'A defensive tilt but we’re not preparing for a recession'

Portfolio manager on the ‘negative skew’ out there and why he is a long way from maximum risk-off

'A defensive tilt but we’re not preparing for a recession'

Contrary to some reports, most money managers seem in no hurry to throw the baby out with the bathwater when it comes to risk assets.

This month’s sell-off, and the disparity between the US Federal Reserve and the markets over rate cuts, sparked fears that a recession was around the corner. Throw in the trade tensions, the length of the expansion and the precarious nature of the global economy and you could be forgiven for thinking the worst.

Michael Greenberg, VP and portfolio manager at Franklin Templeton Multi-Asset Solutions, sought to quell any overreaction and told WP that it’s not all doom and gloom despite concerns about potential downside scenarios.

He pointed to the fact the Fed are cutting rates – albeit not as aggressively as the markets want – and that we are living in a relatively easy monetary policy environment given the direction of other major central banks.

On the trade issue, too, Greenberg believes it makes little sense for Trump to head into the 2020 election with a recession on his hands and is optimistic that the threat of tariffs will quieten down for a while.

All of this has impacted his portfolio positioning. He has employed a defensive tilt but one that is far from preparing for an imminent recession, which is not his base case.

He said: “There's maybe a bit of a skew in the distribution of outcomes to the negative side as far as how the economy could unfold.

“We are a little bit underweight risk and we do that in a few ways. From an asset allocation standpoint, we're underweight our equity targets and overweight fixed income but within that we have been, at the margin, increasing duration within our fixed income and decreasing credit in more of the safe parts of the fixed income market.

“We have been favouring, at the margin, those [funds] that are a little bit more defensive in our factor-based strategies. We are focusing on those that have a little bit more of a quality bias that tend to hold up better.

“We're definitely tilting a little bit more defensively in the portfolios, but we're no means pedal to the metal as far as the maximum defensiveness we could get within the portfolio. We can definitely reduce equities more, there's  definitely more duration we could add and there's definitely more defensive strategies we could add to the portfolio, if we really want to get less aggressive.”

An overreaction to this month’s market swing could be detrimental to your portfolio and Greenberg said that, after the yield curve inverts, equity markets actually tend to be strong. While a great tool for investors, the inversion is no great recession timing predictor but it does suggest that a more severe growth slowdown is on the horizon.

What is beyond doubt is that the inversion was confirmation of growing fears of a major downturn. The weakness in the economy is a non-domestic affair, with US and Canadian consumer numbers looking respectable. The problem is, however, that trade uncertainty is compounding an industrial production or manufacturing slowdown.

Greenberg said: “If it was limited to just that, you could probably skirt a recession but the problem is it’s like dominoes that can fall one after the other.

“Trade uncertainty obviously creates demand uncertainty and that’s a challenge for CapEx, for margins and for profits at the corporate level. That can eventually lead to cost-cutting and layoffs, which eventually can lead to consumer sentiment and consumer weakness, which is the last leg of the stool that, at this point, is still supporting the economy.

“The concern we have is that Europe, specifically Germany, is very weak. Obviously, it’s tied to a very open economy and it’s very tied to exports. Autos is a big part of the German economy and that looks like it's on President Trump's list of concerns and may get a tweet or two over the next couple of months that could cause some weakness.

“Japan has a potential value-added tax that they're launching soon. It's another 2% tax, which may sound small but that could be a headwind for the Japanese consumer. Historically, when they’ve raised that tax, it’s led to at least a shallow recession. The concerns outside of the US, for us, are still there and that’s reason to be a little bit worried about the global economy and potential recession risk.”

The counter to all this – and why it’s not all doom and gloom right now in Greenberg’s opinion – is that consumer and job data in North America has been strong; people are working and seeing some wage growth.

The portfolio manager added: “[But] that won’t hold up forever. If we continue to have all this uncertainty and if corporations see profit growth slow and margins slow, they at some point will retrench and potentially start to lay off workers. Then you could that leg of the stool fall but at this point, that's not happening.”