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Investors need a seat belt, not a life jacket

Tai Hui  |  05 Apr 2018Text size  Decrease  Increase  |  
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While investors would be wise to proceed with caution over the next 12 to 18 months, the situation shouldn't warrant all-out panic, explains J.P. Morgan's Kerry Craig.

Once a flight has taken off, airline passengers are usually reminded to keep their seat belts fastened in case of turbulence. Even at calmer altitudes, unexpected air pockets can still shake the plane. Market volatility in the first quarter of 2018 has shown that a well-diversified portfolio is like an investor’s seat belt in providing protection in case the unexpected occurs.

As we remain constructive on the prospects for global growth in 2018, we believe taking even greater precautionary measures--the equivalent of a life jacket-are not needed just yet.

Buckle up, don’t panic

Equity market volatility in February and March was triggered by two events: (1) a new reckoning about US inflation risk and the potential Federal Reserve (Fed) response and (2) concern over a rise in trade protectionism set off by US President Donald Trump. Indeed, we highlighted at the end of 2017 the risk that these forces could revive market volatility.

However, we do not see a reason to panic as global growth remains above trend and our conviction is that central banks will move gradually to rein in liquidity. The Purchasing Managers’ Indices (PMIs) for both developed economies and emerging markets sustained their multi-year highs during 1Q 2018.

We do not think that growth is likely to accelerate much from this point on, nor is recession imminent. Consumers in the US, Europe and China are still in good shape. With companies posting better earnings and showing stronger confidence, capital expenditure and investment are accelerating, driving the global trade cycle.

Investors should also differentiate among sources of volatility. Economic recessions typically create a sustained negative market impact vs. other exogenous shocks.

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The early-1990s recessions, the dot-com bust and the global financial crisis led to sustained corrections. At other times, such as during the European debt crisis in 2010 and China’s currency devaluation and market crash in 2015, the shock to US equities was temporary.
This variation in market response points back to our argument that economic fundamentals are vital when constructing a portfolio for the next 12–18 months.

Currents that can shake the plane

A surge in inflation followed by an aggressive monetary policy response remain the biggest concerns for investors we have spoken to. While global growth may not accelerate much more from this point onwards, an increasingly tight labour market and falling spare capacity in the US are increasing upside inflation risk, spurring investor concerns about an increasingly hawkish Fed policy outlook.

The latest Federal Open Market Committee Summary of Economic Projections for the Fed funds rate shows that the committee members’ median expectation remains at three rate hikes in 2018 and three in 2019, up from two hikes projected in December 2017.

Several members have also indicated that the central bank may need to be even more aggressive. Learning to live with a rising rate environment, both in short-term policy rates and long-term bond yields, after almost a decade of ultra-loose monetary policy, could prompt some growing pains in the form of volatility in both equity and fixed income markets.
However, it is worth noting that other central banks, such as the European Central Bank and the Bank of Japan, have been very careful when setting the pace of their policy normalisation.

following the Trump administration’s imposition of import tariffs on solar power panels and washing machines in January, on steel and aluminium in February and broader measures announced in March in response to an investigation into Chinese intellectual property rights infringements.

Ultimately, we see a full-on Sino-US trade war having no winners. A surge in import prices will be costly for US consumers and exacerbate inflationary pressures. We expect the most likely scenario is political sabre rattling impacting a narrow selection of products, not an economic sword fight and an all-out trade war.

Another investor concern is geopolitical tension on the Korean peninsula, and not for the first time. This has calmed, for now, amid more dialogue among Pyongyang, Seoul and Washington. Italy’s election result points towards a number of difficult political options, but the impact is likely to remain local.

Chinese policymakers’ determination to reduce financial risks is unshaken, and likely to proceed as planned after the National People’s Congress.
Protection against downside risks to the Chinese economy is likely to come from periods of temporary monetary accommodation, allowing the corporate sector to adjust.

Wear a seat belt, not a life jacket

Investors’ concerns typically focus on the next 12 months, where variation in returns is wide; however, extending the time frame reduces the variance and volatility in returns. As such, we believe a well-diversified portfolio should—like a seat belt—offer investors better protection in the current growth environment.

We continue to favour the risk/return profile of equities over government bonds, since government bond yields are expected to rise further. Corporate credit and emerging market debt are also positioned to benefit from the constructive macroeconomic backdrop.

To enhance risk management, investors could take a more benchmark-agnostic approach using long-short strategies and continue to look for ways to enhance return via active management and alpha generation.

It is too early to switch to a more defensive strategy offering protection from recession or crisis. You may feel safer wearing a life jacket on every flight, but it would be inconvenient and uncomfortable, especially when a seat belt is sufficient.

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Tai Hui is chief market strategist, Asia, with J.P. Morgan Asset Management. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is JP Morgan's chief market strategist, Asia.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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