The risk of a trade war ultimately causing a global recession finally caught up to markets in May. The concern had been pushed into the background as investors came to the believe that the hollow threats of action would eventually recede and a deal between the US and China would be reached. However, hopes for a quick deal seem like ancient history now. US President Donald Trump imposed new tariffs on China and Mexico, and markets are now beginning to price in a slowdown.

The bond market is the best illustration of these events. It wasn’t long ago that investors had positioned for rates to move higher as central banks were openly talking about the removal of stimulus programs. Recent events have reversed that narrative and markets are expecting two interest rate cuts from the Federal Reserve.

The US 10-year Treasury began the year with a 2.68% yield and ended May at 2.12%.  In many parts of the world, interest rates are back to negative and the US yield curve is now inverted at many points of the curve. These aren’t signs of a healthy market – they are warning signals of a coming recession.

Bulls will make the case that all of this can be fixed in one tweet. A removal of tariffs and an end to the hostile trade actions of the US could quickly give investors the confidence to come back to the markets. But the longer this drags on, the more real the risk of a global recession becomes. Markets hate uncertainty and corporations are no different.

Companies are starting to warn that their earnings will be affected and could soon start delaying planned capital expenditures and hiring. This may be a self-inflicted recession, but it will still be difficult to fix. Investor sentiment is one of the most difficult parts of the market to forecast and it has suffered in the last few months.

With so much uncertainty in the markets, many are relying on technical analysis as much as fundamentals. The latest bout of volatility is leading many to make the prediction that equity markets could be headed back to the lows seen in December, which is roughly another 15% lower for the S&P 500. In a very short period of time, markets have turned from all-time highs to levels below moving averages and levels of support.

There have been few hiding places in the last month. Gold and gold equities are finally beginning to act like the insurance policies they are suppose to be. But they’ll require a breakdown in the US dollar before we can call the all-clear for this sector.

One of the more surprising pockets of strength has been the cryptocurrencies. Bitcoin is now up 100% on the year after being written off as dead not long ago. Whether or not the cryptos can be considered a true safe-haven play is still up for debate. It remains a highly speculative asset.

As we head towards the halfway mark of 2019, it’s safe to say that volatility has been heightened so far this year, as we’ve warned it would be. Couple that with the fact that we’re in the later-stages of the economic and likely the market cycles, positioning portfolios defensively just makes sense.

The Toronto Raptors aren’t in the NBA Finals because they can consistently shoot out the lights. They’re there because defence is as important as offence and they’ve made it a pillar of their strategy. Investors should take a page from their playbook and ensure they’ve got their defence in order.

Ideas with Purpose

Purpose Strategic Yield Fund (SYLD) is a defensively positioned high-yield bond fund. Global central banks becoming increasingly dovish and markets pricing in multiple interest rate cuts help make the case for an allocation in high yield over government bonds. SYLD actively manages market exposure and pays out a  yield of roughly 6%. We believe it should do well against its peers in a period of lower yields and increased volatility.

Purpose Multi-Asset Income Fund (PINC) is a defensively positioned balanced fund with a combination of various income-producing investments. There is a heavy tilt towards Canadian dividend stocks, which should be well positioned for a volatile summer. It also includes allocations in our options-income strategy, Purpose Premium Yield Fund, which harvests market volatility to generate a yield, as well as high-yield bonds and some international dividend equities.

— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments

All data sourced from Bloomberg unless otherwise noted.

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