Hedging Your Risks
Uncertainty is an ever-present fact of life but trade conflicts in varying forms make this a particularly confounding time for investors. CMC Markets discuss how you can weather the storm
How to weather the storm financially in these confounding economic and political times
Tensions between the US and mainland China show little sign of dissipating, which means we can expect volatility in the markets well into next year. Neither side is likely to emerge victorious and indeed their wrangling, which is causing chaos by upending all the trade rules that we have become accustomed to over the past several decades, threatens to implicate all members of the global supply chain.
At worst, it will break this chain completely, with consequences the likes of which we haven’t seen since the 2008 financial crisis.
A parallel trade war of sorts is playing out between the UK and the EU. Whatever form Brexit takes, the new trading relationship between the two bodies will take months or even years to define, subjecting both to economic headwinds. We can expect the UK’S economy, in particular, to take several years to recover.
Added to this, global investors face the effects of seemingly unresolvable fighting in the Middle East, a new phase in the US business cycle, and mainland China’s slowing economy. None of these are isolated; all must be viewed as interconnected moving parts.
“In this climate, investors need to think more carefully than usual about how best to diversify their investments between safe havens and riskier assets,” says Biyi Cheng, head of Greater China at CMC Markets, a leading provider of online retail financial services.
“INVESTORS ARE ADVISED TO LOOK BACK AT AND LEARN FROM PAST MISTAKES MADE IN TIMES OF EXTREME VOLATILITY”
In a sideways market like the one that now prevails, the appetite for risk is invariably dampened. The key to gaining yield within this limited tolerance is diversification in different asset classes. Investors could do worse than to look into emerging market equities and currency pairs such as the Japanese yen.
Emerging market equities will benefit from regional central banks’ easing policies, which are designed to counterbalance the risk of recession and other fallout from the trade war. Stimulus in mainland China intended to sustain the economy will also help. But there is still likely to be some impact, and short-term risk needs to be dealt with cautiously. The yen’s stability makes it a natural safe haven should the trade war escalate.
Should the trade war be resolved, we can expect the US dollar, which tends to be counter-cyclical, to go into retreat.
“Above all, investors need to remain alert, think on their feet, and avoid succumbing to lazy misconceptions around risk management,” says Cheng. “These include the belief that government bonds are a safe haven. On the contrary, they represent a highly expensive option that often fail to live up to expectations: this year, 30 per cent of globally developed government bonds traded at negative yield.”
Another common belief is that gold is a safe hedge to a stock portfolio. This is not always so. Gold has become less effective in the face of headwinds brought about by a stronger dollar.
“Investors are advised to look back at and learn from past mistakes made in times of extreme volatility,” says Cheng. “Before building up a portfolio, it is crucial to analyse each scenario’s fundamental background, however complicated—and how they are connected. It is also important not to underestimate the added volatility that a sideways market can bring.”
Lastly, Cheng adds that the winners are those who move quickly. Investors must be prepared to adjust their portfolios in a timely manner to accommodate fast-changing market sentiment.
As 2020 draws nearer and disputes continue to simmer, investors are in for a rough ride. Being prepared—and realistic—will make the dips more tolerable.
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