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Market View

One attraction of actively managed multi-asset funds is their flexibility to capitalize on divergent performance across asset classes through tactical allocation.

According to Morgan Stanley, assets managed by multi-asset funds have risen by more than $2 trillion since the global financial crisis (see Chart 1), and such funds drew more than half of the total mutual-fund inflows last year (see Chart 2)—with good reason: many investors are keen to delegate asset-allocation decisions to the experts.

Actively managed multi-asset funds can make quick tactical changes to their allocations when opportunities arise, enabling managers to take advantage of relative value across a wide range of asset classes—or to mitigate risk, when needed. 

Just ask Giulio Martini, Lord Abbett Director of Strategic Asset Allocation.  With more than 30 years of experience investing across the global capital markets, Martini is constantly monitoring key trends and developments that concern asset allocators; and while his overall outlook on the state of the global economy remains positive, his highly collaborative intraday e-mails alert investment colleagues to important new data for their consideration.

On April 10, for example, Martini was quick to flag an ironic twist in the consumer sector: Although consumer confidence surged to its post-tech bubble highs after the election in November 2016, the rise in confidence among higher earners is happening as discretionary components of consumer spending are slowing down sharply. Households may feel more optimistic about the future, and have expressed an increased willingness to spend, but this sentiment has yet to be translated into accelerating purchases, Martini said.

The following morning (April 11), Martini noted increasing volatility in the eurozone, as the first round of the French election approaches (on April 23). Key eurozone yield spreads were widening.  But in his opinion, very strong, recent economic data make the increase in macro volatility less daunting.  

 

Chart 1. Multi-Asset Funds Have Grown to More Than $3 Trillion Since the Global Financial Crisis


Source: Morgan Stanley Research. For illustrative purposes only.

Chart 2.  Multi-Asset Funds Accounted for More Than Half of Total Mutual Fund Inflows Last Year


Source: Morgan Stanley Research. For illustrative purposes only.

 

Allocation Cogitation  
Martini has ginned up enthusiasm about a global economic recovery that may be long in duration, but still has room to run. Of course, there are risks to that thesis (as discussed below), but in Martini’s view, the upside potential may outweigh them.  “The recovery is old, but it’s immature in terms of gross domestic product [GDP] growth, because so much uncertainty dampened investment for years,” he said.  “So, we’re in an unusual situation where a recovery that’s long in the tooth has the potential to rejuvenate itself and surprise people.” (See Chart 3.)

Martini is encouraged by signs that fiscal policies around the world are turning neutral, if not downright stimulative, after several years of poorly timed measures that repressed economic growth. Also supporting the economic recovery is a rebound in global trade, led by Asia, and a revival in the more durable macroeconomic datapoints that Martini follows, such as those related to infrastructure spending and housing. For example, U.S. housing starts for the last few months are back to 1.2–1.3 million, which is the first time in this recovery that they are in line with household formations in the United States.

What buoys his continued optimism about the markets, though, is the amount of cash on the sidelines, as evidenced by the number of big investors who maintained very low risk exposures through what has turned out to be one of the great bull markets in history; they were skeptical about economic growth and convinced that the financial markets were held up by overly stimulative monetary policy.

Martini is bemused when he recalls some of the Cassandras who repeatedly suggested markets would tank when the U.S. Federal Reserve (Fed) began to tighten.  “Well, let’s just say the Fed started tightening in October 2013, when it started tapering asset purchases, and has raised interest rates three times since then—yet we saw markets rise rather significantly through all that,” Martini said.

All of which underscores Martini’s belief that the markets will continue to do well as long as the economic recovery stays on track, and he does not see the next downturn in the global economy on the horizon yet. 

“If the economy and corporate earnings continue to grow, if you have diminishing bankruptcy risk, if inflationary pressures remain low, and if bond yields are falling or only rising modestly, as I expect, you’re going to have increases in stock prices,” Martini said.   

If you accept those premises, what that then suggests for proper asset allocation is to favor assets that embed relatively high risk premiums, such as tilting toward stocks over bonds or high-yield credit over more rate-sensitive government debt. “Ultimately, any asset that has a future return stream associated with it is defined by that expected return stream and the rate you’re going to discount it at,” Martini added. “If economic growth is leading to improving earnings, and the discount rate is just going up gradually, that’s a recipe for getting rewarded well for risk exposure.”

Martini also noted that when measuring relative value within asset classes, non-U.S. stocks are selling at an attractive discount to U.S. stocks, especially in Europe, where an unexpectedly strong economic recovery has taken hold, driving earnings growth sharply above expectations and unemployment to its lowest level since 2009. However, if the U.S. dollar continues its uptrend, as Martini expects, currency hedging will be imperative to preserve the local market returns.

 

Chart 3.  Cumulative GDP Growth Since 2007 Has Been Abnormally Slow 

Source: MSCI, Bloomberg, and Lord Abbett. Data as of January 31, 2017. Past performance is no guarantee of future results.  The information provided is for illustrative purposes only and does not represent any portfolio managed by Lord Abbett or any particular investment. 

Chart 4.  Global Growth Now Appears Poised to Rise


Source: Bloomberg and Now-Casting.com. Data as of February 28, 2017.  Past performance is no guarantee of future results.  The information provided is for illustrative purposes only and does not represent any portfolio managed by Lord Abbett or any particular investment. Market estimates may not be realized.

 

Martini also challenges the current notion that the U.S. markets rallied on optimistic policy assumptions for the new administration in Washington. The main drivers in his view were: a big earnings recovery in the second half of 2016; better than anticipated economic growth; the end of deflation fears; and receding financial risks in the energy sector. The potential effects of President Trump’s policies articulated during the campaign (but not yet implemented) remain to be seen, which underscores a nagging uncertainty. Suffice it to say that tax reform and deregulation would be good for the markets and certain industries, while protectionism and tougher immigration policies could be negatives for other sectors of the economy.

Weighing the Risks 
What might signal a downturn on the horizon, prompting investors to de-risk?  “You’d have to see strong inflation pressure start to emerge,” said Martini. “But I see very little hint of that. Core inflation is still 1.7–2%, which is basically the Fed’s target.  Wage pressure is very hard to find, even with the unemployment rate at 4.5% and the quits rate rising, so I think you’d really have to stretch to find any sign of an inflationary process beginning, which just means that yields will go up very gradually.”

“At some point, the tension between rising yields and growing earnings is going to tilt in favor of rising yields, thereby pulling asset prices down. But until inflation becomes a problem, I don’t think we’re there,” Martini said.

 

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