
Asset Allocation | Bilal's Weekly Insights | Portfolio Updates
Asset Allocation | Bilal's Weekly Insights | Portfolio Updates
Rarely can we point to one factor driving the performance of all markets. But since the global financial crisis in 2008, that factor is low interest rates. As soon as the Fed and other central banks cut their policy rates to zero and started quantitative easing (QE) in late 2008, it set the stage for one of the largest equity market rallies in history. US stocks rose by almost 400% from late 2008 until the Fed started to hike rates earlier this year (Chart 2). And it was not just equities. Almost every asset market value was inflated – whether bonds, real estate or credit. That is why we call this era the ‘everything bubble’. But the ‘everything bubble’ is clearly bursting.
August was yet another month that demonstrated this. Global equity markets fell 4%, bitcoin fell 16%, US bonds fell 2.5%, and even commodities fell 2.7% (Chart 3). Some markets performed less poorly – EM bonds only fell 0.5%, and EM equities were flat. But the trend is clear, and we see further downside ahead.
The crux of the matter is that central banks can no longer act to stabilise markets and growth. Inflation is simply too high. The risk is that they hike rates further to levels not seen since before the global financial crisis. That means the Fed could raise rates to 5.25%, the ECB to 4.25%, and the Bank of England to 5.75%.
Such levels may seem high, especially since investors have grown accustomed to zero rates and QE. But these were the levels reached in the 2000s when inflation was lower than today and unemployment was higher. And they are much lower than the levels of the 1970s, which is the closest comparison to today’s supply shock.
With central banks acting as a brake on asset markets, it will be left to governments to act as a stabiliser. Yet there is no consensus on the right government response to the current macro environment. The latest US action was to forgive student loan debt, the UK is likely to introduce price controls on energy prices (following much of Europe), and China is attempting to revive its housing market.
In our view, all this points to further downside in asset markets. We continue to be overweight cash. This is a defensive posture but also gives us liquidity and the ability to mop up assets when they reach distressed levels. It also prevented us from losing money in August. We stay underweight equities and bonds given our view above. On commodities, we are neutral: supply issues suggest strength, but weaker growth suggests weakness, so these forces offset each other.
Finally, on equity sectors, here are our favourite views: Within US, we like to be overweight energy, large cap value, semiconductors, financials, traditional infrastructure, clean energy, and healthcare. We would underweight homebuilders, large cap growth, consumer discretionary and staples, and technology.
I understand your investment recommendations, except being overweight semi-conductors, for the following reasons: 1) they are highly cyclical (yet the downturn is ahead of us), 2) we could see an over-supply of chips (as production ramps up, even as demand for goods falls), 3) geopolitical tensions between the US and China will weigh on Nvidia and others.
Also, another headwind to semi-conductors in Ethereum’s switch to a PoS consensus model, that will render mining GPUs useless, and the broader fall in crypto prices. Nvidia’s profited handsomely from selling mining hardware.
Semiconductors is a tough one, and illustrates the problem with broad sector ETFs. Companies making semiconductors for consumer products, esp the kind that boomed during lockdowns are hurting. But most of them are going through what amts to a temporary inventory correction. They ate talking a quarter or two. Meanwhile, companies that make chips for industry face massive demand, with backlogs of quarters, even a yr. Look at Broadcom. Look at autos. Normal auto sales run abt 17mn annual rate. Its been stuck around 13 mn for the past year because…automakers can’t get the chips they need. To me, underlying fundamentals look good, although yes, if a recession scenario develops further that will change. Obviously the tactical trade would be to go long industrial type chip makers and short consumer products. – John Tierney