Buffettisms are de rigueur within our industry, with many repeating the pearls of wisdom emanating from Omaha. Warren Buffett’s following among some of my colleagues is so fervent that they would have his picture on the office wall. I draw a line here, but believe his quotes have great merit.
My current favourite is “Be fearful when others are greedy and greedy when others are fearful.” As a real return investor I always have more than a weather eye on the downside. This means that I can painfully stomach modest short-term absolute loss, but I cannot hide behind an index and point to relative outperformance in a falling market.
‘Be fearful when others are greedy’ resonates at present. Market valuations look stretched on several metrics, with many playing a relative value game between regions and asset classes.
My nagging concern is whether this is now the time to take risk off the table. While catching the top and bottom of markets is more a matter of luck than skill, I do believe that trends can be identified but nerve is required. We have been modestly reducing equity risk over the past 18 months, but is the time ripe to do more?
I believe the short answer is no. While equity valuations do not offer compelling value, they still offer reasonable value, particularly European equities, for example. I realise this is a consensual view but strong GDP growth for Europe and the currency are appealing.
There are warning signs on the horizon, most notably the slowdown of the consumer in the UK, but globally the consumer still appears to be in rude health. Record low unemployment should be leading to some wage inflation, but overall inflation is still manageable.
GDP growth is not going to hit pre-financial crisis levels but remains attractive in the lower-growth environment due to excess capacity within the global economy. Stock dispersion will continue to elevate: it will not be linear, but may lead to further opportunities for active managers.
I am contemplating our next move, which I expect to be to a much more defensive position. Our playbook for this is relatively simple: increase cash for dry powder, employ more absolutist strategies (long/short within equities), and a greater use of alternatives. While global macro managers have had a painful past couple of years, I remain convinced they still have a place within diversified portfolios.
Quantitative easing (QE) and political events have not favoured these strategies but, as QE begins to be unwound and the political environment stabilises, they should be able to provide attractive and uncorrelated returns. Alternative income-producing assets, such as infrastructure, have proven to be very successful and they will remain attractive due to the structural demand for income in a lower-for-longer environment and changes in demographics.
Exogenous shocks aside, markets will continue to drift higher over the short term, due to optimism driven by disruptive themes.
Although returns will look meek compared with recent history, they will be positive. I am becoming more cautious on the outlook for risk assets as current pricing would suggest that greed is at the forefront. I would characterise my approach as having my finger hovering over the defensive trigger but it being too early to pull.