We entered the year with an increased Liquid Alternatives allocation, decided at the end of 2021, as well as tactical overweights in the US dollar, gold, and historically high cash reserves. Duration risk and credit were strongly underweighted, while we had just reduced equities to neutral.
After a long bull market and a quick post-COVID rebound, we had anticipated that this year could bring volatility spikes and require a better downside protection. From a fundamental macro viewpoint, inflation was rising and therefore monetary tightening was looming, just as geopolitical risks were on the rise as well. Hence, we broadened the above-mentioned defensive portfolio features, while scaling back our equity exposure somewhat.
In turn, these features allowed us to act more flexibly in this year's volatile markets. Thus, when markets were still selling off and sentiment was very negative between April and June, we began to selectively redeploy capital, drawing down about three quarters of our reserves to buy into various segments, including investment grade bonds, listed private equity, as well as in public stock markets. Vice versa, when the S&P 500 rallied by as much as 17% from mid-June to mid-August, we started to raise cash again, until it increased to more than 5% again – above the level at the start of the year.
In the meantime, volatility has returned to markets, as the hopes that drove the summer rally – i.e., that monetary tightening would soon end – are being disappointed and fears of a nearing recession resurface. Our own macro assessment is less prone to such swings in sentiment and has changed little over the past few months. As a consequence, we are now inclined to redeploy some of our capital back into the markets. We remain convinced that an environment such as the current one requires an active and disciplined counter-cyclical approach based on a well-diversified multi-asset portfolio.
Outlook for the final quarter
The incoming macro data continue to corroborate the case that large parts of the world economy are mired in a stagflationary environment of low real output gains and high consumer price increases.
At the same time, corporate profit growth is still resilient, owing to the high growth rate of nominal economic output. The latter is also helping to keep credit default rates in the developed markets near historic lows. However, this is countermanded by the fact that higher interest rates reduce the value of future earnings, and the continued tightening of financing conditions.
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Note: The next edition of the LGT Beacon is scheduled for October 2022.