The saying ‘sell in May and go away’ refuses itself to go away.
In our 2017 Investment Outlook, we talked of broadening global expansion and a fading secular stagnation narrative as inflation firms. We also posed the question: is it time to de-risk? The question is worth revisiting now as macro conditions have surprised to the upside in 2017, and risk assets have priced these developments.
This is no time to fully de-risk, in our view. However, the potential for summer volatility and some moderation in data warrant a particularly nimble approach to managing portfolios over the coming months, and we are moderating our equity exposures temporarily. We expect growth to remain robust, but given the run-up in prices we emphasize the need for dynamism in equities and credit. The risks around our view have shifted too. European political risk has faded. Inflation and its effect on rates remains a key focus, as discussed.
Source: www.policyuncertainty.com, Bloomberg, as of May 2017.
From the highest altitude, the number of countries contributing to growth is increasing. We expect macro data to remain supportive in developed markets, and to continue accelerating in emerging markets. For risk assets, strong earnings data and upward revisions to earnings expectations in emerging markets are encouraging. We don’t foresee a hard landing in China, but near-term risks to output are to the downside as policy support has faded. Ultimately, we would expect support to resume if growth continues to weaken, as policy makers continue to balance the trade-off between rising imbalances and the risk of undershooting their growth target.
We do not expect this low volatility environment to persist. That said, it is hard to pinpoint what will bring change. The dense European election calendar has faded as a risk. We are sanguine on the forthcoming UK and German general elections. Geopolitical risk seems centered on the US administration, but serious escalation remains a tail risk. We see risks stemming from imbalances in Europe, Japan and China, but these longer-term concerns are not impacting our positioning for now.
While we are constructive on growth for the year, sustained momentum at these levels would be a significant upside surprise. We expect a natural moderation in macro data. Similarly, while we think equities are still somewhat cheap for the prevailing macro conditions (see March Macro Insights), and this is not a time to fully de-risk, valuations are high on many measures. These elevated valuations present something of a cap on return potential, despite this year’s solid earnings growth. In our view, the combination of less macro momentum and full valuations as we enter a typically more volatile seasonal period warrants a dynamic approach in portfolios, across equities, credit and commodities.
Over the summer we expect markets to be choppier and range bound, with limited compensation for taking risk. As such we are taking down some directional equity risk in our portfolios. We favor relative value country trades, credit trades or commodity positions. We are also adding to carry in portfolios, increasing our yield by selling options in equity and commodity markets, going long in higher-yielding currencies and allocating to dividend futures. We are diversifying our exposure to higher rates in the US with positive-carry positions in US banks and breakeven inflation. We believe this range of positions can help weather summer storms.
Source: GSAM Global Portfolio Solutions (GPS). As of June 2017.
*Note that this does not account for liability-driven investment.