Investors live in a world of worry these days. The US-China trade war, Brexit, a potential recession in Europe and a slowing global economy are all spreading fear. Throw in a host of geopolitical flashpoints, including the stand-off with Iran, protests in Hong Kong and increased tensions between India and Pakistan over Kashmir, and now feels like a wise time to run for cover.
August is typically bad for stocks, being the worst performing month on average over the last three decades. Investors are also wary of the “September effect”, with the Dow and S&P both falling on average over the last 50 years, while the 1929 Wall Street Crash and Black Monday in 1987 both happened in October. Current anxieties suggest we could be in for another bumpy autumn, so it may be worth preparing your portfolio for what happens next.
The first thing to say is, don't panic. Analysts have been warning of a market crash ever since the last one, but instead investors have enjoyed the longest bull run in history. This could be a case of rinse and repeat.
Be aware of global factors
Joshua Mahony, senior market analyst at online trading platform IG, said much now hangs on the outcome of US-China trade talks next month.
Here, the mood swings from one day to the next. Last week, investors were briefly optimistic as US President Donald Trump said he was delaying tariffs on Chinese-manufactured goods such as laptops and cell phones until December 15.
“The upbeat response drove up share prices, as well as the Australian dollar, crude oil and the Chinese yuan, which should all benefit if trade tensions ease and the global economy picks up,” Mr Mahony says.
It didn’t last, though. The next day, Mr Trump and China were at loggerheads again and trade talks look set to drag on, while the October 31 Brexit deadline is also fraying nerves.
To further complicate matters, we live in a world where bad economic news can be good for stock markets, because it encourages central banks such as the US Federal Reserve and European Central Bank to ease monetary policy. The Fed cut the benchmark lending rate last month for the first time in 11 years, and there could be more cuts to come if the economic outlook worsens.
Jahangir Aka, managing director for the Middle East and Africa at fund manager Neuberger Berman, anticipates a “global soft landing of slowing but stabilising growth and moderate inflation” as central banks become more accommodating.
Mr Aka says the world should avoid outright recession but markets remain vulnerable after this year’s strong rally, with the US S&P 500 topping 3000 in July for the first time in history. “Much of the good news of stabilising growth and lower rates are now priced in, and I expect to see elevated volatility given the overall late-cycle environment and wider uncertainty,” he says.
Arun Leslie John, chief market analyst at Century Financial, says a European manufacturing slump, slowing Chinese and Indian economies, Brexit and a potential US recession are rightly causing anxiety. “In the US, S&P 500 companies are expected to post second consecutive quarter of earnings decline for the first time since 2016 and this portends ill for stock markets.”
US rate cuts will help, but they “seem to be more like an effort to prevent the impending slowdown rather than boosting the growth”, he says.
Take a defensive strategy
Maurice Gravier, chief investment officer at Emirates NBD Group, says current stock valuations are elevated, and this will squeeze long-term returns. “The future will be frugal, with the risk of a very serious crash in the next two to three years.”
Emirates NBD started this year in an optimistic mood, selling low-risk government bonds to take more risks on equities, but Mr Gravier is turning defensive again.
He sees “no fundamental upside potential in the short-term for most asset classes, especially in developed markets”, although monetary easing should help. “We have been taking profits on equities, and more recently gold, and keeping the proceeds in cash.”
The bank aims to remain “contrarian” over the months ahead, selling equities when markets are strong, buying on weakness.
Diversify your portfolio
Mr Gravier says “diversification and discipline are now paramount” and private investors should check they have the right asset allocation.
Asset allocation involves building a balanced portfolio with exposure to all the main asset classes, such as shares, bonds, cash, property, commodities and gold, so that if one falls, another can compensate.
The mix should reflect your long-term goals and attitude to risk – for example, younger investors should have more money in stocks, and shift gradually into bonds as they get older, Mr Gravier says.
If your portfolio is mostly in high-risk assets, now is a good time to take profits, he adds. “If it is mostly defensive, it may be too late to join the party, as the risk/reward ratio is simply not worth it, but again, it’s a good time to diversify.”
Most important of all, avoid being a forced seller in the volatile months ahead. “If you are likely to need your money in the next two years, don’t take any risks with it.”
Mr Aka also recommends maintaining a balanced asset allocation, in line with your attitude to risk, as now is not the time to take “big directional bets in stock or bond markets”.
He suggests upping your exposure to parts of the world that have lagged this year as they may now offer better relative value, for example, emerging markets, Europe (excluding the UK) and Japan. “For diversification, consider government bonds primarily US Treasuries.”
One can invest in these markets through low-cost exchange traded funds (ETFs), for example, Vanguard FTSE Emerging Markets (VFEM), SPDR EURO STOXX 50 (FEZ) or iShares MSCI Japan UCITS ETF (CJPU), while one can gain exposure to US government bonds through the USD Treasury Bond UCITS ETF (VDTY).
Avoid riskier assets
Mr Leslie John suggests avoiding riskier assets such as small cap stocks, junk bonds, volatile technology companies and commodities.
It is not necessary to abandon equities altogether, but it is a good idea to lift one's exposure to defensive companies that can deliver stable earnings at every phase of the business cycle, which makes them particularly attractive during a recession. “Large caps, defined as companies with a market capitalisation of more than $10 billion (Dh36.7bn), are far better placed to survive than mid-caps or small caps.”
Utilities such as water and electricity companies are traditionally defensive, as are healthcare stocks, he adds.
With interest rates likely to fall, dividend stocks will remain attractive, and Mr Leslie John tips the SPDR S&P US Dividend Aristocrats UCITS ETF (USDV), which targets companies that have raised their dividends for 25 consecutive years. “Dividend aristocrats such as Coca Cola, AT&T and Abbott Laboratories have outperformed S&P 500 over the long term.”
Stay the course
Unless you are a day trader, you don't have to follow every twist and turn of global events such as trade talks and Brexit.
Mark Chahwan, chief executive of investment platform Sarwa, says the key to successful investing is to last the course when the going gets tough.
“In the face of market turmoil, it's natural to want to get out of the market but provided you do not need the money in the near future, you should stay invested during a dip. It sounds counterintuitive, but it works.”