A bal­anced port­fo­lio al­ter­na­tive

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

In re­cent weeks, an­a­lysts have ar­gued force­fully that the spec­tre of de­fla­tion looms large with cap­i­tal­ism re­turn­ing to its “19th cen­tury roots” of de­fla­tion­ary booms and busts. They point to the wide dis­per­sion of weak prices and re­cently added a twist by high­light­ing weak sil­ver prices as a re­li­able pre­dic­tor of price de­clines. The next ques­tion is whether price sig­nals point to a world econ­omy that faces an ugly bust driven by debt-de­fla­tion dy­nam­ics or could it be an old style gen­er­alised de­fla­tion­ary boom?

A “good” de­fla­tion would re­sult from pro­duc­tiv­ity gains, de­rived in par­tic­u­lar from new hy­dro­car­bon ex­trac­tion meth­ods and rev­o­lu­tion­ary au­to­ma­tion prac­tices. Since in­dus­trial debt tends to be con­cen­trated with pro­duc­ers which are sub­ject to in­tense cre­ative de­struc­tion, much of the core in­dus­trial sys­tem faces an ex­is­ten­tial threat. There will be win­ners and losers in this sce­nario but the econ­omy as a whole should thrive as con­sumers will get more for less.

The headache for in­vestors is that even as the US ap­pears to be en­joy­ing a vir­tu­ous de­fla­tion­ary cy­cle, much of Europe con­tin­ues to face a bad de­fla­tion. Last week’s poor eu­ro­zone PMI num­bers did noth­ing to dis­pel this no­tion. Hence a port­fo­lio ori­en­tated for good de­fla­tion would re­quire an over­weight in the US mar­ket, but with pro­tec­tion in the shape of bonds to pro­tect against a de­fla­tion­ary shock.

But what about al­ter­na­tives? One sug­ges­tion would be to con­sider US high div­i­dend yield plays. Over the long run, a col­lec­tion of high div­i­dend yield stocks (as tracked by MSCI) of­fers a sim­i­lar re­turn pro­file as a bal­anced port­fo­lio. In par­tic­u­lar, US high div­i­dend plays are typ­i­cally well rep­re­sented by: - Knowl­edge-in­ten­sive firms that have high lev­els of in­tan­gi­ble cap­i­tal that is of­ten not cap­tured by stan­dard ac­count­ing treat­ment. - Con­sumer sta­ples and util­i­ties which have an ob­vi­ous de­fen­sive na­ture and a per­for­mance pro­file which re­sem­bles that of bonds.

This is not to say that us­age of high div­i­dend stocks can fully repli­cate a bal­anced port­fo­lio. Re­plac­ing bonds with eq­ui­ties in­creases vo­latil­ity. Such a port­fo­lio will un­der­per­form dur­ing cri­sis pe­ri­ods. In­deed, over the last five years, the best mo­ment to en­ter a high div­i­dend strat­egy in pref­er­ence to a con­ven­tional bal­anced port­fo­lio had been dur­ing cri­sis points. For those multi-as­set man­agers seek­ing a de­fla­tion-beat­ing strat­egy, rel­a­tive val­u­a­tions are clearly not yet com­pelling. How­ever, for those man­agers with a ded­i­cated ex­po­sure to eq­ui­ties and a worry about the im­pact of a dis­in­fla­tion­ary world, the pur­suit of bal­anced port­fo­lio-like re­turns makes sense. And for this group the high div­i­dend ap­proach is rec­om­mended.

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