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Geo-politics… what’s an investor to do?

As the sabre rattling around North Korea continues, world markets seem relatively unfazed. Perhaps concluding neither side would be intemperate enough to press the nuclear button… let’s hope. If the market is wrong about this, money may be the least of our worries! But it has pushed the gold price up a little. If gold price is really a market anxiety indicator, the 10 year gold price graph below suggests markets are not yet very anxious:

Gold price

Aside from Kim Jung-un’s brinkmanship, markets seem to be coping with the gradual transition away from dependence upon central bank interest rate support. Market hope for Trump-ism does seem to be waning, but in our view the US stock market still seems optimistically priced.

Growth asset prices have been pushed up by historically low interest rates, which may slowly begin to reverse as rates return to neutral again – albeit lower than before. At current prices, do investment markets have more upside potential or more downside risk? Australia’s Future Fund thinks it’s the latter and have accumulated more cash within its 32% defensive assets against the time interest rates begin to rise again.

So in this climate of heightened geo-political sensitivity, it is worth reflecting upon how a typical portfolio might cope in the event of a severe market correction. Let’s compare two portfolios:

Portfolio 1 – Balanced 65% growth assets (shares/property) and 35% defensive assets (interest bearing). Some may choose this more conservative mix now, if they judge asset prices are a little high – even if their long view might best suit ‘Growth’ as defined below.

Portfolio 2 – Growth 80% growth assets (shares/property) and 20% defensive assets (interest bearing).

If growth assets fell 25%, this would cause each portfolio mix to change as follows:

Portfolio 1 – Balanced 58% growth assets (shares/property) and 42% defensive assets (interest bearing).

Portfolio 2 – Growth 75% growth assets (shares/property) and 25% defensive assets (interest bearing).

After such a fall, it’s often a good time to move overweight to growth assets as the risk is then lower and future returns enhanced. So, if you decided to use 22% from the defensive part of your portfolio to buy back into growth assets while they were lower, a Balanced mix would then change to a ‘Growth’ mix as shown below.  Similarly a Growth portfolio would become High Growth:

Portfolio 1 – Balanced 80% growth assets (shares/property) and 20% defensive assets (interest bearing).

Portfolio 2 – Growth 97% growth assets (shares/property) and 3% defensive assets (interest bearing).

This is shown in the table below for a $1million portfolio:

Assetalloc

So Portfolio 1 would transform from a Balanced mix when growth assets were considered somewhat highly priced, to a Growth mix (like Portfolio 2) once growth assets became cheaper.

Conversely, Portfolio 2 would transform from Growth into a High Growth portfolio.

Which approach suits you best? While you might be happy to buy back in after prices dropped, would you be reluctant to accept a High Growth mix?  Bullish markets can often run longer than expected, one can never know.  Are you relaxed about your position?

If you would like to discuss your approach to investing, please ask us.

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