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THE past few weeks have demonstrated the need for perspective as investors manage portfolios through increased volatility, says Pendal’s head of multi-asset Michael Blayney.
As the graph below shows, the CBOE Volatility Index spiked to its highest levels for the year after crises involving Credit Suisse and Silicon Valley Bank.
CBOE Volatility Index so far this year
“We are not at extreme panic right now,” says Blayney. “But we are starting to see problems emerging.
“Central banks have raised interest rates at a rapid pace over the last year. By doing so it was always a possibility, or even a probability, that they’d break something.
“That’s what we are now seeing, and regulators are coming out and playing a game of whack-a-mole.”
Investors shouldn’t underestimate the extent to which policymakers will act faced with a crisis, he says.
“Regulators aren’t sitting on their hands for long periods of time – they’re dealing with each problem as it arises.”
Investors need to decide if the recent sell-off in equities is a buying opportunity, or whether markets are mid-crisis, and there’s further to fall.
A big positive this time around, compared to 2007, is that the financial system has been de-risked,” Blayney says.
“The fact that banks are generally better capitalised should give investors a little bit more confidence.
“There’s less downside risk than there was in 2008.
“Last year was poor in markets and that’s made valuations cheaper. Right now you are starting at fair value, so your downside risk is less than if you start at expensive valuations, like markets did in 2007.”
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However higher interest rates are affecting corporates and consumers — and tighter lending standards are having an effect, Blayney says.
“This adds weight to the argument that the US is heading for a recession, which would trigger a fall in corporate earnings, and in share prices.
“In equities, while we are cautious, we are not massively underweight,” says Blayney.
“Valuations are relatively OK and trend-oriented components of our investment process are not bearish.
“But there are economic downside risks.
“If we do see economic weakness but inflation remains entrenched – the stagflation scenario – that’s going to be very difficult for equities.”
“In that sort of environment you want to make sure you have some assets with decent inflation hedging cash flows in your portfolio to give you that defensiveness,” he says.
Bonds have been volatile not only in recent weeks, but for much of this year.
“In the US you are starting to see the market price in cuts later this year,” Blayney says.
“The market has shifted its concern to the economy and financial stability, rather than simply higher inflation and rates
“It’s a conundrum for central banks because inflation is still running too high. The consumer price index is certainly not within the US Federal Reserve’s target range yet.
“But central banks also need to maintain financial stability.
“It puts central banks in a very difficult position and creates a very uncertain backdrop for investors.
“From a portfolio perspective, if we see a more significant economic downturn and a tightening in the availability of credit, then bonds should be a pretty good place to be.
“But there is a caveat — because bond yields are below the cash rate, markets are already pricing some economic weakness ahead.
Another thing that can help a portfolio, particularly for Aussie dollar investors, is currency exposure, says Blayney.
“In times of crisis, particularly if you see falling prices for key commodities, then the Australian dollar can sell off too. Foreign currency exposure can act as a bit of a stabiliser.
“From a portfolio perspective, take a slightly cautious approach. Don’t panic. Hold a little bit more cash. And be ready for a buying opportunity.”
Michael Blayney leads Pendal’s multi-asset team. Michael has more than 20 years of investment management and consulting experience. He was previously Head of Investment Strategy at First State Super and head of Diversified Strategies at Perpetual.
Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.
The team — which also includes Allan Polley — manages our multi-asset portfolios with a focus on strategic asset allocation, active management and tactical asset allocation.
Find out more about Pendal’s multi asset funds:
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