Despite a grim 12 months across the globe, 2016 has been quite good for risk assets. Why are we seeing encouraging performance amidst negative perception?
As we are heading towards the last month of the calendar year, 2016 will be for sure remembered as one full of surprises for investors. There were indeed many potential “black swans” that could have hurt global risk assets: a brutal weakening of the Yuan during the first weeks of the year, “Brexit’ in June, the Trump/Clinton “saga” over the last few months, terror attacks around the world, conflicts in the Middle East, five consecutive quarters of negative year on year growth for U.S earnings, European banks troubles, etc. This led investors to pull hundreds of billions of dollar out of equity mutual funds and leave the proceeds in cash or in fixed income. But despite this gloomy picture, 2016 is (at least so far) not a bad year for risk assets: as of the end of October, the S&P 500 was up +6% since the start of the year; the MSCI emerging equity market was up +15%, emerging bonds were up +12% and crude oil was up nearly 30%. How can we explain this dichotomy between the negative perception and these encouraging numbers? Are we again in bubble territories where valuation levels are decoupling from fundamentals?
Markets have been evolving within a macro-economic context which is known as “Goldilocks”.
We believe that there were two major events this year that helped risk assets to fare reasonably well despite all these headwinds. The first one has been the support coming from loose monetary policy in the developed world. Dovish European and Japanese Central Banks and the further delay of rate hikes by the US Federal Reserve have helped anchoring bond yields at very low levels. This zero or negative interest policy has been a key driver behind the lofty valuations of world equities. The other event which has also contributed to the positive performance of most risk assets in 2016 is the stabilization of the dollar. Back in early 2016, the greenback had enjoyed a 20 per cent rally since mid-2014. This dollar strength was pointed out by many as one of the reasons behind the commodity weakness and emerging market troubles, including the persistent weakness of the yuan. It seems that world leaders realized the dangers of this new deflationary threat. A market rumor of concerted action by the G20 during the meeting that took place in Shanghai in February was enough to stabilize the situation and bring to a halt the high volatility currency regime that prevailed during the first weeks of the year.
Thanks to these two factors, markets have been evolving within a macro-economic context which is known as “Goldilocks”: decent growth with reasonable inflation and thus very low yields. This combination is typically a very good one for risk assets, especially emerging market ones. As we are heading into 2017, it remains to be seen if this “ideal” macro context will persist. Nothing is less sure, as investors will have to solve again an equation with two unknowns: what will be the outcomes of the major macro & political events ahead of us and how markets will react to these outcomes. The “Brexit” shock which took place in June was a text book case as both the outcome and the subsequent market reaction surprised investors.
So how should investors position their portfolios for 2017? To our humble opinion, trying to time the market might again prove to be a losing strategy in the coming months. We are investors (and not speculators) and our fiduciary duty remains to invest the assets of our clients in a diligent way. To do so, there are some key principles that need to be followed: diversification, thorough diligence when selecting instruments as well as the attention paid to liquidity and valuations are among them. “Bargains” are more and more difficult to find in this world but there are always interesting opportunities for astute managers. We do believe that emerging markets bonds and selective emerging equity markets (such as UAE) are among them. But the cheapest asset in this world might very well be volatility…
Charles-Henry Monchau will be participating in the panel discussion PMs Discuss: Investing in an Uncertain Age taking place at FundForum Middle East in Dubai, 20 - 22 November 2016.