Investment
8 min read

A finely tuned balancing act

It is a hard balancing act to capture upside moves in markets and exploit the divergence in returns while protecting from pullbacks. Nevertheless, often the toughest challenges reap the most lucrative rewards.

Published on
May 31, 2011
Contributors
Gemma Godfrey
Credo
Tags
Macro Economics & Asset Allocation
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The global economic recovery is under way but remains fragile and the potential for setbacks is high. Concerns of sovereign debt contagion continue, with fears that other countries with bloated debts and rising deficits will need “bailouts.” Elsewhere, in emerging markets, inflation is becoming a growing threat, especially within Asia. Finally, the turbulence in the Middle East and Japan’s ‘nuclear emergency’ highlight both the political and geological risks that can still rock the fragile recovery.

Consumer Concern Continues
Still driven by the consumer, the environment for spending in developed markets is tenuous. Last quarter many global consumer companies missed their earnings’ estimates and downgraded their earnings’ growth forecasts. The situation in the UK highlights this issue. Retail sales for December were downgraded and January’s figures can only be described as “underwhelming”. The economy also saw its first increase in four months in the number of people claiming unemployment benefit (which would have been even higher had people not given up the job hunt entirely). Moreover, earnings growth slowed to the lowest rate in six months (from 2.5% to 2.0%). With Hometrack, the property analytics business, foreseeing homebuyers facing a continued struggle to obtain mortgages in 2011, the outlook for spending and GDP growth looks tough.

Rate rise risks
We have started to see strong outflows from emerging markets. Inflation remains a key concern and anecdotal evidence suggests that, for example, official figures in China, under-estimate the problem. The crux of the problem is that the risk of inflation can be increased when promoting growth and fighting inflation can increase the risk of weakening growth. The problem is most acute in the UK, where the market is already expecting a 25bps rise in interest rates by May. Unless growth strengthens and unemployment improves, stagflation is a real possibility.

Differentiate and Defend
So what does this mean for investment? With government bond rates rising while corporate bond issuance hits record lows, spreads have continued to narrow. Although attractive opportunities remain within this asset class, it pays to be selective. As for equities, valuations have started to rise above long-term averages. Nevertheless, there’s much cash still to be invested. For example, in the US, large endowments remain significantly ‘underweight’ equities with only approximately 15% allocation to the asset class. As a result there are many investors who have watched big market moves from the sidelines and are eager to catch up. This may provide a certain amount of support, with any pullbacks in the stock markets seen as buying opportunities Again, differentiating between companies is the best way forward, with the correlation between stocks in the S&P reaching a low not seen since June 2007.  

At the same time, a key awareness of the global economic situation can help protect a portfolio from macro shocks.

Committed to your capital
Active management remains vital. While investing with experts within each asset class,
those able to pick the winners from the losers, it is of paramount importance to pay close attention to portfolio construction and the concentration of themes or correlation across asset classes, overlooked by many. Remain alert to downside risk, as well as focused on identifying investment opportunities, to continue to protect and grow your wealth.