TIPS on how to safeguard a portfolio from spikes in volatility could have saved investors a lot of money after a perfect storm of events sent markets reeling last week. A meltdown in Greece, a “fat finger” problem in the US and a hung parliament in the UK served as reminders that there are many unresolved issues – both political and economic – out there waiting to upset the markets.
But how can investors position their portfolios? Two investment banks have given their tuppences worth. Firstly UBS recommends that investors have a balanced allocation between cyclical and defensive sectors and it favours overweight positions in technology, healthcare, consumer staples and energy.
But crucial to performance is the quality of the stock, which UBS measures based on valuation, profitability, growth and leverage. During the post-crash equities boom in 2009, high-beta and riskier stocks outperformed the general market. Not any more, say UBS analysts. On a price-to-book value (PBV) basis, defensives look cheaper than cyclical stocks (see the chart opposite) making them the more expedient choice for the prudent investor.
This is good news for energy and utility companies and consumer staples such as supermarkets, which are traditionally considered safer investments in turbulent times. Conversely, it is bad news for industrial stocks that are typically cyclical in nature, such as car manufacturers, airlines, construction companies and the leisure sector.
The second piece of advice from the banks came from Morgan Stanley. It sees the recent weakness in the markets as a good buying opportunity. Equities remain in a bull market cycle, it wrote in a recent note to clients, and it remains optimistic on earnings growth. Like UBS, Morgan Stanley also favours defensives over cyclical stocks. Its favourite sectors include energy, healthcare, materials and consumer staples. In contrast, sectors that it is avoiding include financials, IT and consumer discretionary.
JAPAN LOOKS GOOD VALUE
Contracts for difference (CFD) traders may also want to look at where they choose to invest to ensure they get the best value. UBS believes that emerging markets and Japan are the best place for investors to find bargains and growth potential. It says that these regions have underperformed their counterparts in the West. It also argued that the Bank of Japan’s stimulus measures, announced last month, should boost domestic consumption and help fuel equity market gains in Tokyo.
While UBS is increasing its position in emerging markets and Japanese stocks, it is simultaneously reducing its exposure to UK and European equities. Although UK and European companies might have exposure to global sources of earnings, UBS argues that for equities listed in these regions, risk premiums are “apt to remain elevated given worries about sovereign debt funding, health of banks, and long-term growth prospects”.
Choosing defensive stocks that are good value and that are listed outside of Europe is one way that investors can ensure their portfolios are sealed, watertight and their sails are reefed as they try to navigate future economic and political storms.