Recent Turbulence and Our Portfolio Strategy Response

Genevieve Signoret

(Hay una versión en español de este artículo aquí.)

Background

First off, we want to remind you that here you can find the current macro-market scenarios set forth by our sister company, TransEconomics, where we build multiple scenarios to support investment strategies maximally robust against an entire gamut of potential market conditions. A refined version of the tail risks mentioned in that article can be found here.

Jitters

Markets have displayed some jitters since last week, the global stock index having fallen by 3.5% since April 9 and the global fixed-income security index Bloomberg Global Aggregate Float Adjusted Composite Index down 2.2%.

It would be premature to decide whether what the market is undergoing is the start of a correction or merely the onset of a few days of turbulence. A correction, recall, temporarily interrupts what remains an upward trend (bull market), with declines in major stock indices of 10% or more. Corrections last, on average, about three months.

Our Hypothesis and Its Support

Our hypothesis is that the primary source of market nervousness prevailing since last week is not Iran’s attack on Israel that occurred over the weekend of April 13 but rather an adjustment of expectations as to when the Fed will begin to cut interest rates. The evidence is as follows:

• The latest inflation reports in the U.S. and communication from the Fed indicate that rate cuts will be delayed. Both these inflation reports and this communication started well before the weekend of April 13.
• Furthermore, these reports and this communication triggered a restart of a positive correlations between fixed income and the variable: both resumed co-movement before April 13.
• Already beginning on April 1, when Israel killed an Iranian military leader in the Iranian territory that is its embassy in Damascus, market participants had been expecting a response from Iran.
• Iran did three things to limit the probability of escalation:
  1. (According to Iran) it announced its attack 72 hours in advance.
  2. Its projectiles advanced slowly.
  3. It avoided Israeli population centers, targeting military installations alone.

What It Means for our Portfolio Strategies

Given the persistent inflation at rates higher than central banks’ targets in developed markets and the consequent delay in rate cuts, for short-term investment horizons (less than two years) or for risk-averse clients with medium-term horizons (two to five years), we are reducing the average duration of our government bond holdings to two years or less.