Dramatic price elasticity is defining a new era of heightened volatility. As spectacular as the fall in markets was late last year, so was the rebound in January. This whipsawing of markets can be very uncomfortable for investors, but for dynamic multi-asset managers it presents allocation opportunities, particularly as gloomy macroeconomic conditions weigh on sentiment.
The problem with elasticity is that each time a band is stretched, some velocity of momentum is lost. Fortunately, from a more amendable Trump to a dovish Federal Reserve chairman, we are seeing reason to be optimistic. In light of this improving outlook, we are cautiously trimming defensive positions and adding exposure to risk assets in unloved areas.
Diminishing trade risk
Whether spurned on by the bruising he received in the midterm elections or his plummeting ratings among voters over the border wall, Trump is subtly taking a more conciliatory tone in global trade negotiations.
Global market fundamentals also look on steady footing. For example, not only did 70 per cent of US companies beat expectations in the latest earnings season, but 80 per cent of tech companies also surpassed analyst predictions.
This is, of course, partly due to analysts having revised their numbers down, but is still a long way from the dark depths of winter for the tech sector, when Apple issued a profit warning in Q4 and there was chilling ripple effect through major tech names. This should go some way to assuaging investor fears that tech is on the verge of another dot-com-like catastrophe.
The Fed’s dovish turn
In early December, the market was bracing for gradual Fed hikes in 2019. This has been put on pause explicitly, with Jay Powell performing his own Mario Draghi “whatever it takes” moment by intonating that he wouldn’t be adverse to cutting rates if required. This caused the more than 70 per cent implied rate hike probability in December to come down to less than 10 per cent currently.
For risk assets, this is as good as it gets. The economy is humming along – earnings remain healthy – and now, all of a sudden, the Fed put is back in place. One caveat is Powell is not as reliable yet as Greenspan, Bernanke or Yellen before him and could be susceptible to flip-flopping on policy. A big risk for central banks is having the ammunition for the next downturn – and Powell may also want to ensure there is some risk premium added to markets as central banks extricate themselves from their position as market guardians.
Navigating risk-on/risk-off markets is difficult as one cannot predict how violent shifts may be – a multi-asset manager must stick to his or her process and capitalise on the market flux.
We are continuing to reduce our allocation to private equity, which has fallen from 26 per cent to 11 per cent in three years,. Valuations in some private equity investment trusts look stretched and there is a risk that NAVs decline more than anticipated in the next round of valuations.
Having skimmed some of our defensive positions, we have put this money to work in risk assets. The UK market remains in quarantine with global investors and we think there are opportunities in this unloved area – particularly in value-based strategies that have been ignored for too long. We have thus added to our positions in the JO Hambro UK Equity Income fund and the Aberforth Smaller Companies trust.
And while it may seem counter-intuitive, we have also added to our gold exposure, due to the potentially weaker dollar and a more dovish outlook from the Fed. Moreover, gold remains an effective hedge against volatility.
We have also taken advantage of global idiosyncratic opportunities as the market dislocates by accessing proven managers that limit equity beta and engage with companies to drive alpha. These include the Mobius Investment Trust, the AVI Japan Opportunity Trust, and Odyssean Investment Trust, all three taking an activist approach in various parts of the world. We have also added a small position in the Fidelity China Special Situations Trust to take advantage of thawing trade tensions and attractive valuations following last year’s dramatic sell-off in China.
As value-based investors, we are not prepared to pay for growth at any price, but some growth strategies continue to come into our investable universe as volatility has brought prices back down to Earth. For example, we added to our position in the TR European Growth Trust recently, with its NAV a third lower than it was a year ago and having shifted from a small premium to a 12 per cent discount.
Vincent Ropers, co-portfolio manager of the TB Wise Multi-Asset Growth fund