How to protect portfolios in 2020

For your clients, the new year might have ushered in new fear, as markets face geopolitical and economic uncertainty. Various reports published this week outlined today’s risks and how portfolios can be successfully positioned.

In an outlook report published by Richardson GMP on Monday, the Toronto-based management firm described the current market challenges.

“Markets are at all-time highs with elevated valuations, central banks are already highly accommodative, trade tensions have faded, and credit spreads are the tightest we have seen this cycle,” the report said.

So markets are aggressively priced. This week, the S&P 500 traded at about 18 times earnings, the peak valuation of this cycle to date and tying the level right before the first correction of 2018. That means the risk of a market correction is elevated, the report said.

Earlier this year, Richardson GMP pivoted on its recommendation to overweight U.S. equities, suggesting more international equity exposure. Asset prices are more moderate in markets around the world, including on the TSX, the firm said.

Alternatively, equity investors could tilt to more defensive value or dividend strategies, the recent report said.

It also noted that the credit market is frothy, with spreads at cycle lows, for example. In fact, investment-grade spreads over Treasurys have fallen to less than 50 basis points.

“That means after a decade of corporations expanding their debt levels, with the investment-grade universe now comprised of almost half BBB (the lowest rating for investment-grade debt), the market is rewarding investors for taking on this risk by less than half a percent a year,” the report said. “Talk about picking up nickels ahead of a potential steamroller.”

Because investors aren’t being adequately rewarded in credit, reducing exposure may prove timely. “Forget about eking out every extra basis point,” the report said. “Take a step back to focus on what this part of the portfolio is truly about: defence.”

Overall, a lot must go right to achieve even average returns this year, the firm said. The market is at risk if economic growth alongside global trade or earnings don’t improve, or if central bank accommodation fails to continue, it said.

At the same time, Richardson GMP said it was no market bear. The firm’s multi-disciplinary model, which incorporates more than 33 indicators such as economic data and market fundamentals, continues to remain healthy, with 23 bullish signals.

Those indicators don’t rule out a market correction. What they do imply is that a correction could “prove to be yet another buying opportunity in this aging bull market,” the report said.

Thus, investors should have some cash on hand.

Moderate growth expected

While economic growth has struggled recently, stabilization may be on tap for 2020, according to an outlook report published Wednesday by New York–based multinational professional services firm Deloitte.

The firm projected Canada’s GDP to accelerate toward 1.9% this year before decelerating to the country’s potential growth rate of 1.7%. (Deloitte estimated growth was 1.7% last year.)

For the global economy, Deloitte forecasted average growth of 3.4% this year and 3.6% in 2021, compared to 3.3% in 2019.

This improved growth profile, relative to last year, reflects global monetary stimulus and a reduction in the most acute risks, such as a hard Brexit and global trade woes, the report said.

In a weekly update on Monday, Unigestion, the Geneva, Switzerland–based specialist asset manager, also cited monetary stimulus as a positive factor.

“For 2020, our major source of optimism comes from monetary policy,” Unigestion said. “A supportive policy mix is likely to remain in place, with a potential for amplification in the case of an economic slowdown.”

As a result, the risk of large market shocks and the probability of sustained financial turmoil would be reduced, that firm added.

It also said it expected interests rates to remain low both in Canada and globally, which would keep the loonie range bound, at about US$0.75.

Still, geopolitics will remain a risk, specifically nationalism and populism.

“The pendulum has swung away from support for open markets and global trade,” the Deloitte report said.

Because of such risk, Unigestion noted that market sentiment would lie at the heart of its tactical allocation: “Political risks are likely to determine investor sentiment and, consequently, positioning and return,” Unigestion said, citing a 2020 political agenda that will include Middle East tensions and a U.S. election.

It also said that markets are more sensitive to sentiment because of high valuations.

In this environment, “the rationale for reducing risk and adding protection to a portfolio is high,” the Unigestion report said.

For more details about the markets, the economic outlook and investing strategies, read the reports from Unigestion, Deloitte and Richardson GMP.