Beyond Brexit, Our Plan For Today's Markets

| About: SPDR Dow (DIA)

Summary

Today's environment places a premium on locking-in near-term gains and avoiding drawdowns.

We favor relative value opportunities over large directional positions and aim to mitigate volatility.

We seek to enhance diversification via duration, currencies, credit and alternatives.

By Mark Hamilton, CIO Asset Allocation & Alternatives, Portfolio Manager

Our investment thesis for the past year has been for markets to move like a seesaw, with modest returns punctuated by bouts of volatility and June proved no exception. The Brexit vote caught most observers by surprise and sent shock waves through financial markets. But three weeks after the vote, most markets have recovered to pre-Brexit levels or better-with the notable exception of the British pound.

Post-Brexit, we are slightly more cautious than last month given concerns about the impact on growth in the UK and Europe, but the themes remain largely the same. Developed economies are near their cyclical peaks and are likely to oscillate between slowdown and expansion regimes over the near-term, while some emerging economies show signs of recovery. Valuations are relatively full for developed equities, while emerging equities and credit are more attractively priced. Finally, risks remain somewhat elevated due to the economic drag from Brexit, weakness in European financials, the ongoing structural transition in China, and uncertainty surrounding the direction of Fed policy.

This month, I thought I'd share our strategies for navigating this type of environment. As we have written before, our macro regime research tells us that these "slowdown" periods typically offer mediocre asset returns, with a significant amount of uncertainty. Given that knowledge, our first strategy is to avoid large directional positions while looking to mitigate volatility and downside risks. Over the past year, our overall risk positioning has ranged from neutral to somewhat defensive, particularly during periods of high market volatility. We do not believe that large moves up or down tend to be as sustained as they are during periods of recovery/expansion or contraction, when we would be comfortable taking larger over/underweights.

Instead, we prefer relative opportunities, such as our decision to overweight European equities in early 2015, or more recently our preference for emerging markets relative to developed. These types of opportunities tend to entail less portfolio risk and offer a higher likelihood of success than directional positions during these periods.

Second, we seek to enhance portfolio diversification through investments in duration, currencies, credit and alternative assets. We overweighted long duration Treasuries early in 2016 in order to add downside protection, and we have actively managed currency both to hedge downside risk (long yen early in 2016, underweight the pound and euro more recently) and to add upside potential (long high yielding emerging currencies versus low yielding developed currencies). We have also maintained allocations to loans and event-linked bonds throughout, and added high yield credit as an equity substitute in the spring. Together, these income-generating assets provide attractive sources of return with less severe ups and downs than equities.

Third, we seek to be nimble. An environment characterized by modest return potential and bouts of volatility places a premium on locking-in gains and limiting drawdowns. Hence, we have been very active in managing positions in the portfolio, more so than would be necessary earlier in the cycle when accelerating growth and lower valuations provided more upside potential.

Our current positions reflect these strategies:

  • We are modestly underweight equities, with a preference for specific emerging markets over developed markets, given more attractive valuations and cyclical improvements.
  • Among currencies, we took advantage of the 10% drop in the pound to lock-in some profits. We remain modestly underweight the pound, as well as the euro, Swiss franc and Canadian dollar. We are neutral on the U.S. dollar and Japanese yen, and are overweight a basket of higher yielding emerging currencies.
  • We continue to hold a broad exposure to assets that offer attractive income, low to moderate volatility and diversification; these include high yield, loans and event-linked bonds.
  • We maintain the neutral duration stance from last month, concentrated in U.S. Treasuries.

Brexit drove another cycle of the seesaw environment of the past year. We expect it won't be the last, and continue to position the portfolio accordingly.

These views represent the opinions of OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.

Mutual funds are subject to market risk and volatility. Shares may gain or lose value.

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©2016 OppenheimerFunds Distributor, Inc.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.