INVESTING: Wait and buy on pullbacks

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on August 13, 2018 - August 19, 2018.
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Investors should not withdraw from the market because value is expected to emerge from a possible correction in the global markets this year. However, they must tread carefully and be nimble enough to take advantage of the opportunities that arise, says OCBC Singapore vice-president and senior investment strategist Vasu Menon.

The year has seen bouts of volatility triggered by a brewing trade war, tightening monetary conditions and expectations of an imminent recession. “The recession may happen in 2020 or 2021, but you would not want to get out of the market completely. Keep some dry powder,” says Menon.

“You would want to invest in the equity markets, but space out your investments over the next nine months because any sharp pullbacks will present interesting entry levels. Asian equities, for example, have already pulled back 15%. If there is a further pullback, they could be quite interesting.”

While political uncertainty is negatively impacting the markets, the economic fundamentals remain strong. For instance, the US saw its weekly jobless claims hit a 48½-year low in July and 78% of corporate earnings beat analyst expectations in the first quarter, according to FactSet.

“On sharp pullbacks, buy gradually. The market is currently very dynamic. You have to go with where the correction has taken place and look at the underlying fundamentals,” says Menon.

But investors will have to be cautious this year. The International Monetary Fund released an economic outlook in July that highlighted how rising trade tensions could derail growth prospects and present risks to investors. Also, some observers are concerned about a possible recession since the US has been experiencing one of the longest economic expansions on record over the last nine years and the tightening monetary policies may finally end this economic cycle.

In the light of this situation, investors should diversify and evaluate their portfolios more carefully, Menon suggests. “I think the risk of a full-blown trade war between the US and China has escalated, with US President Donald Trump threatening to inflict more pain on China by hiking tariffs to get it to concede and negotiate for better terms. Neither country is showing signs of backing down. Instead, they have upped the ante with more aggressive rhetoric. The risk of miscalculation denting global growth has increased. So, investors need to tread carefully, invest gradually and be nimble,” he says.

Menon prefers high-yield bonds over investment-grade ones as they offer a buffer to rising interest rates. He says investors should also buy bonds with tenors of five years or less to mitigate the impact of rising interest rates. The key is to diversify your portfolio with bonds and equities.

“If equity markets plunge another 10% to 15%, then it becomes a very interesting opportunity. So, you should buy stocks with a medium-term view of two years or so and you can probably make decent returns. But you will not be able to make 30% to 40% per annum anymore. You could probably make 10% to 15% per annum if you buy during sharp dips,” says Menon.

“However, it is hard to catch the bottom. A good strategy would be to buy gradually over the next six to nine months and buy more if the markets correct sharply.”

He adds that investors should review their portfolios every quarter and make adjustments if there is a significant change in the fundamentals, given the uncertainty over the unfolding trade war.

A sector that will benefit from the rising interest rate environment is financial, as banks are given pricing power. In terms of geographies, Europe and Asia ex-Japan have interesting opportunities, according to Menon.

For instance, Europe has been underperforming and the market may dip in September, depending on how the populist sentiment in Italy plays out post-election. In May, Italians elected a populist party to power, a first for a Western European country. The party had initially campaigned to exit the European Union, but has now decided to push for reforms from within, according to reports.

“In September, the Italian government will announce its budget. Let’s see if it results in Italy clashing with the EU. If it does, then the market may see more pullback and this could make Europe more attractive,” says Menon.

On the other hand, investors could wait for another pullback in the Asia ex-Japan market. The price-earnings ratio (PER) for the region is still high, according to Menon, but lingering risks may bring down prices. For instance, a full-blown trade war will impact countries such as South Korea, Taiwan, Singapore and Malaysia, which export to China, the EU and the US. Indonesia, the Philippines and India also have current account deficits and could be negatively impacted by a strengthening US dollar.

“Investors should take a diversified approach (to be exposed to each market). Asia ex-Japan has pulled back quite a lot this year and I think the region is starting to look attractive,” says Menon.

“But if you look at the PER, it is still not there yet. If I do a PER band, you will see that the PER is sitting just below the average line. It has not gone into -1 standard deviation territory. If it does, then the market looks attractive. If it is -2, then it is a compelling buy.”

In terms of the Malaysian market, he observes that more policy details have to be unveiled by the new government before the market can look attractive.

An asset class that may offer interesting opportunities is consumer discretionary goods. US tax cuts, tight job markets and rising wages globally are expected to fuel consumer spending, according to Menon. The strong economic fundamentals may translate into opportunities in this cyclical sector.

“We are not suggesting that you throw all your money here, but we think this sector offers quite interesting fundamentals. It is more cyclical, but you should not avoid it altogether. I think when the markets eventually come down and the trade war saga blows over, it will be back to fundamentals again,” says Menon.

He recommends that investors gain exposure to these themes through actively managed funds that are well diversified. Taking individual stock risks, he reckons, could be tricky in this uncertain environment. Investors can put their money in exchange-traded funds (ETF) and robo-advisory platforms, but they should be cognisant that during periods of market volatility, active investing may make more sense, he says.

“For [plain-vanilla index-hugging] ETFs, you are buying into an index, you are taking a market view. But sometimes, it is not enough. You need to go one level below and pick stocks because not all of them will perform in the same way. You need active fund managers to see if there is value emerging because the market over-reacted, which you cannot get with an ETF,” says Menon.

During a bear market, investors may need more hand-holding from fund managers, who can explain the situation to them. “You need the human touch. Otherwise, investors may pull out and the company loses the client. That is the risk of robo-advisors in a down market,” he says.

“I have spent the last 35 to 40 years investing and I have seen how relationship managers and advisers play a role in calming nerves and getting investors not to lose sight of the longer-term fundamentals during down markets. The worst thing to do is sell out when everything is down, only to see the market revive later.”

Most robo-advisors have yet to go through a recession and remain untested in such situations. “Now is a test in the volatile market. Can robo-advisors take in all the information and tell you where the opportunities are? In a down market, you need the human touch,” says Menon.