16 January 2019
Lisa Longino, head of insurance asset management at MetLife Investment Management, argues that while it is prudent to keep a close eye on the horizon, uncertainty and volatility create opportunities for investors willing to take smart risks.
As long-term investors scan the horizon, the waters are looking choppier. We're another year closer to the end of the cycle. Geopolitical risks persist. Economic uncertainty remains. Softness in certain asset classes is becoming more visible. Frequent bouts of market volatility are driving the news cycle. Investors are rightly asking questions, and some are turning the helm towards calmer waters. But is this the right call?
2019 is likely to be a year that is ignored. Improving economic fundamentals, solid growth and ongoing reminders that the US economy can grow at a pace faster than 2% are all likely to be ignored in favour of pessimism regarding 2020 and beyond. Market participants are hyper-focused on calling the downturn and trying to decipher what type of downturn it will be. While the conflict between the present economic conditions and the presumed future will probably be a driving force in the markets in 2019, they will also be impacted by the ongoing trade tensions, likely increasing tension between the White House and Congress and a Federal Reserve torn between adhering to its mandates and their disruptive effects on financial conditions. Combined, these factors suggest a period of higher volatility amid an ongoing cycle of risk-on and risk-off behavior.
One primary driver of US growth is the consumer. Consumer confidence remains at high levels even after a recent dip. Perhaps this is because the consumer has delevered substantially since the financial crisis, has been buoyed by tax reform, is benefitting from higher interest rates, is enjoying tight labour markets and is seeing only modest inflation. Market volatility seems unlikely to trump the positive fundamentals driving consumption. While trade and housing have been softer than anticipated, neither is creating a significant drag on the economy. Likewise, capital spending has also been softer than expected, although it continues to contribute to overall growth. The sustained high growth rate implied by surveys and a tight labour market should prompt some additional investment into 2019.
The global outlook should offer little additional shelter to market participants. China should manage a continued mild growth deceleration in 2019, but likely at the expense of increased leverage. Europe's move toward normalisation could come not just with higher interest rates, but also with potential disruption to European credit markets. Overall, growth in the Eurozone should slow in 2019. Emerging markets should, on average, follow the herd. On balance we believe that the US growth trajectory will be the best of the lot during the year.
Taking Smart Risk
As a consequence of market conditions and the crosscurrents of solid current fundamentals and ongoing worries for the future, markets are likely to prove more volatile. This is exacerbated by the aggressive debt growth in all areas of the credit markets. In such a tumultuous environment it is likely that market liquidity will prove even more constrained than has become the norm. Market illiquidity is not a friend to most investors, but for the long-term investor it can provide opportunity if prepared for properly.
This is the time for the long-term investor to focus on late cycle strategies with a "smart risk" approach. This means maintaining a robust underwriting philosophy underpinned by a heightened awareness of risk. Use bouts of risk on momentum to reduce those sectors that have built up clear excesses and have an elevated risk profile in a future downturn. We may debate the reason for the next downturn, but most agree that the excesses built up in the credit markets will be impacted.
Smart risk also entails putting money to work in asset classes that deliver strong yields and give you heightened protection in a downturn, such as private assets. Privately originated assets such as private corporate debt, infrastructure, commercial real estate and agriculture loans provide diversification from the public credit markets, incremental yield, and most importantly, financial protection in the form of covenants and security interest. In addition, private assets operate in a separate market than the public credit arena with a different base of buyers and sellers. This diversifies your liquidity pool. Private assets provide you a reprieve from volatility in the public markets.
So while it's prudent keep a close eye on the horizon, we're not heading for the shore just yet. For long-term investors, uncertainty and volatility create opportunity. Preparing your portfolio by taking smart risk will allow you to ride the volatility of 2019 and will give you the ability to step in to the turbulent markets when the opportunity presents itself.