21 October 2016
Utilities stocks, often seen as defensive plays, have little safety margin built into their prices. Photo:
Utilities stocks, often seen as defensive plays, have little safety margin built into their prices. Photo:

Risk-aversion assets will not be a haven forever

The MSCI World Index has decreased 20 percent this year, indicating a technical bear market.

Meanwhile, risk-aversion assets like the Japanese yen, gold and public utilities stocks have outperformed the market.

Is investment in those risk-aversion assets a smart choice amid market turbulence?

History says yes.

During the economic recessions in 2001 and 2008 in the United States, investments in gold and the yen offered positive returns.

So a defensive strategy with investments in risk-aversion assets does work.

But investors should keep in mind it is because the lack of liquidity of those assets, instead of their value, that pushes up their prices when investors shift their risk appetites.

After the global financial crisis, the yen and gold prices plunged because of their respective fundamental issues.

So such a defensive strategy cannot provide a haven for risk-averse capital forever.

More importantly, capital flows decide asset prices, especially when funds have limits on their positions, and program trading magnifies the capital flows when a fund switches its investment style.

For long-term investors, keeping a safety margin is always key.

Although the public utility sector is the only one in which earnings and revenue targets have been lifted by analysts, growth of just 3.8 percent in expected earnings this year will still be lower than the average of 4 percent for S&P 500 stocks and other defensive sectors, like consumer staples and healthcare.

Meanwhile the sector is expected to have a price-earnings ratio of 16.6 times, higher than the 15.2 times average for S&P 500 stocks.

So, public utility stocks are not ideal in terms of providing a safety margin.

Neither are the yen and gold.

Although a weaker US dollar will help boost prices of gold and the yen, at present their prices are still too strong against the dollar, as the US Federal Reserve is expected to lower the pace at which it will increase interest rates.

All in all, investors should review the safety margin when making decisions to hold or add more risk-aversion assets to their portfolio.

In a low-inflation environment, holding cash doesn’t necessarily mean having to face opportunity costs.

This article appeared in the Hong Kong Economic Journal on Feb. 15.

Translation by Myssie You

[Chinese version 中文版]

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Analyst at Noble Apex Advisors Ltd

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