Monetary policy divergence is driving volatility in local asset values in markets around the world and investors should prepare for this volatility to continue, according to a report by Manulife Asset Management titled "Dealing with divergence: How investors can position themselves to navigate a fork in global monetary policy".
As a result of the developing environment, US equity investors will need to be especially focused in their search for growth, for example by analyzing opportunities in higher organic growth sectors such as technology, health sciences, and those with a greater domestic footprint such as small caps, the report suggests.
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Fixed income investors may need to look further along the credit spectrum towards higher yielding securities or to examine new geographies such as emerging markets.
While developed markets such as Canada, the UK and Sweden may be "placeholders of quality" in this environment, the report also identifies as opportunities fundamentally strong emerging economies with current-account surpluses such as Singapore, Thailand, Korea, the Philippines, Brazil and Mexico.
Typically, countries adjust to a lower growth environment with some combination of fiscal stimulus and monetary easing, the authors write.
This time, global demand slowdowns combined with fiscal austerity have put an outsized burden on monetary policy and driven many countries to fight for competitive position and export share through lower currencies – an undeclared currency "war."
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By GlobalDataThe US, having taken most of these steps early in the cycle, is now in a relatively strong economic position which allows it to let its currency appreciate and to consider rate increases.
"Ironically, this ‘winning’ position puts US growth and US export share at the mercy of aggressive currency devaluations by other countries.
However, we believe the US economy is in robust-enough shape to withstand this "forex fracas," the authors conclude.
Other areas addressed in the report include:
-Implications for Global Asset Prices.
The mass injection of liquidity into the market since the financial crisis has pushed equity valuations to a level that makes them extremely expensive. In the US, history suggests there is a significant probability of a 10 percent – or further – downwards market correction. In order to find value, investors need to search for areas of higher growth, such as technology and health sciences. Focus and fundamental analysis will be increasingly important in this environment.
Bonds also look potentially expensive because of the huge liquidity flows into the market over the past few years. This means looking across all areas of the capital structure to uncover the best opportunities, for example sovereign bonds in Southeast Asia or within the emerging markets more broadly.
-Divergence brings opportunities for the discerning fixed-Income Investor.
Diversification is the predominant theme.* The global multi-sector fixed income team expects yield curves to flatten, so there could be more opportunities in longer-dated bonds. Geographical versatility is also important, considering developed markets, such as the UK, Canada and Sweden.
Opportunities may also include commercial mortgage-backed securities especially single-asset "trophy" properties that typically cannot be duplicated. The authors are cautious of cyclical sectors like energy and metals and mining companies but see opportunities in healthcare, pharmaceuticals and utilities. In short, investors should remain extremely selective in their approach.
-Keeping an Eye on Risk.
From a credit standpoint, it is prudent to consider de-risking portfolios by reducing exposure to high yield, and the authors see opportunities in markets such as the UK, Sweden, Norway, Australia and New Zealand.
It is also important to test portfolios to make sure that they are prepared for what might happen in an adverse environment; for instance, if there were a return to high levels of inflation, rates rise and the world is caught by surprise. Certain inflation-protected securities can be very low risk in this regard, and may prove helpful in such an adverse environment.
-Opportunities in Currency Markets.
Reconsidering currency exposure may present an opportunity, for example, by hedging foreign bond exposure back to the US dollar.
From a liquidity standpoint, this is a challenging time as bond markets are less liquid. As multi-sector investors, Manulife Asset Management seeks the best opportunities to help provide diversification and outperformance in a volatile market. This can be beneficial in times of more muted liquidity.
-Emerging Markets: Diversification is crucial.
The idea that an improving global economy boosts all countries is not the case anymore, in the authors’ view. "We are careful where we tread," they write.
"Developed" emerging-markets such as Singapore, Thailand, Korea, the Philippines, Brazil and Mexico are fundamentally strong, with current-account surpluses, and appear to offer positive growth opportunities.
The "developing" emerging-markets – such as the Middle East and Africa, may have yield opportunities, but we believe in avoiding them for now due to concerns that there is little or no liquidity.
