Nanette Abuhoff Jacobson
The short answer is no. While risks are higher and should, in my
view, be reflected in portfolios, I view the fundamental investing
backdrop as favorable. This drives my view that investors should
consider retaining a procyclical investment posture with
overweights to equities and commodities relative to bonds. Within
equities, I think investors should consider trimming European
exposure because of geopolitical risks, but remain overweight
equities given attractive valuations and an expectation of
accelerating growth later this year. I remain positive on Japanese
equities longer term, but I have a neutral view in the short term
due to the absence of a near-term catalyst. I also have a neutral
view on U.S. equities, as good fundamentals are offset by
relatively high valuations. Emerging-market (EM) headwinds lead me
to be underweight equities and neutral on debt. However, recent
underperformance and resultant low relative valuations are enticing
from a contrarian perspective, especially considering the
structural improvements many EM countries have implemented since
the crises of the 1990s. Overweighting commodities may be prudent
in light of attractive valuations, incipient inflation, and
My primary concerns stem from events in Ukraine and continuing
stresses in emerging markets more broadly, but my base case is that
tensions between Ukraine and Russia will not escalate to military
conflict, and that emerging markets will not experience a
What Has Not Changed in My Thesis?
Heading into 2014, my view was that the global economy was
healthy, supported by improving fundamentals and accommodative
monetary policy. I also saw a case for incrementally higher
inflation, particularly in the U.S. and Japan. Emerging markets
were the bigger concern at the beginning of the year, given the
stresses in the so-called Fragile Five (Brazil, India, Indonesia,
South Africa, and Turkey) and slowing growth in China.
The first quarter of 2014 was a clear reminder of the importance
While U.S. data softened, the situation in Ukraine erupted and
concerns about shadow banking in China grew. Equities were flat and
safe-haven government bonds delivered positive returns. Looking
ahead, many underpinnings of my earlier thesis remain in place. The
fundamentals supporting developed-market growth are still
). The impact of severe weather in parts of the U.S. will continue
to cloud the outlook, but it is likely to be temporary, and Europe
and Japan are at inflection points that suggest potential positive
The drivers of inflation I identified at the beginning of the
year, including nascent wage growth, continued improvement in labor
markets, and aggressive policy action in Japan, are still apparent.
In the U.S., wage pressures are percolating in small-business
shows, the percentage of small businesses with positions they are
unable to fill is an indicator of labor-market tightness and a
strong predictor of hourly earnings. In the broader Job Openings
and Labor Turnover Survey (JOLTS) by the Bureau of Labor
Statistics, the number of hires and the number of job openings are
both increasing off their 2009 lows as well.
The U.S. Federal Reserve (Fed) remains accommodative. Concerns
resurfaced about a quicker pace of rate hikes after Chairman Janet
Yellen suggested at a recent press conference that tightening could
begin approximately six months after tapering is complete. However,
although the market's expectations of the timing of the first rate
hike may have moved up a few months, the Fed's intentions are
consistent with a gradual, measured path toward more normal rates
from its current highly accommodative stance.
While inflation in the European Union (
) has been troublingly low at less than 1%, German inflation is
roughly twice that of most peripheral countries. Leading indicators
suggest wages in the U.K. are set to rise, and the Bank of England
) appears committed to maintaining low interest rates despite the
unemployment rate falling to near its 7% target; the BOE still
believes there's significant spare capacity and room for wage
In Japan, headline inflation turned positive in 2013 after
averaging a negative reading over the past 10 years. The Bank of
Japan (BOJ) is likely to remain extremely accommodative, and the
value-added tax (VAT) increase from 5% to 8% in April will provide
a boost to inflation. I don't expect the BOJ to alter its course
until the impact of the VAT increase is known in the early summer,
but in the event it results in slower growth, I expect the BOJ to
What Has Changed?
The most significant change to the investing landscape is a new
risk in emerging markets, namely the tensions between Russia and
the West over Ukraine. This situation increased the risk premium on
EM assets as it reminded investors of the importance of political
risks and their ripple effects in less-familiar markets. Russia and
Europe are the most obvious areas of potential impact, but the
ripple effects could be wider in the most negative scenarios.
Another, more incremental change in the global growth picture
relates to China. In the past month, concerns about China's
corporate debt were validated by the first default of an onshore
domestic company. In addition, the doubling of the currency bands
from 1% to 2% around the People's Bank of China's target helped
pushed the yuan lower. Both of these changes impacted a widely held
carry trade that relied on the assumptions that all debt was "money
good," meaning that the chance of default was nil, and that the
yuan would continue to rise. While China's efforts to liberalize
the financial system are intended to improve the allocation of
capital and curb excess financial liquidity, the transition
introduces greater uncertainty.
How Should We Think About Ukraine?
The situation in Ukraine is difficult to analyze, since its
evolution depends in large part on decisions by political
Russian President Vladimir Putin appears to have several
geopolitical goals. He does not want Ukraine, which has strong
historical and cultural ties to Russia, to move "too far" in a
European direction, further concentrating global power in the West.
The removal of then-president Viktor Yanukovych from office and the
decision to replace him with a more Europe-friendly leader
represented a diminution of Russian influence regionally and
Mr. Putin also has important economic motives. Ukraine is a
large trading partner, has significant natural resources, and
contains extensive natural-gas pipelines that run from Russia to
Europe. These assets, plus Ukraine's geographic location, are of
great value, and so there is an incentive to avoid a severe Western
response. From a trade perspective, the economic costs of a
protracted standoff with the West over Ukraine could be substantial
for Russia. Around 45% of Russia's exports go to the EU, and oil
and gas account for 70% of the country's exports and more than 50%
of its federal budget revenues.
Trade restrictions would also affect the West, but they would be
much less painful; only 7% of EU exports go to Russia. Europe is
vulnerable to energy-supply disruption, as roughly 30% of the
region's oil and gas comes from Russia, but I suspect that the U.S.
could mitigate this by releasing some of its own imports to
Ultimately, I believe Russia will decide that economic
incentives will be more powerful than further geopolitical gains
and thus avoid military escalation. The risks are not trivial, and
we need to carefully monitor the situation's evolution, but I
believe that a reduction of risk and diversification of exposures
may be a more prudent investment decision than an outright
Equities: Still Rising but Likely to Pause
Part of my rationale for reducing risk in portfolios but
maintaining a procyclical stance relates to valuations. European
equities remain my primary developed-market suggestion given my
view that they are attractively valued -- trading at a 5% discount
to U.S. equities -- and the region will see improving growth
through year-end. As for Japan, I believe that Abenomics is an
important positive and will continue to aid Japanese equities
longer term, but the market has no catalyst to drive it higher at
the moment. Earnings estimates have already moved up substantially,
the currency has weakened substantially, and equities have climbed.
In the next few months, markets will gauge the impact of the VAT
hike and progress on the third arrow of Abenomics, and the BOJ is
unlikely to weaken the yen much more in the short term. This lack
of a catalyst leaves me neutral on Japanese equities in the short
term. U.S. equities are perhaps the most attractive fundamentally,
but they are also most expensive relative to their developed-market
peers and therefore have little room for error. I prefer a neutral
The biggest corrections have occurred in emerging markets, so a
careful look at this asset class is warranted. Emerging markets are
facing cyclical headwinds from China's relatively weak growth, the
beginning of the end of ultra-easy monetary policy in the U.S., and
current account pressures in some countries. As a result, I believe
the emerging markets will struggle, and investors should
differentiate among countries, currencies, and companies. That
said, the longer-term positive fundamentals are important as well.
Many countries have made significant structural improvements since
the 1990s and are likely to grow faster than developed countries
long term. While the road will be bumpy, I believe that low equity
and debt valuations relative to developed markets present an
interesting opportunity. Within EM debt, I prefer sovereigns over
corporates. Sovereigns' spreads have widened significantly, and
they could outperform corporates in the low-EM-growth environment I
As for other developed-market fixed-income assets, I encourage
investors to consider maintaining an allocation to high-quality
government bonds for their unique role as diversifiers to equities.
In riskier fixed income sectors, I prefer bank loans over high
yield. Bank loans have wider spreads, are higher in the capital
structure, and have higher recovery rates (around 70% vs. 40% for
high yield). I think investors are being rewarded for the
illiquidity of the bank-loan sector, which long-term investors can
Finally, commodities look attractive. Valuations for commodities
as a group have been low for some time, and there are early signs
that excess supply may be diminishing.
shows the strong relationship between equity and commodity prices
in the past, and the recent divergence. When I take into account
the potential geopolitical concerns referenced above, as well as
the potential for asset-allocation flows to return to this recent
underperformer, I believe investors should consider taking an
Investors should consider:
Reducing risk in portfolios:
A pro-growth tilt may still be appropriate, but caution is
warranted given higher risks from the Ukraine crisis and EM
Trimming Europe but remain overweight:
The possible ripple effects of the Ukrainian crisis justify
taking a look at reducing exposure to Europe in my view, but the
economic outlook is still supportive of equities.
Maintaining a neutral allocation to U.S. and Japanese
The U.S. has good fundamentals but high valuations, and Japan's
rise is likely to pause until a new catalyst appears.
Increasing commodities exposure:
Commodities broadly could do well if global growth accelerates.
Precious metals are also a hedge against geopolitical risk from
Underweighting emerging-market equities:
Dollar-denominated and local EM debt look attractive based on
valuations relative to other fixed-income risk assets and lower
volatility compared to equities.
Diversification does not ensure a profit or protect against a loss
in a declining market.
The MSCI World Index is a free float-adjusted market capitalization
weighted index that is designed to measure the equity market
performance of developed markets. The MSCI World Index consists of
the following 24 developed market country indices: Australia,
Austria, Belgium, Canada, Denmark, Finland, France, Germany,
Greece, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New
Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland,
the United Kingdom, and the United States.
The S&P GSCI® Goldman Sachs Commodity Index is a composite
index of commodity sector returns representing an unleveraged,
long-only investment in commodity futures that is broadly
diversified across the spectrum of commodities.
Investors should carefully consider the investment objectives,
risks, charges, and expenses of Hartford Funds before investing.
This and other information can be found in the prospectus and
summary prospectus, which can be obtained by calling 888-843-7824
(retail) or 877-836-5854 (institutional). Investors should read
them carefully before they invest.
A Word About Risk:
All investments are subject to risks, including possible loss of
principal. Fixed-income investments are subject to interest-rate
risk (the risk that the value of an investment decreases when
interest rates rise) and credit risk (the risk that the issuing
company of a security is unable to pay interest and principal when
due) and call risk (the risk that an investment may be redeemed
early). Foreign investments can be riskier than US investments.
Potential risks include currency risk that may result from
unfavorable exchange rates, liquidity risk if decreased demand for
a security makes it difficult to sell at the desired price, and
risks that stem from substantially lower trading volume on foreign
markets. These risks are generally greater for investments in
emerging markets. Sovereign debt investments are subject to credit
risk and the risk of default. Commodity investments are subject to
The views expressed here are those of Nanette Abuhoff Jacobson.
They should not be construed as investment advice or as the views
of Hartford Funds. They are based on available information and are
subject to change without notice. Portfolio positioning is at the
discretion of the individual portfolio management teams; individual
portfolio management teams may hold different views and may make
different investment decisions for different clients or portfolios.
This material and/or its contents are current at the time of
writing and may not be reproduced or distributed in whole or in
part, for any purpose, without the express written consent of
All information and representations herein are as of 4/14,
unless otherwise noted.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
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