The past few weeks have been quite volatile. First, tensions in the Middle East continued to grab the headlines, pushing oil prices higher. Second, US job growth, services activity and inflation came in higher than expected, leading to markets expecting smaller, more gradual US Federal Reserve (Fed) rate cuts. Third, the monetary stimulus out of China ignited a significant rally in Chinese equities, partly spilling across the Pacific region, though initially underwhelming details on fiscal policy led to a partial reversal. Finally, more clarity on China’s stimulus over the weekend provided some market support, but military drills around Taiwan raised uncertainty at the same time.
One could argue that investor reaction to the news, which can lead to exaggerated market movements, is a ‘bug’ in the financial system. However, I’d say it’s a ‘feature’. Market volatility tends to rise and fall as economic, corporate and (geo)political developments prove or disprove the current sentiment among investors. So, rather than knee-jerk reactions, we aim to maintain composure amid volatility. Instead, we stay invested for the long term, run globally diversified portfolios to mitigate the impact of local issues, and adjust our investment strategy as required.
With a global economy that’s growing more slowly, we think the risk-reward of some of the risky parts of the fixed-income market looks more unattractive. In essence, the difference in the yield available between risky and safer bonds (known as the spread) isn’t large enough to warrant the extra credit risk.
In other words, we think risky bonds don’t sufficiently reflect our expectation that economic growth might decelerate further. Plus, in a hypothetical Trump 2.0 scenario, we believe that trade tensions and tariffs, especially directed at emerging markets, might rise further. As such, we’ve reduced our exposure to emerging market debt and, in some conservative profiles, further lowered our exposure to high yield.
We’ve reinvested the proceeds from the sale of some of our risky credit exposure in money-market instruments, as they offer an attractive yield for lower risk. We continue to believe that, for the moment, money markets are a more compelling option than short-dated European bonds, as the yield is higher.
As the European Central Bank continues to lower interest rates and the yield of money markets eventually declines further, we stand ready to reallocate elsewhere in fixed income and explore alternative, higher-yielding options.
In March, we bought an ‘insurance’ instrument in portfolios where client knowledge and regulation permit. The instrument goes up in value when US equities fall, which partially protects portfolios from market sell-offs. We’ve now adjusted the degree of protection this instrument provides so that it will kick in earlier if US equities unexpectedly fall between now and the middle of December.
We’ve also adjusted our equivalent instrument for European equities by extending it to the end of March next year. This will give us more opportunities to trigger the protection if volatility rises further, and the benefit would more than offset the small cost we paid for it. We also did this because if new US tariffs were to hit NATO allies such as Europe, we’d be able to navigate the resulting volatility more easily and cushion hypothetical drawdowns.
A weakening US dollar is one of our longstanding currency calls. From a long-term perspective, we believe that the dollar is overvalued, and a wide budget deficit combined with a high level of government debt might weigh on the currency. In the near term, we think the Fed has greater scope to cut interest rates than other central banks, which might also impact the dollar. Therefore, we’ve increased our euro exposure and reduced our dollar exposure.
We don’t trade currencies in our portfolios, so how have we reduced our dollar exposure? This is where the concept of ‘currency hedging’ comes in. Exchange rates can have a significant impact on returns. For example, we run our portfolios in euros, so if we own US equities bought in dollars, then our returns would be lower if the dollar were to weaken against the euro. Therefore, to reduce our dollar exposure, in some conservative portfolios we’ve bought euro-hedged US equities, which limit the effect of currency fluctuations, and sold unhedged US equities, which don’t. By doing this, we still own US equities, but a weakening dollar has less impact on returns.
Staying on the topic of US equities, after such a strong rally, our forward-looking models suggest a moderate reduction in our long-term (5-10 year) strategic allocation to this asset class. However, with central banks cutting rates and our expectation of no recession over the next 6-12 months, the rally could continue for some time. So, at this stage, we’ve decided not to reduce our US equity exposure, meaning we now own slightly more US equities relative to our long-term strategic asset allocation. In other words, we’re now tactically overweight US equities, despite not changing the level of US equities we hold.
This document is designed as marketing material. This document has been composed by Quintet Private Bank (Europe) S.A., a public limited liability company (société anonyme) incorporated under the laws of the Grand Duchy of Luxembourg, registered with the Luxembourg trade and company register under number B 6.395 and having its registered office at 43, Boulevard Royal, L-2449 Luxembourg (“Quintet”). Quintet is supervised by the CSSF (Commission de Surveillance du Secteur Financier) and the ECB (European Central Bank).
This document is for information purposes only, does not constitute individual (investment) advice and investment decisions must not be based merely on this document.
Whenever this document mentions a product, service or advice, it should be considered only as an indication or summary and cannot be seen as complete or fully accurate. All (investment) decisions based on this information are at your own expense and at your own risk. It is up to you to (have) assess(ed) whether the product or service is suitable for your situation. Quintet and its employees cannot be held liable for any loss or damage arising out of the use of (any part of) this document. All copyrights and trademarks regarding this document are held by Quintet, unless expressly stated otherwise. You are not allowed to copy, duplicate in any form or redistribute or use in any way the contents of this document, completely or partially, without the prior explicit and written approval of Quintet. See the privacy notice on our website for how your personal data is used (https://www.quintet.com/en-gb/gdpr).
The contents of this document are based on publicly available information and/or sources which we deem trustworthy. Although reasonable care has been employed to publish data and information as truthfully and correctly as possible, we cannot accept any liability for the contents of this document.
Investing involves risks and the value of investments may go up or down. Past performance is no indication of future performance. Any projections and forecasts are based on a certain number of suppositions and assumptions concerning the current and future market conditions and there is no guarantee that the expected result will ultimately be achieved. Currency fluctuations may influence your returns.
The information included is subject to change and Quintet has no obligation after the date of publication of the text to update or inform the information accordingly.
Copyright © Quintet Private Bank (Europe) S.A. 2024. All rights reserved. Privacy Statement
