Tactical Asset Allocator: safe place to gain from US growth

Turkey’s crisis and fears of wider emerging markets contagion may be overdone, but the global risks flowing from higher interest rates are very real.

Far from a quiet summer lull, volatility and risk-aversion intensified over the holiday season. At various times the FTSE 100 index tumbled over 100 points in a day, as markets became nervous about the Turkey crisis and deepening trade wars. US Treasury Secretary Stephen Mnuchin is warning of further sanctions to hamper Turkish competitiveness, unless pastor Andrew Brunson is released from house arrest on espionage charges. It is a row that could easily escalate. President Trump, who is facing the mid-term elections in November and looking for the evangelical vote, is unlikely to back down from a position of strength.

The Turkish lira has plunged by around 40 per cent against the dollar in 2018 alone. The worst scenario, and the most likely, is the imposition of capital controls, which could result in defaults on some $500 billion of credit, with wide-reaching impact across the globe.

The US/China trade stand-off is also escalating, which is scarcely surprising given that the Chinese completely deny Trump’s allegations over intellectual property theft. After initially reacting in a conciliatory manner, China’s stance has hardened in the knowledge that President Xi Jinping can fight US sanctions without fear that his policies will wreck an election result.

Turkey dollar debt

Turkey’s chronic trade deficit is too extreme to make this a buying opportunity. Its economy is heavily beholden to the dollar strength as it imports virtually all its raw materials, including oil.

The way to make money in this environment could be to invest in emerging markets that have been caught up in the selloff. Most emerging markets are down over 10 per cent this year, but countries such as Indonesia and the Philippines are down more than 20 per cent and are cheap compared with other markets. We’re not advocating China – which has also plummeted – because of the risk of capital flight stemming from the strong dollar. The administration’s time-honoured policy of printing more renminbi is dangerous as long as the Fed is raising interest rates, and gives investors reason to move elsewhere.

However, emerging nations are no longer largely dependent on the West and deeply in debt, as they were in the 1990s. Widespread institutional and market reforms have transformed the business culture, and the recent sell-offs have been driven by monetary policy rather than structural weaknesses. Most positive long-term themes remain intact, such as high savings rates, rising productivity, infrastructure spending and openness to trade. Bank stocks look particularly cheap as there are few bubbles or excesses in the system.

Large and liquid

Investors might consider a large and liquid emerging markets ETF such as the Lyxor MSCI AC Asia Pacific ex-Japan ETF (LSE:AEJ), or an active trust – given that these markets present many challenges to navigate – such as JPMorgan Emerging Markets IT (JMG), which the portfolio already holds, while these bourses correct.

Meanwhile the dollar’s strength and its attractions as a safe haven have pushed down commodity prices, particularly copper, hitting mining stocks such as Antofagasta, Glencore and BHP Billiton. Confoundingly, gold has not benefited from this flight to safety, and has even sunk to a 1.5-year low, along with other precious metals; it may still represent a buying opportunity.

In the UK, the prospect of a no-deal Brexit and the impact of this uncertainty on the falling pound have also heightened risk aversion. If sterling continues to weaken relative to the dollar, the cost of imported goods will rise, pushing up inflation here too. Recent retail sales have been encouraging, albeit the online market is becoming concentrated in fewer hands. However, price inflation is already outstripping growth in wages, which is a sluggish 2.4 per cent, and the loss of disposable income will impact consumer spending. As recent experience has highlighted, a weak currency will continue to support FTSE 100 companies with an international outlook and exporters, whose products then look more attractive to foreign customers and partners.

Wealth management firms have certainly been scaling back their risk assets. UBS Wealth Management, for example, has predicted a 60 per cent likelihood of the trade conflict intensifying until the US mid-term elections in November, and perhaps throughout the duration of Trump’s presidency. The firm is reducing its cyclical exposure to US industry and utilities, as well as to consumer discretionary businesses in the eurozone.

US strength

Investors have poured into US markets over the summer, some no doubt rueing the fact that they missed much of last year’s party. It is a mystery why the fallout from the escalation in trade wars has been so muted. Arguably the impact is small in the whole scheme of things. Imports only account for 15 per cent of US GDP, so the tariff element equates to around 1.5 per cent of GDP, and some businesses will find ways to avoid expensive imported inputs. More likely, we are all assuming Trump’s threats are just that: threats and posturing. However, Republicans back his protectionist stance and it was one of his central election platforms.

Still, with so much uncertainty, there are safer ways of benefiting from the strong US economy and unemployment rates at a decade low. Returns from all assets could be slim moving forwards, and in this light, US inflation-linked bonds could be a sound place to park cash as employers are forced to pay higher wages, leading to higher inflation.

The portfolio will be investing some of its cash pile in the London-listed iShares TIPS Bond ETF (LSE:TP05), which tracks the ICE US Treasury Inflation Linked Bond 0-5 index, providing exposure to US Treasury inflation-protected bonds with maturities between zero and five years. The portfolio is short on bond exposure at a time when equities are at all-time highs, and the purchase is a start on the likely next journey to mitigate the risk of rising interest rates. The fund replicates physically, has a total expense ratio (TER) of 0.10 per cent, and pays twice yearly, in May and November.

Stock EPIC Category Risk level* Quantity Price paid (£) Current price (£) Current value (£) Current weighting (%)
                 
Lyxor ETF FTSE 250 L250 UK Equity 81 1000 12.32 25.19 25,185.00 13.17
iShares Core S&P 500 UCITS ETF CSP1 US Equity 110 100 103.70 216.79 21,679.00 11.33
iShares Euro Total Market Growth Large IDJG Euro Equity 104 325 18.14 32.94 10,705.50 5.60
iShares FTSE EPRA/NA Glbl Prop Yld (2) IWDP Property 84 402 13.38 20.48 8,232.96 4.30
Neptune European Opportunities NEOA Euro Equity 104 1097 3.62 6.28 6,891.35 3.60
Schroder Frontier Markets Equity fund M9S0 Em Mkts Equity n/a 80 100.00 114.13 9,130.40 4.77
iShares Japan Sterling hedged ETF IJPH Japanese Equity 139 200 47.41 57.43 11,486.00 6.01
Standard Life Investments Emerging Market Debt GU4Z Bonds 81 1300 5.15 6.06 7,881.90 4.12
DB X-TRACKERS DBX MSCI INDIA ETF XCX5 EM Mkts Equity 143 900 6.59 9.67 8,698.50 4.55
DB X-Trackers MSCI EM Asia Index UCITS ETF XMAS EM equity 129 420 24.12 38.39 16,121.70 8.43
iShares Global Clean Energy ETF INRG Global equity n/a 400 3.59 3.88 1,552.80 0.81
iShares Physical Gold SGLN Commodities n/a 300 18.26 18.21 5,461.50 2.86
Polar Capital Global Insurance fund NAU4 Equities 105 400 5.35 6.52 2,608.00 1.36
iShares Automation & Robotics ETF RBTX Equities n/a 1000 4.66 5.83 5,834.60 3.05
iShares J.P.Morgan EM Local Currency Bond LEMB Bonds n/a 100 36.59 33.85 3,385.00 1.77
JPMorgan Emerging Markets IT JMG EM Equities 135 1000 8.46 8.60 8,600.00 4.50
iShares US Pharmaceuticals ETF IHE Equities n/a 100 116.00 131.40 13,140.00 6.87
iShares S&P SmallCap 600 UCITS ETF GBP ISP6 Equities n/a 100 44.76 55.74 5,573.50 2.91
VinaCapital Vietnam Opportunity fund VOF EM Equities 136 1000 3.58 3.23 3,230.00 1.69
Xtrackers S&P Select Frontier Swap ETF SXFR EM equities 120 500 11.72 10.48 5,240.00 2.74
Jupiter UK Smaller Companies fund GB00B3LRRF45 UK Equities 84 1000 4.06 4.05 4,052.50 2.12
iShares TIPS Bond ETF TP05 Bonds n/a 1000 3.87 3.87 3,873.00 2.02
Cash             2,701.60 1.41
Total             191,264.81 100.00

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