SCB CIO advises reallocation of investment portfolios
Recommends top picks: US Bonds, utility stocks, and commodities
SCB CIO suggests an investment strategy for a potential recession caused by Fed’s rising interest rates. The recommended portfolio allocation includes 35-40% in fixed-income securities, 35-40% in defensive stocks (utilities, alternative energy, consumer products) and Chinese A-shares, 5-10% in gold, oil, or commodities, and 5-15% in a USD money market fund for liquidity and offshore asset investment opportunities.
According to Mr. Sornchai Suneta, Executive Vice President of SCB Investment Office and Product Function at Siam Commercial Bank, major central banks are currently leaning towards raising policy rates. Specifically, the Fed is expected to increase interest rates by an additional 0.25% at its meeting on July 25-26. This decision is primarily influenced by the sluggish decline in core US inflation. However, it is anticipated that the Fed will soon reach the end of its rate hike cycle. Consequently, the US banking sector is becoming more cautious in its lending practices, adding additional pressure that may lead to a slowdown in the US economy and the possibility of a mild recession.
Given this economic landscape, for investors looking to navigate through the potential economic recession, it is recommended to allocate approximately 35-40% of their portfolio to debt instruments. Another 35-40% should be invested in stocks, with a focus on defensive segments. Additionally, 5-10% of the portfolio should be allocated to gold, oil, or commodities. It is also advisable to maintain 5-15% of liquidity in a USD money market fund, which can be utilized for investing in various offshore assets when opportunities arise. However, the allocation of investments in different assets should be tailored to each individual investor’s specific investment goals and take into account their risk tolerance.
It is advisable to maintain such investment assets in the portfolio during the second half of this year, as there is a 30% chance of the US economy slowing down and inflation declining faster than anticipated in the next 12 months. In such a scenario, there might be no need for further interest rate hikes. However, there is a 60% possibility of a mild regression and a gradual decline in core inflation. Consequently, the Fed may opt for 1-2 more interest rate increases, potentially reaching 5.50-5.75%. Subsequently, the Fed may signal the likelihood of interest rate cuts in 2024, with a decrease of 1 percentage point to 4.6%, and a further reduction of 1.2 percentage points to 3.4% in 2025. Investing in fixed income still presents an opportunity for attractive returns with lower risks compared to other asset types.
Analyzing the market’s perception of interest rate hikes, it is evident that investors were already well aware of the expected rate hike by the Fed in July. The expectations of investors in Fed Fund Futures align closely with the Fed’s perspective that inflation is gradually slowing down and further interest rate increases may be necessary. Therefore, if the Fed raises interest rates by another 0.25%, it is unlikely to significantly impact the market, and bond yields are expected to be only marginally affected. With inflation adjusting slowly and the labor market remaining tight, SCB CIO believes that short-term interest rates will remain high throughout 2023, exceeding 5%, which is a noteworthy level. This level of interest rates has been relatively rare in the past decade and may be suitable for investors seeking to invest in low-risk assets for the short term. Additionally, there has been a considerable influx of funds into USD money market funds managed by global asset management companies.
Regarding investments in long-term debt securities, it appears that bond yields reached their highest level earlier this year. At that time, there was a general perception that the Fed’s monetary policy was relatively tight. However, the Fed’s stance has since changed. They are now placing emphasis on incoming data, particularly related to inflation and employment. Consequently, if the Fed raises interest rates one or two more times, it is likely that bond yields will trend downward rather than upward. Inflation may not reach the Fed’s desired range by 2024, but with high policy interest rates and inflation lower than the policy interest rate, the real yield (interest rate – inflation) is expected to be positive. This makes long-term debt investments still appealing, particularly in government and high-quality bonds with a rating of AA- or higher from strong companies that tend to be less impacted by economic conditions. These debt instruments can still offer attractive returns, including the potential for higher interest rates and increased bond price profitability during periods of lower interest rates.
When it comes to investing in stocks, it is advisable to take profits on stocks that have already experienced significant returns, such as the mega technology group in the United States. Since the beginning of the year, their prices have increased by 30-40%, and caution should be exercised when investing further in such stocks. Instead, reallocating funds to defensive stocks in the US appears to be an interesting option. These stocks have shown relatively weaker performance compared to the overall market, but they tend to fare well during challenging economic times or recessions. Recommended defensive stocks include utilities, such as alternative energy companies, which have experienced slower growth compared to technology stocks. Consumer staples or essential consumer products also fall under this category, as they often exhibit more stable performance than the broader S&P500 during bear markets.
Furthermore, diversifying investments by shifting from developed markets to emerging markets presents an interesting alternative. Chinese A-Share stocks, for instance, although currently performing less favorably compared to other markets, offer long-term attractiveness. As a result, the allocation of investment in emerging markets remains relatively higher than that in developed markets. It is advisable to include a portion of the portfolio dedicated to gold, oil, or commodities. SCB CIO believes that allocating 5-10% of the overall investment portfolio to these assets helps mitigate risks during economic downturns. This asset group has the potential to enhance overall portfolio returns when compared to assets with similar risk levels.
“When we engage in investments, we anticipate positive destination returns in line with our intended targets. However, investing inherently carries risks, and fluctuations or temporary decreases in returns may occur. Nevertheless, with sufficient time for investments to mature and a well-diversified asset allocation that aligns with individual risk tolerance, the path to investment success is certainly attainable,” emphasized Sornchai.
