‘Hard times ahead for investors’: Buyers start to de-risk portfolios as macro backdrop deteriorates

Equity markets suffered record-breaking falls during ‘Red October’ as a cocktail of risks – including concerns over the Fed’s tightening cycle and FAANG valuations – took their toll sending the SP 500 to a record loss of 6.9% for the month, its worst month since September 2011.

Volatility subsequently spread into other markets with the MSCI All Country World index suffering its worst month since May 2012, dropping 7.6%, while the MSCI Emerging Markets index plummeted 8.8%, its largest monthly fall since August 2015.

The rout in the FAANG stocks continued into November with Facebook down 11.2%, Apple tumbling 20.5% and Amazon dropping 8.9% this month, as at 21 November, meaning $1trn has been wiped off their value since reaching fresh highs earlier this year.

As markets fail to retrace earlier peaks at the time of writing, the question remains whether this is just a healthy correction or the beginning of the end of the decade-long bull run.

Abhi Chatterjee, head of asset and risk modelling at Dynamic Planner, said tightening monetary policy, especially in the US, will continue to put pressure on asset prices.

He warned the move from quantitative easing (QE) to quantitative tightening (QT) meant it was time to start looking at the world in terms of a “defensive play”.

The Fed started reducing its “gigantic” $4.5trn bond-buying programme in October last year, while the European Central Bank is set to bring an end to its QE programme in December.

Furthermore, the Fed has already hiked interest rates three times this year and has signalled another in December and three more next year.

As a result, Chatterjee has increased cash weightings to 10% in his medium-risk portfolios and rotated out of emerging markets into US equities.

“There are some hard times ahead for investors,” he cautioned. “We have moved out of fixed income into equities because the defensive play is not bonds.

“With rate hiking in play, bonds lock in a loss,” Chatterjee continued. “Another concern is the traditional negative correlation between equities and bonds has become positive.”

Echoing his views was Mark Harris, multi-asset manager at City Financial, who added the environment was beginning
to display a number of key late-cycle features.

He highlighted Fed chair Jerome Powell’s comments about the FOMC struggling to determine the appropriate pace of tightening amid the lack of inflation pressures against a tight labour market.

In this environment, Harris said US Treasuries will offer a “substantial opportunity” heading into 2019.

“We continue to expect the synchronised global expansion to fade further and structural inflationary pressures to be limited.

“Should tighter global credit conditions persist or heighten, we could see a return to a very vicious cycle, putting marked downward pressure on economic growth and prices,” Harris added.

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Edward Park, deputy CIO at Brooks Macdonald, added the “liquidity backdrop is worsening” even though equities still remain attractive.

“It looks like the rate of growth has peaked but we are not seeing signs of a retraction or recession just yet,” he said.

“We expect the US to slow down in 2019 and as a result we are
more cautious.”

Although he added the Brooks team is “not turning risk off yet”, they have maintained a cash position of 5% for medium-risk clients as a precaution.

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