WHAT HAS CHANGED IN RECENT MONTHS?
The past 12 months have been particularly challenging across a wide range of asset classes. From a stock market perspective there were two key global factors that contributed and in both these areas the momentum has turned:
US MONETARY POLICY TAKING A PAUSEThe first relates to US monetary policy, with the growing perception towards the end of 2018 that the Fed may be making a mistake by rising rates too quickly into a potentially weaker growth environment. Over December and January, however, the policy stance of Powell (Chair of the Federal Reserve) turned as he became more dovish – ultimately mentioning the Fed would ‘pause’ on their tightening path on 4 January. Whenever there is a change in US monetary policy it tends to have material implications across financial markets, and this ultimately provided comfort to investors that the Fed would support growth, and financial conditions (bonds, credit, the USD) would remain stable.
TRUMP EXTENDING THE DEADLINE FOR CHINESE TARIFF INCREASESThe second factor that was driving weakness last year, but has since improved, is geo political risk and specifically the deterioration of Sino-American relations driven by the threat of higher tariffs on Chinese goods. Again another area of change in recent months with Trump recently confirming that the intended increase would be delayed beyond the 1 March deadline.
Both these changes have supported markets and equities in particular in 2019 – ultimately overcoming the challenge posed by a continued deceleration of global economic growth and downward revisions to profit expectations.
WHAT IS OUR OUTLOOK FOR THE GLOBAL ECONOMY AND FINANCIAL MARKETS?As we have mentioned previously, we are acutely aware that regardless of any opportunities that may arise (such as the pessimistic sentiment in December) the reality is that we are at a later stage of the economic cycle and global growth levels are slowing. This hasn’t been helped by the challenge that protectionism brings to one of the key engines of global growth (i.e. international trade) over the past couple of decades.
This is ultimately not the most attractive part of the cycle to be buying risk assets and return expectations need to be moderated. Coupled with that, as growth slows we are reminded about the lack of tools policy makers now have to manage the cycle and stimulate growth if we move towards a recession. From a monetary policy perspective rates aren’t far from zero and from a fiscal perspective the flexibility to expand here is more limited due to high levels of government debt.
That aside, whilst the global economy is slowing, economic cycles don’t die from old age and typically require a catalyst – whether this be in the form of policy error, financial market bubbles, a marked deterioration in economic confidence, or instability in financial conditions. On these factors we remain comfortable that we are not moving into a recession over the next year.
We expect a fairly benign environment to continue and therefore if the recent deterioration in economic momentum stabilises there will shortly be a time to become more constructive on risky assets. Ultimately, a ‘boring’ growth environment is what markets need to make progress. If growth deteriorates worries will develop as the risk of not being able to manage a recession is high. On the other hand, excessive growth could lead to inflationary pressures in the US that will lead to tighter financial conditions which in turn would create volatility.
HOW DOES THIS IMPACT OUR PORTFOLIO STRATEGY?If we had to describe our portfolio strategy, we would classify it as
‘slightly cautious at the headline level’ (due to lower equity and higher cash balances than usual), but ultimately
‘fairly balanced’ due to a number of other positions and views across the portfolios that are less pessimistic. The areas that are less pessimistic include recent moves such as broadening our exposure to Emerging Market Debt, the Technology sector, taking a short duration approach in fixed income, removing some of our previously held hedge positions (on foreign exchange and fixed income), and again raising our exposure to UK small and mid-cap stocks.
The composition of a multi asset portfolio at this stage of the cycle needs to evolve and look for additional and/or different sources of return. We have started this process with regards to some of the asset classes mentioned above and will continue to look for alternative ways to diversify return potential over the coming months.
WHAT ARE WE FOCUSSED ON?
There are a number of areas of the portfolio strategy that we are currently focusing on and to simplify I would categorise these into:
- Traditional asset allocation (our equity view) - whilst we are mindful of the challenges of the slowing economic momentum, at the same time if monetary policy remains loose, financial conditions stabilise, and geopolitical risk subsides, this will create an opportunity.
- Different areas of the fixed interest market - if we are in a world of lower returns (and higher cross asset volatility) then we expect that the risk / return outlook in certain higher yielding fixed interest markets / sectors are worth exploring. We are now more routinely looking at return expectations and scenario analysis in this area.
- Putting our cash to work - to avoid sitting on a low yielding part of the portfolio we are looking at low duration fixed income strategies as well as absolute return strategies in this area.Ultimately, we are ensuring we are proactive across the portfolio in an environment where we all have to work harder in generating attractive risk adjusted returns.
Ultimately, we are ensuring we are proactive across the portfolio in an environment where we all have to work harder in generating attractive risk adjusted returns. For further information, please contact your usual Brown Shipley Adviser.
Toby Vaughan // Chief Investment Officer
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