Investors are advised to rebalance their portfolios more frequently and increase their cash holdings this year, says Vasu Menon, vice-president and senior investment strategist at OCBC Singapore.This year is likely to be one of unusual uncertainties and volatility as global markets watch what US President Donald Trump does in his first 100 days in office. Menon says investors should keep track of potentially market-changing events and adjust their portfolios accordingly.
“Given the highly uncertain and volatile environment, investors may need to review and rebalance their portfolios more regularly. If an investor has 5% cash in his portfolio, for example, he may wish to increase it to 15%,” he says.Rebalancing usually takes place every 6 or 12 months. But under the current conditions, Menon thinks it should take place every quarter.
“Things are changing rapidly. For now, some investors may want to hold more cash. But three months later, they may wish to invest their cash if there is a sharp pullback or if the outlook turns decisively more positive. So, if they only review their portfolios every six months, they may miss the opportunity to put some money back into the markets,” he says.Investors must hold equities, bonds, gold and cash in their portfolios. In terms of asset allocation, however, it depends on the investor’s age and risk appetite, says Menon.
“Investors in their twenties should take risks. For them, the asset allocation should be 60% equities, 30% bonds and 10% cash and gold. If they are in their forties and have a smaller risk appetite, the asset allocation should be 40% equities, 50% bonds and 10% cash and gold,” he says.“My advice is to put money into the market gradually over the next 12 months. Do not buy stocks for the sake of buying. You should buy the right stocks. Moreover, do not try to time the market because the next 12 months will be very volatile.”
For the time being, investors with significant exposure to equities should consider liquidating some of their holdings to build a larger cash reserve. However, they should not withdraw from equities completely, says Menon.“If investors feel a bit nervous about the equity market because it has done well, they may want to review their equity exposure. This does not mean getting out of equities completely. They may want to put more funds into the US, and less into Asia, Japan and Europe for now,” he says. Menon is most positive on US stocks. “We like the US financials. If the economy picks up, the banks over there should benefit,” he says.
“We have seen the yield curve steepen as long bond yields have gone up, and the curve could steepen even further. We think it is possible that the 10-year US Treasury yield could go to 3% by the end of this year. This should augur well for the financial sector, especially if the policies of the Trump administration help to boost the economy further.”Another segment to look at is companies that are leveraged to US consumer spending, says Menon. They include companies that sell consumer products as well as retail stocks, as they should benefit from a pickup in the economy.
“Investors can consider infrastructure and construction-related stocks too. Construction stocks have already had a good run. But if Trump is going to boost infrastructure spending further, these stocks may continue to benefit from it,” he says.
Continued demand for bonds
Within the bond space, the most attractive segment is high-yield corporate bonds, says Menon. Bond markets pulled back quite sharply in the fourth quarter of last year after Trump won the presidential election as 10-year US Treasury bond yields went up and dragged down prices.However, looking ahead, Menon thinks that the search for yield will continue. Factors such as the growing ageing population around the world, very low yields offered by many government bonds, volatile equity markets and abundance of savings should augur well for high-yield corporate bonds.
“An ageing population is one structural factor that should offer support for bond markets. As the global population ages, it means more investors will be less receptive towards putting money into equity markets. They will turn towards relatively safer assets such as bonds, especially those that offer good yields and income,” he says.“There are also a lot of savings sitting on the sidelines as people have been nervous about investing in equities in the last few years, given the various uncertainties and headwinds. As it dawns on investors that the world economy is the new normal and uncertainties are unlikely to go away anytime soon, idle savings could make their way into safer assets such as bonds in their search for yield.”
On the outlook for the US dollar, Menon thinks Trump’s fiscal stimulus could cause the greenback to strengthen. This means emerging markets in Asia stand to suffer the most from a stronger US dollar as it will cause their currencies to weaken and make their capital markets less appealing.“We have seen Asian currencies weaken a lot since the US election. We think the risk is that they may weaken more, so it may not be time to really jump in and buy Asian equities yet,” he says.
He notes that the fundamentals for Asia are still strong, unlike during the 1997/98 Asian financial crisis, when many countries had internal problems. This time around, they are less likely to be affected by the strong US dollar.“So, if the Asian markets correct by, say, 10% or more because of the strong dollar, it may offer a buying opportunity to investors with a strong risk appetite and medium-term horizon as the region is still the fastest growing in the world,” says Menon.
One bright spot in Asia, he says, could be financial stocks. Like their US counterparts, they too could benefit from the steepening of the yield curve. For example, banking stocks in Singapore have risen significantly in the past few months, partly due to the steepening of the yield curve.In addition to financial stocks, investors could look at dividend stocks, says Menon. “Investors may also keep an eye on the real estate investment trusts (REITs) and stocks that give good dividend yields. A lot of Asian companies have started increasing their dividend payout, making the region an interesting choice for those seeking yield.”
On the other hand, if there is a sell-off in Asia, almost everything will get hit. Menon believes that if there is increased protectionism measures out of the US and Asian currencies take a further beating, there will be a sell-off across the board.“Sectors that are exposed to the risk of protectionist measures are the export-oriented stocks - the ones that export to the US or China. If the US hits China with protectionism measures, it will be hitting the rest of Asia indirectly as well because the region exports quite a bit to the US indirectly through China,” he says.
When it comes to gold, Menon says investors should only treat the precious metal like an insurance policy for unexpected events that could cause significant risk aversion. He does not think gold is the place to invest significantly as he is not very positive on the asset class.“I think gold could be US$1,100 per ounce by year-end, compared with about US$1,230 now. In between now and year-end, gold could see occasional spikes if risk aversion rises sharply from time to time. We are cautious on gold because we see a stronger US dollar and higher interest rates, which are headwinds for the commodity,” he explains.
As for other commodities such as base metals, Menon says they could benefit from the infrastructure spending in the US, China, India and Indonesia. This should support strong demand for base metals. “Oil prices have rebounded, but we are not seeing a big pickup. We think oil prices will hover in the region of US$50 to US$65 per barrel. As long as prices are stable, it will make it easier for energy companies to invest with greater confidence,” he says.
In the past, when prices were plunging and very volatile, energy companies held back on capital expenditure. If prices stabilise, the companies may increase capital spending, which will be good for the energy sector, says Menon.
Trump’s first 100 days
The markets are currently fixated on developments in the US, especially what Trump does in his first 100 days in office. If he does not impose protectionism measures on China, is able to increase spending on infrastructure and succeeds in getting support for deregulation, he could be seen as a positive for stock markets. However, if he imposes tariffs on China and clashes with Congress on his fiscal policy, this could spook investors, says Menon.
“Markets are waiting with bated breath. Trump means greater uncertainty and risks for markets. The key thing is that there is still a lack of clarity about what his policies are going to be. He may play mind games to gain leverage over the negotiations, but this strategy could also ruffle feathers and cause global economic and political tension,” he says.
Trump’s potential policies have both positives and negatives for the global markets. Menon points out that the markets have been cherry-picking and focusing on policies that may be good for the US economy. This includes his promise to cut corporate taxes significantly (from 35% currently to 15%), increase infrastructure and defence and spending sharply and undertake deregulation in key areas such as finance and energy.
“The stock markets pulled back slightly immediately after Trump won the election. Then, it recovered and rallied. That is because investors felt that he would be good for the economy, that he would help reflate the economy - boost economic growth and inflation. These are good for US and global equities,” says Menon.Investors have so far chosen to be complacent about the risk of protectionism, he says. Trump accused China of undervaluing the US currency and being responsible for job losses when he was campaigning for the presidency. He also cautioned China about staking its claim on the South China Sea.
“So far, the markets have taken comfort in the fact that Trump has agreed to the One China policy and has had a friendly conversation with President Xi Jinping. Despite this, Trump’s penchant for doing the unexpected means that he could still label China a currency manipulator and slap it with trade tariffs,” says Menon.
“I think investors are hopeful that Trump, being a former businessman, will not take a hardline stance with China as it could hurt US companies with businesses in the country. It remains to be seen whether Trump will indeed live up to his promises.” Menon thinks that imposing tariffs on China could spell bad news for the US economy. “A tariff imposed on China will increase the cost of goods imported into the US. China is a big source of imports for the US. If costs go up, then US companies will have to pay higher prices for their inputs and that will hurt profits. US consumers will also find Chinese goods more expensive and this could hurt consumption spending, which is a key driver of the US economy,” he says.
Furthermore, imposing tariffs may not necessarily bring the jobs back to the US, says Menon. Between former presidents George W Bush and Barack Obama, the US had lost millions of jobs in the manufacturing sector.“Some of the jobs may have been lost for good. The manufacturers have left the US and settled down somewhere else. These companies are not going to just pull out and return to the US. Automation has also taken over many of the jobs. So, trade protectionism may do more harm than good for the US,” he says.
“Even if the jobs come back, Americans need to have the skillsets required by companies. Over the last eight years, many jobs have left the US and the current skill levels of Americans may not be suitable for re-entry into some of these manufacturing jobs. Clearly, policies need to be put in place to re-skill workers so that the US can attract manufacturing jobs back. This is something that will take time to achieve.” Menon believes that Trump may face road blocks with his aggressive economic policies, especially if they are seen as causing the US budget deficit and debt burden to balloon further. Many of these policies still require approval from Congress, which serves as a check and balance.
“The stock market rallied, thinking that Trump can implement economic policies that are good for businesses. But in reality, the final outcome may not be so rosy if Congress decides to rein in his aggressive plans and fiscal excesses,” says Menon.
“If Trump focuses on the positive economic policies and does not go overboard, this may be good for the markets. For instance, if he cuts taxes, spends and deregulates in a modest way and takes the middle ground in his policies, then I think it could be a positive for the market. But if he goes overboard with these policies, people could worry about the US budget deficit and this may eventually hurt sentiment on US stocks.”Menon believes that if Trump takes the extreme approach, his own party’s members will pull him back. The Republicans have been hawkish on government spending.
“In the past, they contributed to the shutting down of the US government temporarily on a few occasions because the debt ceiling was hit and the Republican-controlled Congress refused to increase the debt ceiling. So, it makes no sense for it to give Trump a blank cheque to spend aggressively,” he says.
US inflation will not spike
Menon says inflation in the US will not see a drastic rise in a short period of time even if Trump does something out of the ordinary such as increase spending sharply. “When it comes to fiscal policy, government spending is not something that takes effect overnight. Unlike the monetary policy, where central banks can raise interest rates and money supply fairly quickly, it takes longer for fiscal policy to take effect. Trump will also need congressional approval before he can pursue any plans and this could take time.”
Menon notes that the Personal Consumption Expenditure index, used by the US Federal Reserve as a gauge of inflation, is now running at about 1.6% - not far from its target of 2%. The Fed sees price stability on target and the US economy is close to full employment, with the unemployment rate at 4.8%.“The risk is that if Trump increases spending significantly, this could fuel inflationary pressures given the tight labour market. If inflation increases gradually, though, it may not be a bad thing. In the past two years, we have been worried about a deflation. So, a little bit of inflation is not a bad thing,” he says.
Trump’s reflationary policies may cause the US dollar to strengthen further. If the currency goes up significantly, it will hurt US export competitiveness and make the country less attractive as a manufacturing hub.
Whether Trump adopts the middle ground remains to be seen. Menon suspects that he will not slap tariffs on China just yet. His rhetoric may be a tactic to get China to negotiate and get concessions from it.
“The Chinese also have leverage. They are one of the biggest purchasers of the US treasuries and unless they continue to buy US government bonds, the Trump administration may not be able to raise enough debt to fund its grand plans,” he says.