Playing defensive: Time to hedge against rising uncertainty.
    Category: Smart Investing 2016 By : Forbes Indonesia team Read : 477 Date : Monday, June 20, 2016 - 03:07:12

    March marked seven years of the U.S. equity bull market. If the S&P500 index holds up until the end of May, investors will celebrate the second-longest bull market in U.S. history. This scenario begs the inevitable question: is this bull run getting too long in the tooth? And, if so, how should we hedge against an eventual downturn?  

    The first question is always difficult to answer with any degree of certainty. This difficulty became apparent in the first quarter when U.S. stocks plunged more than 10% from the start of the year until mid-February, only to bounce back more than 13% to end the quarter with net gains. The factors behind the early year sell-off—concerns about slowing growth in the U.S. and China, falling commodity prices and worries about a sharp devaluation in the Chinese currency—also led to the subsequent rebound as those concerns eased, helped in no small measure by increasingly accommodative central banks.

    However, one should not be lulled into complacency by the recovery in riskier assets, which included a strong rebound in commodities, emerging market stocks and higher yielding bonds from oversold levels. In our view, the latest rally masks an increasingly uncertain outlook for global growth and earnings. Given this, we believe the rally offers an opportunity to partially rebalance out of equities into more defensive assets such as bonds and alternative strategies which are less likely to move in tandem with equity markets.

    U.S. Expansion Continues

    The U.S. economic expansion since the 2008-09 financial crisis is already the fourth longest in the past century. So, history is not on our side. Economic expansions are typically longer following a major downturn as providers of goods and services cater to pent-up demand. In the current context, the U.S. economy has been recovering from the most prolonged and deepest recession since the Great Depression as demand for housing, automobiles and other consumer durables are met.

    Moreover, with borrowing costs near record lows, inflation still subdued and central banks worldwide staying highly accommodative, the U.S. economy continues to generate jobs at a steady pace, keeping the consumer-driven economy humming for a while longer. The recent weakness in the USD and recovery in oil prices also reduce drag on U.S. export and energy sectors. 

    Meanwhile, China’s economy appears to be stabilizing—note the nascent recovery in manufacturing and services sector business confidence, strong pick up in the property market as well as exports and the pause in capital outflows in March. With policymakers in Beijing cranking up fiscal and monetary gears to defend growth—temporarily at the cost of reforms—the economy is likely to avoid a hard landing.   

    Warning signs

    Nevertheless, warning signs are emanating from the U.S. corporate sector. U.S. corporate earnings are forecast to have fallen by 8% in Q1 from a year ago. That would make it the third straight quarter of earnings decline. Although energy and materials sectors are largely to blame, there are signs of broad-based weakness in demand—corporate revenues are estimated to have fallen for the fifth straight quarter. For sure, there are tentative signs of stabilization in full-year earnings expectations after several months of downgrades, but this needs to be watched closely