Six risks on our list
There is no shortage of attention to political and geopolitical risk in financial market analysis. These risks impact commodity prices, influence business sectors, or prompt currency volatility, all of which can weigh on investor returns.
Persistent policy uncertainty contributes heavily to the cautious stance in our portfolios. There are a few key scenarios that could accelerate our move towards more defensive portfolio positioning.
The trade war infects the U.S. consumer: We believe that the U.S.-China trade war is here to stay, and that “tough on China” – a bipartisan issue in the U.S. Congress – will continue to play out over time. Tariffs and business planning uncertainty have already weighed significantly on global manufacturing.
We do not expect a U.S. recession in the next 12 months, but this view depends heavily on sustained – albeit slowing – consumer spending. New tranches of tariffs will impact consumer prices more directly, and U.S. consumer spending will likely begin to slow in the first half of 2020. If consumer confidence is impacted more swiftly, we would be much more concerned about the U.S. economy and would likely move our portfolios to a more defensive posture.
Self-fulfilling prophecy: Related to our trade war risk, prolonged uncertainty and market volatility could weigh on the consumer more quickly than a potential economic weakness. This, too, would increase the risk of recession.
Markets overestimate the Fed: While the U.S. Federal Reserve’s monetary policy positioning is accommodative, the market is pricing for more interest rate cuts than the Fed suggests. This could indicate room for disappointment later.
We expect another 25-basis point cut to the Federal Funds Rate in their September meeting, but we are concerned that market expectations may be too rosy. If market expectations are not met, or if Fed communication creates additional concern, financial conditions could tighten swiftly. This would be unequivocally bad for equities and credit alike.
Financial instability: Low interest rates over a prolonged period have contributed to higher valuations across asset classes. We expect inflation to remain low in the medium term, allowing a low interest rate environment to persist. However, there are two key risks to this “new normal.” First, if we begin to see higher inflation in the U.S. and long-term interest rates rise, valuations could be at risk. Second, easy credit may itself erode financial conditions. The corporate sector has levered up and face the risk of downgrades as the U.S. economy slows. Downgrades could prompt a spike in credit spreads.
Messy politics maintain drag on international growth: Markets face several meaningful political risks in the remainder of 2019. In Japan, A VAT tax increase is coming (October 1), and previous increases have resulted in poor investor outcomes. The next Brexit deadline is approaching (October 31). Italy faces high debt levels and sustained electoral risk. Each of these risks could impact investors. Add them together, and we see a drag on international growth that impacts global asset allocation and weighs on government bond yields worldwide.
China’s economy fails to stabilize: China’s economic slowdown has both structural (a long-term shift from manufacturing-driven to consumption-driven economic growth) and cyclical (trade-related) components. Our balanced perspective on the global economy relies, to a certain extent, on the Chinese government’s ability to manage this steady change. If instead China’s slowdown accelerates, it would impact not only China’s economy and asset but also those of emerging markets and other trade-focused economies such as Germany and Switzerland.
What it means for investors: No risk list is complete without the potential upsides. At this time, those upsides are mostly the resolution of the risks we’ve just mentioned. While plausible, we consider the catalysts for these upside risks to be elusive. We believe that it is more prudent to prepare for continued economic slowdown and sustained market volatility.
For long-term investors, this means it is likely appropriate to move gradually toward a more defensive posture, focusing on generating income across a broad range of sources. Our latest market outlook update highlights key indicators we are watching and ideas for investing accordingly.
This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.
The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.
This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.
“New York Life Investments” is both a service mark, and the common trade name, of the investment advisors affiliated with New York Life Insurance Company.