Asset Allocation | Portfolio Updates
Asset Allocation Update: Fragile Markets and Cash
- By Bilal Hafeez
- 2 min read
Our core investment view remains the same. Markets are fragile, preservation of capital is paramount, and cash is king.
This is a transition year, ending the era of low interest rates since the Global Financial Crisis (Chart 2). So, while equity markets bounced after the Fed reassured with a 50bps hike, rather than 75bps, we should not lose sight of the amount of rate hikes to come. The Fed could raise policy rates to the 5.25% peak of the 2000s or even 8%.
In this environment, we are likely to face constant sharp market moves. The latest was the Chinese yuan plunging, but other markets are likely to follow in the months ahead. We are tracking extreme market moves on a weekly basis.
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Our core investment view remains the same. Markets are fragile, preservation of capital is paramount, and cash is king.
This is a transition year, ending the era of low interest rates since the Global Financial Crisis (Chart 2). So, while equity markets bounced after the Fed reassured with a 50bps hike, rather than 75bps, we should not lose sight of the amount of rate hikes to come. The Fed could raise policy rates to the 5.25% peak of the 2000s or even 8%.
In this environment, we are likely to face constant sharp market moves. The latest was the Chinese yuan plunging, but other markets are likely to follow in the months ahead. We are tracking extreme market moves on a weekly basis.
With this backdrop, our preferred asset allocation is to be underweight equities and bonds, and overweight crypto, commodities and cash (Chart 1). It may sound odd to favour cash in an inflationary environment. But what you lose in yield, you make up for in peace of mind. Your investment in cash will not lose (nominal) value, while your investments in bonds and equities can. Indeed, over April, cash returns were close to zero, while bonds fell 3% and equities fell 9% (Chart 3).
The only adjustment we make for May is to reduce our ‘big overweight’ in commodities to ‘overweight’. The rationale is that the global growth picture has worsened recently with China’s lockdowns. This could add a headwind for commodities. We still think the trend in commodities is up, as supply issues remain, so we maintain an overweight.
Finally, on crypto, we maintain an overweight. It clearly is correlated to equities, and so our bearish equity view suggests crypto weakness and hence an underweight. But we note that crypto has lost less money than equities on a volatility-adjusted returns (Sharpe ratio) basis (Chart 4). And from a strategic basis, crypto is attracting inflows from a diverse range of source. We therefore like to have an overweight.
Note, though, that the volatility in crypto is much higher than equities, so sizing positions is crucial. Over the past 12 months, the volatility in equities has been 16%, while for bitcoin it has been 68%. This means to get the same level of risk exposure as equities, you would need to hold a quarter of the size of the position in crypto. That is, a USD250 position in crypto is the equivalent to a USD1000 position in equities.
Finally, in terms of equity sectors, here are our favourite views:
- Within US, we like to be overweight financials, homebuilders, large cap value, reopening trades, semi-conductors, traditional infrastructure and underweight large cap growth and retail.
- Within Europe, we like to be overweight financials and renewables.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.