Market Views: Responding to the October selloff
After rallying steadily through much of 2018, US stock markets took a hit in October with several key indices seeing their year-to-date gains wiped out, at least temporarily.
Both the S&P 500 and Dow Jones Industrial Average (DJIA) posted 8% falls over the month, while the technology-heavy Nasdaq Composite lost more than 9% as investors were spooked ahead of Halloween by disappointing results from the likes of Amazon and Google parent Alphabet.
Asian markets were not immune from the sell-off, with Hong Kong’s Hang Seng index, Japan’s Nikkei 225 index, and Korea’s Kospi index shedding 7.9%, 9.7%, and 12%, respectively, in October as the trade fears intensified.
Given the volatile market environment, we asked a wealth manager, two consultants, a global market specialist, and a fixed income investment specialist how Asian investors are responding and positioning themselves for the future.
The following extracts have been edited for brevity and clarity.
Tuan Huynh, chief investment officer and head of discretionary portfolio management, Asia-Pacific
Deutsche Bank Wealth Management
In this late-cycle environment, we still prefer equities to fixed income. We see little risk of recession in next 12 months. Therefore, the resilient macro environment, the favourable corporate earnings and still-loose monetary environment should support the equity performance, in our view. While we expect the volatility to continue ... we think risky assets should still generate decent returns.
In late October, we initiated our high conviction idea to be long Chinese equities. After the MSCI All China index was down nearly 25% year to date, we think it is time ... We think possible catalysts for Chinese equities in the coming months are: 1) any signs of easing US-China tensions after the mid-term elections; 2) any signs of a recovery in Chinese infrastructure investment with government fiscal stimulus; 3) further monetary easing measures by the People’s Bank of China such as additional reserve requirement ratio cuts; 4) further tax cut reforms by the Chinese government, especially on the corporate front; 5) any other government policies to support equities, which could include allowing more insurance and pension funds to invest in stock markets and deregulating foreign equity investment inflows.
We take a more selective approach on fixed income. We favour credit (particularly US investment grade) over sovereigns as solid economic growth, the low likelihood of a recession, modest spread tightening and strong corporate balance sheets should support credit performance. We favour emerging market bonds (both sovereign and corporate) as a stabilising US dollar, solid economic fundamentals, and expectations of falling trade concerns should support emerging market debt in select regions.
Paul Colwell, head of the advisory portfolio group, Asia
Willis Towers Watson
There hasn't really been an obvious or clear response at this point. I would say most of the institutional investors tend to be a bit more long term in their asset-allocation decision making ... so it takes a bit of time for them to act.
Emerging markets and Asian markets have been worst hit, so in response to that there is some interest to raise allocations and increase exposure to those markets -- probably more Asia than emerging markets, where Asia is a bit more resilient and higher quality across fixed income and in equity.
There has been some interest in re-allocating some capital back towards the US Treasury market. With yields at one point over 3.2%, 10-year Treasuries start to look attractive again for investors. So it's more about getting some reasonable yield and re-allocating back there rather than in equity markets that are falling.
What we have seen, though, is that some institutional investors have been making changes gradually to their portfolio over the course of this year. They have been rotating into more defensive strategies with a focus on income and quality and where there is value ... There has been some liquidity raised, a bit of cash allocation, to have the ability to make investments in market downturns and when markets become more volatile.
Other things that they've been looking at include investing into hedge funds and liquid alternative risk premia. They are much less correlated, or much less sensitive, to the growth of the economy and the equity market. It can provide some balance and have in the past demonstrated their ability to provide a buffer in times of market slowdown and stress.
It's a balanced approach -- raising liquidity, having cash, having shorter duration-type investment strategies, more variable rate or floating investment strategies, on the one hand, and on the other investing into various forms of alternative credit, private debt, and fixed income strategies ...
Adeline Tan, wealth business leader
Our clients are still long in equities but are reviewing the structure of the equity portfolio and its exposure -- questioning if the equity portfolio can be adjusted to lower the overall volatility while retaining opportunities to the upside. Value investing has struggled and our investors are not entirely comfortable to increase their allocations to that style, especially since these strategies would have significant allocations to emerging markets, given the relative valuation of emerging markets versus developed markets.
Fixed income in global markets continues to be a staple in institutional portfolios but strategies with various fixed income-related levers are gaining more attention, both for clients looking to reduce portfolio volatility and those looking to diversify their fixed income exposure.
The recent market volatility is not entirely a surprise and we actually see some pulling back from the market, with clients holding term deposits and similar short-term instruments. Allocations into illiquid strategies are still going through, as these tend to be made at a high level, and investors that have already approved this asset category accept that short-term volatility will not change the long-term case for attractive private investment opportunities.
The market is likely to exhibit significant volatility, partly due to the withdrawal of liquidity from central banks and reactions to news on international policies. Investors have to be selective, even if they have the risk appetite for the ups and downs.
Hannah Anderson, global market strategist
JP Morgan Asset Management
Investors have not shifted [towards fixed income] to the degree I would have anticipated. I do see investors globally, particularly those here in Asia, taking a more defensive position based on some of the flow data ... However, investors have not moved as aggressively away from equities as I would have expected. As we've moved into a bit of a later cycle, investors have finally come around to the idea that volatility has returned and is normal, and that produces steelier nerves amongst investors than I think we saw earlier this year. This year we're seeing a lot more volatility in equity markets and there's been some rallying in the bond markets, but not much.
One other thing I think might be driving investor positioning is that in response to a lot of the individual local dynamics in emerging markets, as well as central bank activity in the US, cash is paying you a lot more than it used to. This year I'm seeing a lot of investors being more willing to have larger cash balances than they were last year, or the year before. Investors are riding out this volatility and willing to hold more dry powder to get back into the market when they see an opportunity, simply because they're getting at least some modest return on holding that dry powder.
Over the long run they're not particularly sold on cash because it has historically not beaten inflation for them, and they've gotten much better returns elsewhere. But right now, based on investors not finding anything exceptionally appealing either in fixed income, which is still as a whole very expensive, or in more volatile equity markets, they're just more willing to sit on their hands for the time being.
Investors are still buying into markets, they're still making rational choices on the whole with what they're holding, but they're also thinking further into the future. So they are moving much more defensively -- investing more in sovereign bonds, thinking more actively about their currency exposure, and switching from more of a growth to more of a value position within their equity portfolios.
Karan Talwar, emerging markets fixed income investment specialist
BNP Paribas Asset Management
The slightly challenging part that clients have is given the current environment where generally bond yields have been rising, fixed income isn't necessarily providing that same level of diversity or safe-haven status as would normally be the case ... when equity markets are selling off. So that's a bit of a challenge for investors, where if they're not comfortable investing in equities, given that there might be more of a sell-off or there's still a lot of uncertainty, and given fixed income isn't necessarily providing that same safe-haven status, then where should they reallocate their capital?
If you're, for example, in US investment grade corporate bonds, you have very little additional spread cushion or premium to shield you from rising US interest rates. Now in emerging market investment grade credit there is a little more value than in developed market, so, yes, we've seen some clients opt for that. But even there, if you look at that space from a total return standpoint, even these markets have generated negative returns year-to-date given their interest rate sensitivity. So from a total return standpoint, those strategies have not lost a lot of money, but they've not been able to protect and make money when equities have been selling off in an environment of rising interest rates.
In Hong Kong, in particular, we've seen a bit of an upward movement in deposit rates as well, so we saw a tightening of Hong Kong interbank liquidity. Hong Kong rates are finally catching up to US rates. So at least Hong Kong cash has finally started to rise up a little bit as well, which makes it less of a drag to hold on to than cash would have been six months ago. We are having more and more discussions where clients are seeing where they can deploy capital back into markets given the sell off that's already happened.