Take profits or run the risk of a correction 18 September 2019

Take profits or run the risk of a correction

Dilemmas facing the modern-day active manager

While the turnaround in central banks' tone since the beginning of the year helped boost equity prices and dampen volatility, it looks highly unlikely this is enough to maintain a longer term rebound.

The impressive V-shaped movement we witnessed in recent months complicated strategists' and portfolio managers' work; market timing in particular is proving to be quite tricky. 

Those who reduced risk levels when markets crystallised all fears - without later increasing equities exposure - took a place on the sidelines during the year's first half.

Related articles

Is a global recession inevitable?

'Better macro backdrop' is needed for EM earnings to improve

The interplay between liquidity and economic growth

How can investors position against a no-deal Brexit?

What the US bond market really means for equities

Furthermore, inflows into equity funds have barely been positive, meaning that strategists' traditional market timing techniques have failed.

Fund managers slash exposure to global equities on trade war fears

At first sight, those who exploited the strong rebound find themselves in an enviable position.

But they face the thorny issue of whether to take profits with six months of the year still to go: too early and they will face criticism from clients already frustrated by poor performances in 2018. 

But equities' 20% rise since the beginning of the year was preceded by a 15% correction. 

The V-shaped movement shows performance is substantially more modest over one year, in line with the sluggishness of company earnings, even with their contracting trend emerging in the past few months. 

Now the rebound has boosted equity prices, markets are close to their fair price, with valuations in line with historic averages.

Further improvement looks limited, given the persistence of threats such as the US-China trade war and turmoil in various political spheres. 

It is to these weaknesses that the markets owe the central banks' abrupt policy shift, paving the way for interest rate cuts and more monetary activism.

The inversion of the yield curve: Still a reliable indicator of recession?

2019 could possibly become a mini-cycle, where activity contracts but does not quite become a recession.

By acting in sync with each other, central banks are attempting to prepare their economies to weather this economic slowdown. 

The real question here is: will the redeployment of an unconventional arsenal have as much of a positive impact as quantitative easing in full swing had? 

With leverage already maxed out, the previous dynamic today looks almost impossible to recreate.

The power and speed of the US Federal Reserve's shift in direction are in step with what is at stake: avoiding a recession at any cost, but companies find themselves in a much tighter corner.

For the recent recovery to transform 2019 into an exceptional year, stockmarkets must be given good news - otherwise a potentially severe correction cannot be ruled out. 

During such uncertainty, sound asset management is the order of the day, which translates into more complex asset management strategies and models that make use of derivatives. 

Michael Lok is co-CEO asset management at Union Bancaire Privée