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Investment strategy and trade wars

Many investors recognise that the investment world is changing from a low interest rate, high central bank accommodation world to a better growth, higher interest rate environment. The changing landscape means portfolios in most cases should evolve to recognise this sea change for economies and markets, yet some investors are slow to do so.

There is a complicating factor. The trade disputes between the US and China may drag on for months, or even years to come. The likely extended timeframe means that most investors cannot afford to simply “wait and see” how, if or when the differences are resolved. However a strategic response could see investors profiting from this current market driver.

Context is important. The trade disputes are not an existential threat to markets, and this is not 2008. The escalating trade barriers and inflammatory rhetoric are a danger to asset prices, but the underlying question relates to how much global economic growth there will be, not whether there will be any. This means that a major market meltdown is a lower probability scenario.

Instead investors are likely to react to developments as they unfold. The impact of announcements, headlines and tweets are already affecting market behaviour at a number of levels. The reaction following the weekend announcement of a temporary truce between China and the US is a case in point. One important impact is the overall effect on sentiment, and therefore the Australia 200 index level. The weekend news sent it soaring.

Another is the choice of stocks and sectors to buy or sell.

Naturally any signs of escalation are usually a weight on the market. However rising global growth fears affect sectors differently. Often investors hone in on those areas of the market most exposed to international trade and global economic expansion. Information Technology, Materials and Industrial shares often bear the brunt of investor reactions to bad news on trade.

The reverse is also evident in market behaviour. When other factors are driving the market higher but trade fears linger, investors tend to buy locally focussed, less cyclical companies. Utilities, consumer staples and healthcare stocks generally garner better support. If, for example, a US Federal Reserve president indicates in a speech that interest rates may stay lower for longer, investors in Europe, the US and Asia currently tend towards their own domestic stocks with steadier earnings.

A feature of the Australian share market is a clearly defined trading range for the 200 index. Since early 2017 the 5,640 level has provided support for the local market. On the topside is the 6,000 level that has contained many up moves. While both levels have been breached at times, including this week, so far the Australia 200 index has returned to this trading range each time.

Naturally the response from investors to these factors is a matter for the individual and their specific circumstances. However in broad terms there are potential strategic responses that recognise these market factors while harnessing a key risk management technique – diversification. While not suitable for every investor, some may utilise a “matrix” approach to investment decision making.

Depending on the current portfolio, and the desired or required changes, investors may re-shape their portfolios at what may be more opportune times as these two key factors drive market action. A diversified portfolio is an effective, lower cost strategy to manage market risk over the longer term and through the market cycles. By re-balancing at potential higher opportunity points in the market investors can seek higher returns while maintaining their diversified strategy.

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