The financial markets are now definitely in a new, more challenging waters compared to the investment climate in recent years. In our model portfolio (CAP-M), we have already downsized our portfolio weight in risk assets accordingly. The reduction of risk started one year ago in June 2018 where our two high-risk portfolios: High Risk & Risk On in total weighted 63% of the total portfolio vs. an aggregated 37% in our low-risk portfolios: Low Risk & Risk off. Today, the high-risk segment holds a weight of 54% and the low-risk segment 46%. (See chart below)
Currently, we work with three scenarios for the risk composition of our total portfolio over the coming six months. The first one is our Investment scenario. In this, we hold our current ‘‘neutral weights’ for a period until more clarity emerges. The second scenario is a ‘Risk on’ scenario, where we slowly raise our High-Risk portfolio weight to the long term average (approx. 63%) of the total portfolio. This scenario will become our Investment Scenario if global GDP recovers and the Liquidity cycle remains positive. The third scenario is a ‘Risk off’ scenario, where we step-vise further reduce exposure to risk markets. The holding of High-risk assets may be reduced to below 45%. Global GDP moved an estimated full percentage point lower from summer 2018 to Q1 2019, and as it stands her in June 2019, the slow down has only continued in Q2 2019. The global trade dispute is adding to the signs already at hand that the global economic expansion has entered a slow down period, which may further exacerbate.
Below we, in short, go through the key points defining the current investment climate and some of the visible triggers for the dynamic allocation steps that we believe will become relevant in the months to come.
The trade disruption
The policy dispute on trade between the US it’s trading partners is currently standing in the way for clarity on the direction for the global economy. The situation – if it escalates – could eventually evolve into a Cold War 2.0 where the world again is separated into economic silos. The route to this regime is not pretty when it comes to the performance of asset markets.
Investors have ‘picked a winner’
If we look at the most recent performance of the regional equity markets, one could argue that the investors have picked Wall Street as a winner while both EM, Europe and Japan appear tied into a loosing streak. Eventually, however, the US equity market is bound to be restrained by the trade conflict as the conflict impacts the US consumers and companies.
IMF has cut forecast for global GDP
IMF has just released forecasts including the effect from the trade conflict so far. On a two year basis, the IMF has cut real Global GDP by 0.5%. Our own GDP lead models ( see chart) started to point towards a new growth expansion from the start of Q2 2019. Asian activity, lower energy prices, favorable credit conditions, and DM consumer incomes are all pointing towards a – at least temporary – lift in growth rates. Still our six mth. forecast model has started to point towards further slow down.
For now, we invest with a neutral bias as our Macro Climate indicator (see chart below) also suggests.
US is entering a soft patch
As the chart on the lower right suggests, real US GDP may slow to 1-1.5% in H2 2019. As also seen in the chart, soft patches like the one indicated for H2 2019 was experienced both in 2013 and 2016. None of these soft patched showed to be critical for Risk assets. Still, our assessment is that due to the mature state of the US economy, we only need a ‘black swan’ event like e.g., a trade conflict-related credit event to bring the US economy to its knees. Recession is within reach for H1 2020.
China – hit by global trade disruption or saved by liquidity?
Chinese activity data has over the recent months been mixed. PMIs indicate that the slow down has stabilized. Still, investors are worried that China will see further slow down when and if the Trump trade policy is fully implemented. As the chart below indicates, however, China has spurred liquidity to compensate for the global slow down (see chart below) and trade disruptions. Also here it is unclear whether we will see a new expansion or, as we fear, that China will slow further when and if US sanctions on trade, will take effect.
OECD Consumer inflation on the rise.
One of the most significant unrecognized risks to the OECD economic prospects is the higher consumer inflation (see chart above). Nevertheless, neither central banks nor the investment community believes in sustainable consumer inflation above two percent. Still, the pick-up in recent months three mth price inflation, is a factor that indicates softer growth in the coming months.
Our investment scenario
For now we stick to a neutral allocation. Neutral between the risk classes and close to neutral within our risk classes as also revealed in our asset allocation for June 2019.