The past few weeks have been quite volatile. First, tensions in the Middle East continued to grab the headlines, pushing oil prices higher. Second, US job growth, services activity and inflation came in higher than expected, leading to markets expecting smaller, more gradual US Federal Reserve (Fed) rate cuts. Third, the monetary stimulus out of China ignited a significant rally in Chinese equities, partly spilling across the Pacific region, though underwhelming details on fiscal policy led to a partial reversal. Finally, more clarity on China’s stimulus over the weekend provided some market support, but military drills around Taiwan raised uncertainty at the same time.
One could argue that investor reaction to the news, which can lead to exaggerated market movements, is a ‘bug’ in the financial system. However, I’d say it’s a ‘feature’. Market volatility tends to rise and fall as economic, corporate and (geo)political developments prove or disprove the current sentiment among investors. So, rather than knee-jerk reactions, we aim to maintain composure amid volatility. Instead, we stay invested for the long term, run globally diversified portfolios to mitigate the impact of local issues, and adjust our investment strategy as required.
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With a global economy that’s growing more slowly, we think the risk-reward of some of the risky parts of the fixed-income market looks more unattractive. In essence, the difference in the yield available between risky and safer bonds (known as the spread) isn’t large enough to warrant the extra credit risk.
In other words, we think risky bonds don’t sufficiently reflect our expectation that economic growth might decelerate further. Plus, in a hypothetical Trump 2.0 scenario, we believe that trade tensions and tariffs, especially directed at emerging markets, might rise further. As such, we’ve reduced our exposure to emerging market debt and, in some conservative profiles, further lowered our exposure to high yield.
We’ve reinvested the proceeds from the sale of some of our risky credit exposure into gilts, as they offer an attractive yield for lower risk. More tactically, we’ve also sold some US Treasuries and bought gilts.
As the Bank of England continues to lower interest rates and gilt yields eventually decline further, we stand ready to reallocate elsewhere in fixed income and explore alternative, higher-yielding options.
In March, we bought an ‘insurance’ instrument in portfolios where client knowledge and regulation permit. The instrument goes up in value when US equities fall, which partially protects portfolios from market sell-offs. We’ve now adjusted the degree of protection this instrument provides so that it will kick in earlier if US equities unexpectedly fall between now and the middle of December.
We’ve also adjusted our equivalent instrument for European equities by extending it to the end of March next year. This will give us more opportunities to trigger the protection if volatility rises further, and the benefit would more than offset the small cost we paid for it. We also did this because if new US tariffs were to hit NATO allies such as Europe, we’d be able to navigate the resulting volatility more easily and cushion hypothetical drawdowns.
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Information correct as of 14 October 2024.
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