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Happy new investment strategy

09-01-2015 | UK | Insight | Lukas Daalder With the rally in stock markets entering a new, more volatile phase Robeco Asset Allocation has taken some risk off the table.

Speed read:
  • Multi-asset portfolio is rebalanced as market sentiment changes
  • Many factors cause slump, from Grexit fears to oil price collapse
  • Overweight in equities is lowered to neutral to reduce risk exposure

The multi-asset portfolio of equities, bonds and real estate has been rebalanced following a market rout caused by a return of the Greek saga and a collapse in the oil price among other problems. An overweight position in equities has been cut to neutral while we have increased our position in real estate from underweight to neutral. A slight overweight in high yield bonds has been maintained however.

“Those who had hoped to enjoy a couple of slow days at the start of the year have been disappointed,” says Lukas Daalder, chief investment officer for Robeco Investment Solutions. “Three trading days into 2015 and all of the major stock markets are into the red, bond yields have dropped to new all-time lows (with the exception of the US), and the oil price has plummeted below USD 50 per barrel.”

“For the third time in four months there is a sense of panic in the more risky parts of the financial markets, with European stocks dropping by more than 3.5% in a single trading day. Greece and oil seemed to be the culprits behind the sell-off, but there have actually been several issues simmering below the surface for some time. The growth slowdown in China, weaker European economic growth prospects, pricy equities, Russia, and the fear of deflation are all weighing on sentiment.”

Getting to the more difficult part of the stock market rally
stock-market-rally
Source: Bloomberg, Robeco.

More serious shake-out
Daalder says the new year shake-out is more serious than previous wobbles, partly because so many factors are involved. “In both previous sell-offs (October and December) we stuck to our overweight positions in equities and high yield,” he says. “We had been willing to bear the volatility but we are currently less inclined to do so, and have decided to lower the risk profile of our portfolio.”

He says the two headline problems are Greece and oil, combined with the fact that the equities rally of 2014 has now passed and stocks have become expensive.

“Greece’s failure to elect a new President at the end of last year means that new parliamentary elections will take place at the end of January. This has revived the concept of Greece leaving the euro (the so-called Grexit) as a potential risk,” says Daalder.

“The most important point to note is that there are stark differences compared to the last time that Grexit fears roamed the markets. Then, a Grexit was synonymous with the end of the euro, as it would have caused subsequent dominoes (Portugal, Ireland, Spain and eventually even Italy) to fall. This time around, whereas the spread on Greek bonds has risen sharply in recent months, spreads on for example, Portuguese bonds have on balance declined. This can be seen as good news: contagion is no longer the big driver these days. On the other hand, it can also be seen as an indication that bond markets have been too complacent in the light of the potential risks.”

‘There are stark differences compared to the last time that Grexit fears roamed the markets’

Oil halves in price
Most market participants have been astonished at the speed and severity of the fall in the oil price, tumbling from over USD 100 a barrel last summer to under USD 50 this week.

“There is simply more supply than demand – that’s the short answer to why the oil price has collapsed by more than 50% over the last six months,” says Daalder.” If we want to add some more color, we could talk about the shale gas revolution, Middle East oil production coming back on line, weak European and Chinese growth, and the decision by OPEC (or the Saudis) to refrain from cutting production.”

“The outcome is still the same: the oil price has tumbled and this has unsettled markets. There are three reasons why a decline in the oil price could be considered bad news for markets. The first is that this in itself is an indication of even more weakness in world demand where oil acts a proxy for the strength of the world economy, which is clearly pointing lower.”

“The second and probably more important reason is the uncertainty about the health of the oil-producing companies. The impact has been most direct in the US high yield market, where the oil sector comprises a substantial 17% of the total index. The third reason is the disinflationary impact of a plummeting oil price, which currently adds to deflation fears in Europe and plays a role in extending the rally in bond markets worldwide.”

The scale of the oil price drop has shocked many
the-scale-of-the-oil-price-drop.png
Source: Bloomberg, Robeco.

A year of increasing volatility
Meanwhile, Robeco had already predicted in its 2015 outlook that this would be a year of heightened volatility. “The period of cheap valuations in equities has passed and gains in stocks will be more linked to the underlying fundamentals,” says Daalder. “This is particularly true for the US, where the Fed has ended its QE expansion program and markets are generally anticipating the first rate hike later this year.”

“Volatility in itself does not need to be bad, so long as the general direction of stocks remains up. With liquidity still ample and increasingly fewer return-yielding investment alternatives available, we continue to expect stocks to trend higher. This more volatile trading environment means that we are no longer comfortable with being overweight all of the time, like we were during 2014.”

“Overall we are still not negative on stocks, but we think it is prudent to adjust the buy-and-hold approach that has served us well to a more flexible investment approach.”
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