Asset Allocation
Long-time subscriber Mr. X recently visited our office to discuss three issues: Brexit, the outlook for China and the seeming contraction between the performance of equity and bond markets. This <i>Special Report</i> is a transcript of our conversation and, not surprisingly, the broad conclusions supported a cautious investment strategy.
A spike in economic uncertainty explains the recent move lower in Treasury yields. Given the resilience of global growth, we expect yields to rise as uncertainty ebbs in the coming months.
Our <i>Cyclical Indicator Update</i> reveals that a defensive portfolio strategy remains the best bet to navigate the crosscurrents of stagnant profit/economic growth yet abundant global liquidity.
Please see attached our <i>Third Quarter Strategy Outlook<i/> which discusses the major investment themes and views we see playing out for the rest of the year.
Smart beta strategies can be useful in both strategic and tactical asset allocation. Combining different smart beta strategies can smooth out the cyclicality of individual strategy and provide a better return/risk profile.
Brexit is putting our bearish short-term dollar view in question as global policy uncertainty has surged. Yet, investors are displaying elevated signs of risk aversion but the global economy still looks fine. This dissonance is likely to end with investors increasing risk taking, a bearish development for the counter-cyclical dollar. Favor commodity currencies over European ones.
We test three channels of contagion from the Brexit shock: political, banking system, and economic.
Our strategic and tactical trades were up an average 24.6% in 2016Q2, led by strategic energy recommendations. Going forward, we continue to favor energy exposure over base and precious metals, ags and softs.
We view the "sweet spot" for market-balancing oil prices to be within a range of $50-$65/ barrel: Oil prices will be below/in the lower half of this range during 2016H2 and will average in the upper half of this range in 2017, perhaps exceeding the range in 2018. Without OPEC serving as an attentive "human regulator" of production, bouts of oversupply and undersupply will have to be managed through the drill bit (not the output valve), leading to increased price volatility beyond our "sweet spot" range. In this environment, quick-reacting U.S. shale producers and service companies are best positioned to benefit early in the up-cycle.
A number of divergences have emerged in global financial markets. These gaps are unsustainable. The recent improvement in Asian trade/manufacturing has been largely due to firming demand for electronics/semiconductors. Meanwhile, demand/output for industrial goods and basic materials - the areas leveraged to Chinese capital spending - remain weak. Fixed-income traders should bet on yield curve steepening in India: receive 1-year/pay 10-year swap rates.