The current macro economic environment is dangerous for investors, who must be intentional and goal focussed, Morningstar has said.
In a research note this week (March 21), the company said that fears of the dreaded “triple r” are growing, which is a recession, rising rates and a loss in real household incomes.
The war in Ukraine will most likely lead to secondary-effect risks, such as an impact on commodity prices, the report said, highlighting that “several respected voices” have noted we are seeing the pre-conditions for a global recession.
Diversification should go beyond spreading your eggs across multiple basketsDan Kemp, MorningstarHowever, the authors, Dan Kemp, chief investment officer, Mark Preskett, senior portfolio manager, and Ricky Williamson, head of outcome-based strategies at Morningstar, said investors should remember that the link between geopolitical conflict and investment markets is notoriously weak, as is that between economic recessions and investment markets.
They said investors can add value during economic weakness in two ways, firstly by taking advantage of negative sentiment by buying “unloved” assets, and secondly by diversifying against risk factors to reduce the impact of said event.
“Putting aside the eroding challenges of inflation, we believe investors can benefit by buying into negative sentiment, especially if they are willing to take a long-term view.
“The long-term nature should not be underestimated given that most economic recessions prove temporary and are recoverable in the investor timeframe.”
When looking to diversify, the authors said, they say it should go beyond “spreading your eggs across multiple baskets”.
It instead is about understanding the underlying risks to assets, whether that be economic or market-risk factors, and not just volatility or correlations as these can change quickly and drastically.
For example, they said, corporate bonds and equity markets can behave very differently, yet both are vulnerable to an economic shock as damage to corporate earnings could cause equities to fall while bond spreads would widen.
So this offers less diversification than holding equities with unrelated assets, such as inflation-linked bonds or nominal government bonds.
“The message is to diversity against fundamental risks and be very intentional with how you are diversifying if you want to reduce the impact of an economic recession.”
Economic turbulence
Global markets have swung wildly since the start of the year as inflation has continued to soar and central bank continue their interest rate rises.
Putin's invasion of Ukraine at the end of February caused further turmoil, with markets suffering from a wide range of knock-on effects such as booming commodity prices and economic and financial sanctions on Russia.
sally.hickey@ft.com
