Investors To Adopt a ‘Defensive Growth Tilt’

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High inflation and rapid monetary policy tightening have created increasing headwinds for the global economy. Economic momentum has slowed sharply, uncertainty about the economic outlook has increased, and forecasts of a global economic recession continue.

Puneet Narula, CEO and director at SH Capital, has broken down the global economic pressures facing different markets, and has offered advice to investors on how to manage their portfolio in light of this uncertainty:

“The US equity markets have enjoyed a summer rally with encouraging economic data releases in July- unemployment rate fell to 3.5% and inflation also showed signed of easing – 8.5% YoY growth versus 9.1% in June. The markets have also been buoyed by the fact that many believe that the Fed may pivot to a monetary easing stance once inflation is brought closer to its target rate of 2%.

“While analysts expect that the pace of monetary tightening in the US has peaked and will slow down after the Fed’s rate-hiking cycle concludes in November, the risk remains that markets are misreading the level of inflation and it could be more embedded and at a higher level than anticipated. Expectations for a Fed pivot is uncertain: Labor market remains tight, and households may cut spending after savings run out.

“The energy crisis in Europe and the real estate crisis in China have placed downward pressure on economic growth expectations and investors can expect market volatility in the coming months with an increasingly high chance of a global economic recession. As markets rarely offer safe havens during such an environment, there is the real fear of holding on to a falling knife and it makes sense for cautious investors to build some downside protection into their investment strategies.

“In this environment, investors should stick to a defensive growth tilt. Fully or partially capital protected notes can enable investors to mitigate portfolio volatility while remaining participated in any potential gains if markets rise. Of course, the cost of this strategy is that these structures may underperform in the event of a market rally.

“Yield enhancement strategies where investors generate yield by selling volatility could also be used by investors who are willing to give up upside rallies while taking some exposure to market downside. For such strategies, investors should focus on stocks where the implied volatility is elevated compared to historical levels, but performance is expected to be stable or even resilient in a recessionary environment. Defensive sectors would be preferred over more cyclical sectors and preference should be given to quality-income and large cap stocks.

“In commodities, investors could consider selling downside on crude oil and copper. Oil prices are likely to remain elevated for a longer period. Copper also presents an opportunity for such strategies with the decarbonization efforts in the US and Europe and a lack of mine supply ensuring strong structural demand.

“In currencies, the US Dollar has peaked against most commodity currencies and investors could sell the upside potential against currencies like the New Zealand Dollar, Australian Dollar, Canadian Dollar or Norwegian Krone to generate income.

“Investing in bonds can be tricky in a rising interest rate environment and investors should seek to match duration of their bond portfolio with their investment time horizon. The second half of 2022 is expected to be much better for bonds even though uncertainty about both rates and spreads remain. The duration risks appear to be balanced now and adding good quality short-dated high yield and regional bank perpetuals is recommended for the rest of the year.

“While navigating an uncertain environment, investors should also consider implementing more dynamic bands on their asset allocation to accommodate larger swings in allocations between equities and safer assets like bonds and cash. This allows investors to participate in a market rally of long-term and stable equities, while also remaining flexible to significantly reduce their risk exposure when market volatility is high.

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