2017 Outlook: Part 3 – Kardashian markets
Paul Gambles, MBMG Investment Advisory
In previous decades, it has taken a while for the transitions between the various economic phases to fully eventuate. However, I would contend that the events of 2007-9 could have unfolded at any time from 2005 onwards, had there been suitable exogenous triggers to burst the western debt bubbles.
Forecasting the exact timing of major financial events is, of course, practically impossible. Risk management therefore requires being prepared for the eventuality, instead of counting the cost afterwards. In other words, it’s better to forecast an event too early rather than too late.
As we enter 2017 there is the concern that, as China’s debt bubble has been amassed with unprecedented haste (see graphic), the transition may also occur at unprecedented speed. Added to that, the election of Donald Trump has clearly raised the risks of exogenous triggers in Europe and has done little to clarify whether the risks in China have been ameliorated by the apparent demise of the TPP or not.
My feeling is that at some point the outcome of all this is an extreme equity correction. Unlike a year ago, I believe that there are now some potentially immediate triggers in evidence. These have largely arisen from the European socio-political response to the US election result; but also less evidently in the continuing machinations in Chinese policy responses, which could trigger a major global capital market event. Added to this, there are indications that, despite all the easing policy of the last 7-8 years, liquidity may rear its head as a factor in 2017.
In fact, we’re another year further down the same line but the territory in which we now find ourselves seems much more dangerous than the station that we left a year ago.
Roughly speaking, a global depression, a Japanese-style stagnation or something altogether different remain the most 3 likely outcomes. But the chances of a dramatic global bust sooner rather than later are now much, much greater; even though the expected response from policy-makers will now likely include some element of fiscal stimulus/monetization. The change here is that there are no longer reasons to believe that this stands at least a 50/50 chance of succeeding in its objectives in the near term.
Portfolio allocation implications
More than ever before, the optimum portfolio for you in 2017 has to be cognisant of the disparate range of understood ultimate and near-term outcomes. To that end, the strategic portfolio should continue to focus on limiting volatility, if anything even more so than previously.
With all that in mind, I’d make the following general points:
1. CTA/trend-following assets are the most volatile that we favour at this time; especially commodity trend followers. They have no significant correlation to any asset price throughout the cycle but exhibit strong negative correlations to prolonged asset-price corrections. In other words, you could describe their pricing overall as a pretty random walk, relative to asset prices, through an entire cycle. But they tend to do extremely well when capital markets do badly. In my view, this is because corrections tend to be much clearer and more linear trends that market – or as the below graphic shows – markets tend to climb the stairs but fall down elevators and a straight line (a fall down an elevator shaft) is a more pronounced statistical trend:
Therefore, I’d continue to favour such exposures.
2. Long/short equity can provide proxy participation in global or specific equity market alpha with the downside protection of shorts. However, we would look to further de-risk the portfolio at this time by reducing (but not removing) allocation to even this limited-equity Beta and increasing cash holdings.
3. The best-run multi-asset funds performed well during the Global Financial Crisis. The limits of traditional asset-class diversification, in times when all assets are expensive, has been very much highlighted at various times during the last few years. But if anything, the recent boost/bubble in high Beta assets such as US financial and infrastructure-related stocks and the recent fall in the likes of utilities, US Treasuries and gold has created additional relative value opportunities. While these remain counter to the Trump Rally short-term trend, it’s possible that these assets may have to sail against the wind for some time. But experienced relative value managers should be able to exploit these.
4. Market-neutral equity exposures to a market-neutral equity style that seeks to isolate and exclude Beta altogether shouldn’t be considered bullet-proof; but they remain an important way to try to exploit some equity market alpha while avoiding Beta.
5. Global macro funds remain quite distinct from risk asset Beta and allocation should be increased slightly as any global disruption will create opportunities for such funds.
6. Tactical exposures: The case for US Treasuries is now becoming compelling – yields at the long end seem to have fallen too far too quickly as noted in the preceding commentaries and the short end remains the most obvious flight to safety asset alongside gold. We would therefore look to increase gold holdings slightly and to add to both long and short-dated UST holdings within the tactical portfolio.
Having dangled our toes over the river of opportunity, without risking having our feet bitten off in 2016, we’re now suggesting that we leave little more than our toe nails exposed. If the risk of financial market disruption recedes we can review this, as we will maintain an outlook that is flexible enough to capture risk-adjusted opportunities should they arise.
My base case remains that we’re entering a period of unknown duration, where outcomes are so difficult to predict that the focus needs to be significantly on risk management.
So, I think 2017 is the year of Kardashian markets. In other words, these markets look all right but there’s a huge but[t].
It’s also my base case that the start of 2017 is a much riskier continuation of the trends that have been developing for some time. Therefore, I think that our performance expectations, more than ever, have to be subordinated to risk management and focus on capital preservation.
Paul GamblesMBMG Group, Bangkok, Thailand
T: +66 2 665 2536
Paul Gambles is co-founder and managing partner. He is licensed by the Thai SEC as both a Securities Fundamental Investment Analyst and an Investment Planner. Paul is also well-known as an expert commentator, appearing regularly on Bloomberg TV, CNBC and Channel News Asia. He also writes the weekly newsletter MBMG Markets Flash, regular Updates and articles.
MBMG Group was founded in Asia in 1996 and has since grown steadily. It offers services ranging from investment advisory, corporate advisory, tax advisory, family office, accounting and audit, legal, insurance, estate planning and property solutions.
Published: January 2017 l Photo: Colourbox.de