Ahead of visiting Australia to speak at this week’s Investment Magazine Fiduciary Investors Symposium, Daniel Farley, chief investment officer of State Street Global Advisors’ Investment Solutions Group, answered a few questions about his current market outlook and asset allocation strategy.
Investment Magazine: Do you think the risk of another global financial crisis is on the rise?
Daniel Farley: I don’t think the backdrop is one that is conducive to the type of co-ordinated, global financial crisis that we experienced in 2007-08. There have been a number of improvements in the underlying financial system that were not [in place] 10 years ago. Now that doesn’t mean markets aren’t going to have corrections and we won’t have recessions. Those will happen again. But the type of crisis that causes the near breaking of the system does not seem to be immediately likely from my perspective.
IM: What do you think is the biggest geopolitical risk to global financial markets at the moment?
DF: In the short term, I think the situation in North Korea is the biggest wildcard, largely due to the tail risk of the situation. If things go poorly and the North Korean Government feels compelled to act, it has the potential to be a very bad outcome. From a longer-term perspective, there continues to be an overhang in Europe [based] on their ability to keep the union together and functional. That is not a near-term issue, and clearly the outcomes of the Dutch and French elections were a positive in this area. But there are structural issues that need to be worked through.
IM: Do you think the market response to the Trump presidency has been rational?
DF: Markets often overreact to positive news or expectations, and the response to potential programs of a Trump presidency is no different. The positive impact that could be had is not irrational. However, the expectation on the speed at which changes would be made, the ability to get it all done, and when that would affect companies are all ways markets probably got a bit ahead of themselves. And we saw that over March to mid-April, when equities paused a bit and expectations adjusted. There is still probably some room for more of that as investors better understand the new administration.
IM: What is your outlook for US equities over the next four years?
DF: We are pretty constructive on equities in the near term, and are overweight stocks across our tactical portfolios. The underlying economic backdrop is strong enough to help drive earnings, but not so strong as to require a sharp change in the monetary policy environment. I think four years out is a bit of a challenge as, at some point, equity markets will need to deal with the transition from a globally accommodative monetary policy into one that is at least neutral. Also, we have been in an extended, albeit weak, economic recovery. Time by itself does not call for a recession, but the business cycle has not been ‘solved’, so there will be a downturn that investors will need to deal with.
IM: What issue is having the biggest influence on your tactical asset allocation strategy at the moment?
DF: At this point, the biggest thing we are watching is how companies grow into their valuations in markets like the US, where price-to-equity ratios are a bit more expensive than normal, and how other markets, like Europe, find a catalyst to realise their otherwise cheap prices. We need to see the fundamentals start to follow through to spark the next leg up. Since we are overweight stocks at this point, that will be an important thing for our positioning.
IM: What asset classes are you allocating away from and towards at the moment and why?
DF: We are overweight equities right now, so the offset there has been an underweight [allocation] to bonds, specifically government bonds. This is driven more by a better opportunity in stocks, than a major concern about a big increase in interest rates. For the overweight in stocks, there are a number of factors – generally improving economic environment, a moderating monetary policy environment, generally good business stability. All of these create a good backdrop for stocks and other risk assets. So, while we are underweight bonds, within that asset class, we favour things like high yield. Not a case where we are thinking there is a lot of room for spreads to tighten more, but the incremental pickup in yield, while concerns about defaults are limited, makes it an attractive play from our perspective.
IM: What equity markets do you favour at the moment and why?
DF: Within stocks, we are overweight across the developed market large caps. We think this has given us positive exposure to the improving fundamentals but also some safety in the large companies.
IM: What trends are you seeing in terms of institutional clients wanting customised portfolio strategies?
DF: There are a number of trends we see amongst our institutional clients, all largely starting from a need to determine how to drive returns in an otherwise low-return environment. This is leading to conversations around smart beta and how to leverage various risk premia to help generate higher returns. It also leads to discussion on portfolio construction, and how to combine managers so they get the right complements and value for money. We have also seen an increase in conversations on where and how to best use active management – within stocks and bonds but also tactically across asset classes. All of these are about getting portfolios to work a little harder within a risk-controlled environment.
State Street Global Advisors is a sponsor of the Investment Magazine Fiduciary Investors Symposium, May 15-17, 2017, in the Blue Mountains, NSW.