Investment strategy
January 26, 2022
3 mins

Global economic recovery can endure despite market de-risking

January 26, 2022
3 mins
Steven Wieting
Chief Investment Strategist & Chief Economist
SUMMARY

The US Federal Reserve’s communication of an altered, more complex monetary policy tightening approach has catalyzed a rapid de-risking in financial markets in early 2022. Investors must remain cognizant of the de-risking when it comes to realigning their portfolios in a recovering macro landscape.


The ongoing market volatility has been led in particular by US growth shares and poorly capitalized firms. While certain geopolitical risks have also risen, the balance of new information this year has not changed our view that the economic recovery that began in 2020 can endure and outlast present threats.

Against this backdrop, on January 26, 2021, our Global Investment Committee kept its mix of fixed income and equities unchanged (Global Equities 6% overweight, Fixed Income and cash 6% underweight). However, we shifted some holdings within both asset classes and across regions to account for a changing macro policy landscape, new risks and opportunities.

In 2021, we raised portfolio quality and cut the absolute equity weighting in anticipation of a less positive return environment. We moved to underweight US small- and mid-cap equities and certain emerging markets; and to overweight global dividend growers, healthcare shares, Intermediate US Treasuries and Inflation Protected Securities.

We continue to see diversification across regions and asset classes as a risk mitigator for core portfolio wealth. We believe a barbell strategy of select higher risk and lower risk assets is a prudent approach to sustain returns following the sharp rally in global equities and credit markets in 2021. Historically low global government bond and cash yields in isolation offer poor inflation-adjusted returns.

We see investments in firms with sufficiently high current profitability to raise payouts to investors as providing the strongest long-term core portfolio opportunity. Today, we added further to global dividend growers, where we already have a 10% overall portfolio allocation. We also nudged up further our small overweight to China, which is preparing for greater macro easing and growth support.

We also added a thematic overweight position in Digitization assets. This includes cybersecurity, payments and fintech shares, which have fallen nearly 30% from their recent high as a group. We reduced our position in US small and mid-cap shares further and shifted some international overweights to add greater diversification.

In equities, we eliminated the thematic overweight in US mortgage REITS. These were the last of the assets we held solely to benefit from market dislocations from the COVID shock. Since we added the asset in June 2020, the total return has been about 42%. We also trimmed the size of our healthcare overweight somewhat to allow for the broader thematic investment in cybersecurity and Fintech. We continue to expect strong, stable long-term returns in the sector.

In fixed income, we reduced the size of our overweight in US Treasury Inflation Protected Securities. We have added to our TIPS weighting over time, with the last substantial increase in March 2021. This was in anticipation of earning enhanced inflation compensation in the past year. We believe TIPS are among high quality investments and should remain a core holding in fully-diversified portfolios as a risk hedge.

However, the asset has risen sharply in valuation with negative real yields implying an inflation-adjusted return-to-maturity of about -6% for this relatively long-duration asset class. While other US Treasuries delivered a negative total return over the past year, TIPS have jumped 4% as inflation compensation surged just over 7%.

Continuing to reverse actions we took in 2020 - which added capacity for equity overweights – today we reinvested 1% of the total asset allocation in intermediate duration nominal US Treasuries and Investment Grade corporates. While we still maintain a 5% underweight in global bonds, US intermediate government and IG corporate securities now discount six or more 25 basis point Fed rate hikes, rising 120 basis points in yield over the past year.

While their value could fall further, their limited duration lowers price risk and will allow us to add long-duration bond exposure if 10-year US Treasury yields rise above 2%, as we expect. As discussed in our Outlook for 2022, we have shifted our emphasis from investing in a cyclical rebound to finding sustainable sources of return. We believe our quality global dividend grower position is in line with our theme of investing in Long-Term Leaders.

Our investments in healthcare equities focuses capital in the secular growth of the world’s older population and its quest for longevity. The new positions in cyber-security, payments and fintech are key opportunities within Digitization which we believe is an unstoppable long-term trend shaping the world economy. While we continue to believe the most profitable US IT-related firms deserve a valuation premium, the Federal Reserve’s oncoming tightening cycle represents a challenge for firms requiring external financing to deliver on future growth plans.

We believe lower valuation is not sufficient to ensure strong returns in international value shares. However, we see solid dividend yields and EPS growth justifying moderate equity overweights in many international markets. This includes the UK, Eurozone, and Japan, but also China, where macroeconomic policies are easing, in contrast to the US. Broadly speaking, non-US equities now trade at an attractive 13X expected 2022 EPS, a more than 30% discount to US shares.

With less attention from short-term speculative investors, they have been somewhat insulated from the turmoil now hitting in US growth shares and could benefit from future moves toward global diversification in portfolios.

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