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Look with an open mind beyond consensus forecasts

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Central banks will pursue prudent policies to shoulder the economic recovery, but this should lead the US and the EU to move towards a more balanced policy mix, says Didier Duret

THE political changes in major economies will represent defining moments for the rest of 2016 and 2017. Volatility and investment opportunities, however, may come not from the events themselves, but from a new policy order triggered by political changes. This scenario requires investor agility to find sources of return and imperative portfolio diversification to diffuse the risk.

In the months to come, we can expect considerable political and economic changes that will shape the investment landscape. To name a few, the UK decision to leave the European Union (EU) may likely be the least among many challenges facing the EU. Secondly, the highly dynamic economic changes in China will continue. On the US front, there will be a new president and higher US interest rates are expected to stay on the agenda. Lastly, the technological revolution will continue to reshape the way we live. If you add the unknown, this all looks complicated considering that these elements will all have global consequences. Economic forecasts, which are quantitative by nature, may be too narrow to depict the changes we will be facing. Most economists have revised down their forecasts for 2016 and now expect the world economy to grow by 2.9 per cent for 2016 (Source: Consensus Economics) but the current status quo of forecasts can and will change.

At ABN Amro, we take the view that in the next 18 months, the change may be more qualitative than reflected in the numbers. Political changes will mean new policies, and new policies imply that growth paths may be different than what we forecast today. Of course, the market will anticipate with anxiety or enthusiasm, whether these changes should lead to lower or higher growth, and greater or reduced opportunities for firms and investors.

While we cannot prejudge the result of the US presidential election or the particular impact of the reforms in Europe, there is one element emerging from the apparent complexity: the world economy is probably moving away from an overreliance on monetary policy, and fiscal policy is currently drawing away from fiscal austerity (first graphic).

Central banks will pursue prudent policies to shoulder the economic recovery, but this should lead the US and the EU to move towards a more balanced policy mix. We have probably reached a mature phase for monetary stimulation, and we are of the view that fiscal policy will play a larger role in supporting growth.

We should also recognise that China is ahead of the game in rebalancing its policy mix since the authorities were able to stabilise the volatility that hit the country in August 2015 and early 2016 with a powerful and efficient combination of monetary stimulation, infrastructure spending, and exchange rate stabilisation actions. These changes and the additional demand created should help the world to depart from the current Catch-22 situation of slow growth, low productivity, and palliative monetary policies, opening the way for a new cycle, eventually lifting global trade.

We must also assess the risks along the way, for example, nationalist policies could endanger the process of necessary structural changes or free trade policies. Additionally, the oversensitivity of financial markets to fear and risks could persist and can lead to investors ignoring the value available in the market. At the same time, the recovery in oil prices and major commodity prices from the lows of early 2016 have stabilised the situation for emerging economies, and we think Asia is well placed to benefit from this stabilisation and the continuation of the recovery.

This fluid and changing environment requires investor agility and proper global diversification. Agility means keeping a buffer of cash to reduce the overall risk of the portfolio and be ready to invest to benefit from opportunities created by market corrections.

At the same time, the generalisation of negative yields on fixed income instruments requires a new approach to generating income and capital gains for the future. While this changing political and new policy order brings new ideas and new risks, it will affect the bond market and alter the search for returns.

We are of the view that this implies finding the right mix between high-quality and high-yield bonds. International government bond exposure, where the duration is managed actively and hedged in base currencies, can add both diversification and protection to an investor's portfolio. Within equities of which we are slightly overweight, the stakes have also been raised. There is no return without taking a managed risk. We retain our preference for defensive-growth companies. Given the potential for political and geopolitical changes, a wide geographical diversification is an imperative to diffuse risk.

The preferred value for the medium term rests with defensive growth equities with earnings potential (see second graphic). We think this can potentially be found in the information technology, healthcare and telecom sectors, while avoiding the financial sector. Within Asia, we maintain a positive view on China (Neutral) in companies and sectors riding favourable trends in tourism, consumption and infrastructure.

Korean equities (Overweight) display the lowest valuation in the region and is likely to benefit from a competitive position created by the strong Japanese currency and accommodative monetary policy from the South Korean central bank. Low volatility and quality strategies may be used to buffer equity exposure. Finally, we are of the view that rising commodity prices and wage pressure are likely to lead to higher headline inflation in the US in the coming months. This may create a risk for bonds which we are underweight as an asset class and may justify exposure to real assets, such as commodities (overweight) and real estate (neutral).

In conclusion, the money management does not stop just because the world no longer looks like the past. Looking with an open mind beyond the consensus forecasts may help investors to appreciate the nature, the benefits and the risks of the changes to come.

  • The writer is chief investment officer, ABN Amro Private Banking.
  • The views expressed in this document may be subject to change at any given time. Recipients of this document are advised to seek independent and professional guidance prior to making any investments.
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