February 28, 2019

February 28, 2019 | Adviser News


Goodbye December?

Charles Stodart, Investment Specialist, Zurich Investments

 

Investing in global equities has been something of a roller-coaster ride over the last few months. After an 11% drop in the final quarter of 2018 took away most of the gains for the calendar year, performance at the start of 2019 has seen markets surge back. In fact, the Dow Jones Industrial Average has recently posted its ninth consecutive week of gains – the longest weekly winning streak in over 2 decades.

What are investors to make of these gut-wrenching market moves and how might it shape investor thinking towards global equities?
 

The usual suspects

The common view is that the rebound was due to three factors. Reported corporate earnings were reassuring, even though earnings are projected to weaken sharply in 2019. There is also the possibility that the worst will be avoided in the trade dispute between the US and China. And, perhaps most importantly, the Central Bank in the US pivoted to a neutral stance, making future rate rises increasingly unlikely.

Technical factors may also explain the helter-skelter market action. There is growing evidence that the actions of the combination of passive, quasi–passive and other mechanical investment approaches, including risk parity and high frequency trading that are now so prevalent in markets exaggerated the extent, timing, and abruptness of recent market turns in the US. Investors need to remember that, by definition, passive investment strategies are momentum investments, prone also by definition to overshoot.

While there are various suspects in the line-up of catalysts for the recent slump and subsequent recovery, the back-drop of late cycle developments should not be overlooked. The long experiment of Quantitative Easing support, which has been such a boon to asset prices in general including equities, has built up excesses that may be painful to unwind. Perhaps we had a taste of that in the December quarter before the Fed blinked.

How should investors in global equities be thinking about positioning, given where we are today? Is now the time to be adding to exposure, noting that Central Bank support has been such an important crutch for equities in recent years; or should investors be lightening exposure, even if that risks missing out should equities continue higher?

Perhaps it’s not a question of how much exposure, but rather what sort of exposure. What do you want to have in your portfolio and what do you want to leave out?
 

Long term wealth creation

In this environment, it seems prudent to focus on wealth creation in the long term, driven by technological and structural change. For example, looking to harness the benefits of data and digitization, but at the same time containing this exposure due to possible regulatory challenges, and also recognizing the extent to which technology stocks have dominated aggregate market returns in recent years.

Interestingly, if there is a decline in economic prospects, technology stocks may begin to hold up better, due to less economically sensitive business models, generally strong balance sheets and continued high free cash flow yields. However, it does seem prudent not to overly rely on this part of the market for returns going forward.

Another area of opportunity includes companies with genuine barriers to entry that can prevent disruption in a digital world. Amazon has looked at and disrupted a wide number of business models, but it appears that there are some that may be “un-Amazon-able”, at least in the medium term. For example, the paint industry is interesting in this light. Given the weight and logistical challenges of distributing paint, it is unlikely that Amazon has its sights on this market in the foreseeable future.
 

Heinz did(n’t)!

A further area of investment opportunity may be around management philosophy. Companies who by virtue of their culture align themselves with long-term shareholder interests through investing in research and development and focusing on building long term brand value. These companies have been overlooked in recent years as markets insist on cost-cutting and maximizing profits in the short-term. However, this short-term approach can go awry, as Kraft Heinz has recently discovered.

But managing bouts of volatility is increasingly important too, and it may prove sensible to deliberately include holdings that can moderate risks in uncertain markets. For example, one of the winners in the fourth quarter turmoil was gold. Gold is an unprintable currency and is interesting as a safe haven in a period of turmoil. The exposure doesn’t have to be large to contribute significantly when markets are stressed.

Portfolios can also be bolstered by deliberately avoiding leverage. In a world of low interest rates, high debt levels are forgiven, but debt sustainability becomes a pressing issue if that environment changes.

Built around a global framework that considers strategic opportunities and challenges, the Zurich Investments Global Thematic Share Fund is a diversified portfolio of distinct opportunity sets. The fund is built through fundamental research, garnering insights from company observations, and is focused on structural change over the medium to long term. The investment themes are the filters that identify industries and companies that can capitalize on structural changes, which may in turn help them to navigate today’s challenges successfully.

Find out more about Zurich’s Global Thematic Share Fund at Zurich.com.au/globalthematic
 

Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated February 2019, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such. Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich. Past performance is not reliable indicator of future performance.GIIN FVHHKJ.00012.ME.036.    CSTT—014255-2019

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