balanced portfolio of equities and bonds has only delivered a negative return over a five-year horizon on 3% of occasions. We also think investors should maintain updated “shopping” and “disposal” lists to stay disciplined during turbulent times and help take advantage of periods of volatility to make strategic trades at more favorable prices

So, we reflect these changes by adjusting our asset class preferences. Following strong performance from quality bonds, we are closing our preference for fixed income and for high-grade (government) bonds within the asset class. We continue to recommend shifting excess cash into quality fixed income, including investment-grade corporate bonds, to prepare for lower interest rates.

In equities, we focus on quality companies with strong balance sheets, competitive advantages, and exposure to structurally growing revenue streams. We see potential gains ahead for gold and the Swiss franc, which can improve portfolio diversification and insulate against risks. We move the US dollar to Least Preferred and upgrade the euro, British pound, and Australian dollar to join the Swiss franc as Most Preferred currencies.