INTRODUCTION
Many of us may hold fond memories of LEGO building blocks, mini plastic toy bricks that come in a variety of colours. Adored by both children and adults alike, they can be interlocked and assembled to construct objects in as many ways as your imagination allows.
In 2022, financial markets witnessed an unprecedented correlation among asset classes, particularly with both stocks and bonds suffering losses. This year, the US economy has shown surprising resilience thus far despite having faced a banking and debt ceiling crisis, not to mention 10 consecutive interest rate hikes. That said, risk of recession remains although it has been pushed back into late 2023 or early 2024. In Asia, China’s growth is starting to wobble and there is pressure for the authorities to add more stimulus. Against such uncertain macro environment, diversification is beyond critical for asset allocation.
The LionGlobal All Seasons Funds (Standard and Growth) were set up in 2018 with the aim of helping investors tide through market volatility, with a diversified portfolio at low cost. Using both active funds and ETFs (what we also call, building blocks), the Funds invest across asset classes and geographies. Both Funds utilize similar building blocks but employ different asset construction to suit two different investor profiles, based on different risk tolerances. The LionGlobal All Seasons Standard Fund targets a below average level of portfolio risk (70% Bonds, 30% Equities) while the LionGlobal All Seasons Growth Fund targets an above average level of portfolio risk (30% Bonds, 70% Equities).
In view of the changing investment climate, this article highlights the tactical asset allocation adjustment that we have made to both Funds while maintaining diversification across asset classes and geographies.
BONDS
The Federal Reserve (Fed) left interest rates unchanged at its June policy meeting, after a series of 10 hikes that increased the Fed funds rate by 500 basis points (bps). The Fed has expressed that they are on a data-dependent mode, with the dot plot suggesting one to two more 25bps hikes for the rest of 2023. We are of the view that we are close to the end of the tightening cycle, even though inflation may stay higher for longer.
As interest rates peak, we are shifting our preference towards longer duration government or government-related bonds. We also like short dated high quality, investment grade bonds to lock in decent yields as well as capture potential capital appreciation.
EQUITIES
We are cautious on US equities on slowing growth and valuations running ahead of expectations. The S&P 500 is trading on 18x forward price-to earnings (As at 13 July 2023), a meaningful premium to its 10-year average, while corporate earnings forecasts are on a downtrend. While the banking sector contagion has been largely contained, we are still not out of the woods yet. Aside from tighter credit conditions, headwinds from the lagged impact of 500 bps of interest rate hikes remain. With that said, we are moving towards high quality companies with high Return to Equity (ROEs) and strong cash flow. On the other side of the Atlantic, Europe equities are also facing growth headwinds with its economy losing momentum after a strong 1Q 2023, as the tailwinds from declining energy prices fade.
Within Asia equities, we are positive on Japan. After many years of lacklustre performance, tides are finally turning. First, corporate governance reforms are underway – the Tokyo Stock Exchange has taken steps to urge companies to improve corporate value and accountability to shareholders. We expect Japanese corporates to deliver the highest dividends and share buybacks for fiscal year 2022. Second, inflation is finally catching up in Japan. Wages are rising, especially after the latest spring wage negotiations have been passed. Consumer spending is bouncing back post pandemic recovery, while inbound tourism is returning meaningfully. The government has also recently approved the country’s first casino in Osaka, demonstrating their renewed vigour to rejuvenate the tourism industry. Indeed, the rally year-to-date (YTD) has reflected investors’ optimism and interest in the market.
The China market has returned a big chunk of its gains since its 60% rally post reopening last October. Mixed signals from recent high frequency data suggest that growth momentum may have stalled. However, we believe that markets may be too bearish at the moment, and that the current negative sentiment has been priced in. Valuations are attractive with higher growth prospects versus its developed market peers. That said, we are mindful of rising geopolitical tensions that could further erode confidence and cap meaningful upside potential.
COMMODITIES
As the Fed starts to pause its rate hiking cycle, other central banks continue to tighten. Therefore, we expect the US dollar to continue drifting lower through the year. A weakening dollar should support Gold, which also serves as a hedge against inflation. Indeed, during the banking turmoil in March, Gold held its ground as the dollar softened. Furthermore, central banks are diversifying their reserves and increasing their holdings to Gold. With that said, we look to increase our exposure to Gold.
KEY RISKS
First, inflation stays elevated, and the Fed is forced to tighten further, leading to a sharp slowdown. Second, China’s economy shows further signs of faltering, without any broad-based stimulus by the government. Third, geopolitical tensions continue to shake our increasingly deglobalizing world, causing more supply chain disruptions.
CONCLUSION
Classic LEGO pieces are made of Acrylonitrile Butadiene Styrene (ABS), a type of hard, highly durable and scratch-resistant plastic. Similar to LEGO building blocks, we select high quality, diversified building blocks in our asset allocation strategy, as we endeavour to construct resilient portfolios for investors to tide through all seasons of volatility.
All data are sourced from Lion Global Investors and Bloomberg as at 13 July 2023 unless otherwise stated.
Disclaimer
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