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rebalance summary

Q1 2022

“It was the best of times; it was the worst of times.”

This well-known phrase from Charles Dickens’ “A Tale of Two Cities” may well describe our situation at this juncture. The past two years have been an ordeal for most; an experiential crash course of unpredictability. To be sure, anxieties remain high. However, can we say we are near the end of the worst of times?

We believe so. Frankly, based on the information that we have today, we feel comfortable dwelling on the positive … on the coming “best of times” soon to play out ahead. Let’s briefly consider some pertinent facts.

For one, health professionals have gained much experience since the start of the pandemic. 21 months ago, they were overwhelmed and not knowing what to expect. Within the next six to twelve months innumerable “COVID-fighting” drugs and regimens will become available. Some — such as Paxloid —are near approval. These treatments are sure to lower death rates, reduce susceptibility, and greatly improve recovery times. We can also expect that the world will come to grips with COVID in due time. 

On the economic front, the best of times are expected to continue. We expect continuing reflation and economic recovery.

Consider that household wealth has soared. The net worth of American households has increased from $110 trillion at end of the first quarter of 2020 to $137 trillion by the third quarter of 2021 — up 24.5% in less than one and a half years! Yes, these gains have not been equally distributed. Nevertheless, this accumulation of savings and wealth (in addition to soaring income growth) represents much potential future consumption.

Corporations are also slated to turn in strong profits for yet another year. This is in part attributable to high fiscal and monetary stimulus as well as rising prices. Much liquidity remains idle and has not yet been absorbed. Also encouraging is that money velocity is turning up after long last. This should serve as another positive economic boost.

Debt levels are not as high as they were at the time of the 2008-09 global crisis. In fact, the banking system is finally showing real credit growth of late. Previously, businesses and consumers were still hunkering down. 

Looking abroad, we have also been heartened by China’s recent turn in monetary policy. To date these measures have been furtive. However, we expect that an upswing in GDP growth in China over the next few years will have a positive knock-on effect for world growth; particularly in emerging markets.

We have yet to quote Charles Dickens’ entire sentence. He goes on to say that it also “was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity.” All seem to apply.

While we have an encouraging outlook for both health and wealth at this year-end, we must not lose sight of one condition. Whether “incredulity” or not, one must not lose one’s head and bend to “foolishness.” Long-dated equity assets rank best for the long-term.

We expect that most investor gains and returns from this point will be proportional to one’s handling of market volatility and risk. Many investors are uncomfortable with market gyrations and therefore experience sub-par returns. We will strive for “wisdom” in the handling of risk and volatility.


Moving Underweight Cash

  • Despite numerous central banks recently adopting a more hawkish posture, we expect the reflationary environment to persist.
  • Cash and equivalent holdings remain a viable portfolio volatility dampener; but come with a relatively high opportunity cost as inflationary pressures are likely to remain elevated.
  • We have lowered cash levels below benchmark in client portfolios this quarter, and deployed cash towards asset classes which offer a better hedge against inflationary value erosion.

Maintaining Partial Hedge on USD

  • The US dollar has reversed course in recent months, moving from weakness to strength as investors began to bring forward their expectations of Federal Reserve tightening.
  • We continue to see downside risk in US dollar holdings, emanating from long-term overvaluation, counter-cyclicality and the likelihood that the Bank of Canada may be more aggressive than the Fed in tackling inflation.
  • We have elected to maintain our partial hedge on US dollar exposure this quarter.


Increasing Equity Overweight

  • We continue to view equities as the best option in a reflationary environment, as economic growth should be supportive of earnings and corporations are able to “pass-through” a portion of their rising input costs to consumers.
  • We expect investors to largely take the removal of central bank stimulus measures in stride, as policymakers in major economies are likely to maintain a gradualist approach to tightening that should not be forceful enough to derail the recovery.
  • Equity exposure in client portfolios remains overweight and has been increased this quarter.

Re-initiating Chinese A Share Equities

  • Chinese equities have had a challenging year; facing headwinds including power shortages, a regulatory onslaught against internet companies, the high profile Evergrande default situation and restrictive monetary and fiscal conditions.
  • The year-to-date underperformance has left the asset class oversold, attractively valued and brimming with upside potential as policymakers have begun to shift into stimulative territory. 
  • We have added Chinese A share (onshore) equity exposure to balanced and growth-oriented strategies this quarter.


Remaining Underweight Fixed Income

  • With consensus inflation expectations adjusting higher and “catching up” with the data, we expect inflation to surprise to the downside in 2022, which should provide support for bond prices.
  • However, the extent of any price gains will be limited by the already depressed level of investment grade bond yields, which are negative on an inflation-adjusted basis in most markets.
  • We remain underweight fixed income exposure in client portfolios.

Adding Floating Rate Note Exposure

  • We continue to view the yields offered on longer-term developed market bonds to be completely insufficient to compensate for their high degree of interest rate risk.
  • While we do not view a sudden spike in longer-term yields to be a highly likely scenario in the near term, risk is nonetheless significantly skewed to the upside.
  • We have added investment grade floating rate note exposure to further portfolio shorten duration this quarter.


Shifting from Oil Services to Industrial Metals Equities

    • Cyclically-oriented commodities including energy and industrial metals should continue to be supported by the underlying reflationary economic environment and a lack of capital investment over the past decade.
    • However, we believe the sharp appreciation in energy prices in response to recent shortages has created some short term vulnerability as a meaningful supply response is likely to materialize in 2022.
    • We have taken profits on oil services equities and purchased industrial metals equities in balanced and growth-oriented strategies this quarter. 

Initiating Hong Kong Equities

    • Hong Kong equities have struggled this year as concerns about exposure to the mainland Chinese property sector, continued political risk and weak consumption (in part due to relatively onerous travel restrictions) have all weighed on performance. 
    • The asset class trades at deeply depressed valuation multiples and the financial sector-heavy index should benefit from bellwether Chinese companies moving their respective primary listings from the US to Hong Kong.
    • We have initiated a position in Hong Kong equities in balanced and growth-oriented strategies this quarter.
Portrait of David Kletz, VP & Portfolio Manager of Forstrong Global.

David Kletz

Vice President, Portfolio Manager

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