Recognise risks and opportunities and be prepared for multiple outcomes

Updated: August 21, 2019 8:43:46 AM

Today, all policy emanating out of the US is intended to insure there is no sell-off in the S&P 500. Once markets sold off this month, Trump pulled back on China tariffs, called bank CEOs, and gave Huawei a reprieve.

risk, opportunity, multiple outcome, personal finance, money, bank, market, growth Global central banks are announcing stimulus packages, so the severity of slowdown is difficult to gauge.

By Sunil Sharma

Asset allocation is shaping up yet again to be the most important predictor of returns looking ahead. To be clear, we are not predicting a recession; rather, prudent investment strategy today is to recognise risks and opportunities and be prepared for multiple outcomes.

Key issues to consider

> The yield curve prediction is generally early, so it could be 15 months before a market peak, or as little as three months. That is a wide spread. In the last 25 years, there have been a couple of instances where a recession did not unfold post an inversion, but we got the Asian currency crisis and sharp selloff in 2006 instead, both sharp selloffs. So, the track record has held up since 1980.

> Global central banks are announcing stimulus packages, so the severity of slowdown is difficult to gauge.

> On the other hand, President Trump cannot afford a recession in 2020 and has already demonstrated he will buckle to market pressure (S&P 500 selling off).

> This is the first time the US enters a possible recession with a Fed that has very few bullets left to work with. Historically US interest rates were in the 6-8% ranges, today it is in the 1.5%-2.0% range.

> Finally, this is the first recession indication this decade, and should the noise on yield curve inversion impact consumer confidence, there is a non-zero probability that QE may not achieve the desired results.

Risks of a bearish positioning
Today, all policy emanating out of the US is intended to insure there is no sell-off in the S&P 500. Once markets sold off this month, Trump pulled back on China tariffs, called bank CEOs, and gave Huawei a reprieve. Trump cannot afford a recession in 2020. The Trump playbook will involve a well-timed QE announcement, rate cuts, and some version of a trade deal. Trump has demonstrated a willingness to cave to market pressure and global central banks will be desperate to avoid a loss in confidence.

India’s domestic-oriented economy
In the event of QE, this liquidity will yet again flood emerging markets, including India. The notion that India’s markets will not be affected is wishful thinking. In the interim, India could be affected by foreign investors’ flight to quality. Of late, our fundamentals look shaky, and much is dependent on a strong stimulus package.

Large-caps preferred
Despite calls to the contrary, we are finding no meaningful bargains in small or mid-cap. The universe of quality opportunities continues to shrink. The market remains quite expensive. The best performing companies are the ones delivering earnings growth. That being the case, we prefer to remain focused on large caps. With respect to equities, the market continues to reward companies that can deliver in challenging circumstances. We believe large-cap quality growth, and for that matter mid and small-cap quality growth, priced reasonably, will deliver. The risks remain on a re-pricing of valuation, or slowdown in earnings, and that is where we intend to focus attention at a portfolio level.

Gold
Gold has a clear breakout and that is a further indication that this time things look different. Gold did have a similar breakout in 2015 that failed, so we would not get carried away with a gold allocation, but gold clearly deserves an allocation in portfolios, as a hedge against fiat money devaluation.

The writer is chief investment officer, Sanctum Wealth Management. Edited excerpts from Investment Strategy report

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