IT’S ABOUT INCOME AND QUALITY FOR 3Q 2019

Navigating 3Q 2019 as volatility persists

The current economic expansion in the US is the longest on record2. Central banks around the world have stayed accommodative, which may prolong this late cycle.

Still, the global growth outlook has become more challenging entering the second half as business confidence was affected by escalating trade tensions. Although the US and China have agreed to resume negotiations, major hurdles remain as fundamental issues remain unresolved. The US and China, the world’s two economic heavyweights, represent over 40% of global gross domestic product3.

Given the twists and turns in the past 18 months, an agreement may not deliver a swift recovery in corporate sentiment.

The effect of protectionism on US imports from China4

US imports
US goods imports, June 2018 = 100

The past few months also reminded investors the US’ turn toward protectionism is not just a one-country dynamic nor a hurdle that markets will be able to clear easily.

Seek a consistent income stream

In our view, yields are no longer expected to rise and may fall further as investors are expecting the Federal Reserve to cut rate. Should that occur, other global central banks will likely follow suit.

While the prospects of lower interest rates may bolster risk assets, the issues that are driving rates down suggest a more defensive strategy going forward, one that emphasises income and quality.

Allocating to fixed income could help balance riskier assets in portfolios, as shown in the chart5 below.

Yields and correlations of fixed income returns to equities
Yield, 10-year correlation between monthly total returns

In a low-yield environment, bonds are likely to benefit through either price appreciation or even relatively attractive coupons in some fixed income sectors.

Go for quality

Although the global economy is slowing and corporate earnings remain subdued, we believe the outlook may still be positive in the third quarter. Thus, an outright rotation into defensive equities seems premature in our opinion.

A defensive hue should be applied to equity allocation, with a focus on quality and income. Income investors could still find attractive dividend-paying stocks across global equity markets, as shown below6.

Number of companies yielding greater than 3% by region
Constituents of MSCI AC World Index

Conclusion

Investors could face a more challenging investment environment in the second half of 2019. In a late cycle, a multi-asset strategy1 with income-generating assets could be a key part of investors’ portfolios to stay agile and resilient.

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