Investment Outlook

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September 18, 2018

Investment Outlook

Tom Elliott

Market sentiment: A little relieved. A combination of strong U.S economic data last week, and a U.S offer to China to hold further trade talks, and a weaker dollar, all support investor confidence. Hope that a global trade war can be averted through U.S/ China dialogue helped emerging markets stocks especially, as did Turkey’s higher-than-expected interest rate hike last week that took rates from 17.75% to 24%. This helped to stabilise the lira and in so doing giving support to other EM currencies. 

Is the dollar’s rally over? The U.S dollar index has fallen 1.7% over the last four weeks, having risen 7% between mid-April and mid-August. So are we seeing the end of the dollar rally? Much will depend on the future path of U.S interest rates. Fed chair Jerome Powell revealed himself to be nervous of the risk of raising rates too far, too soon, at August’s Jackson Hole meeting of central bankers. With core CPI inflation falling in August (albeit from a 10-year high reached the previous month) and August consumer spending weaker than expected, some of the recent economic data supports the view that the current interest rate cycle may peak within a year’s time at 2.5 or 2.75%, well below the 3.25% level that was consensus expectations for much of the summer. This could, in turn, lead to a reversal of the dollar. Particularly if the economy starts to slow sharply from early next year, as the one-off effect of Trump’s tax cuts wears off.

But the dollar bulls might retort that last week’s U.S industrial production output data, and the University of Michigan’s consumer confidence index, were both strong and that the Fed’s 2% current rate may need increasing substantially. The data contributed to the 10-year Treasury bond yield reaching the psychologically important 3% point on Friday, as the market priced in a near-certainty a Fed rate hike later this month, and a 75% chance of a hike in December. 

A weaker dollar will offer respite to emerging market countries running current account deficits in particular, such as Turkey, Argentina, India, Indonesia. We can expect to see their stock and dollar-denominated bond markets rally if the dollar continues to weaken, as debt servicing costs and capital repayment becomes less onerous in local currency terms.

Brexit and sterling. British Prime Minister Theresa May meets E.U leaders in Salzburg this week, to try to pave the way for a Brexit agreement in November. She is sticking to her Chequers plan, which would result in a soft Brexit. Bank of England Governor Mark Carney has suggested that if the Chequers plan wins, the U.K economy could benefit by £16bn, since it would release pent-up investment. However, the E.U has been critical of the plan since it was agreed by a fractious cabinet meeting in early July. Brussels considers a key part of plan to be unworkable (an electronic border between Northern Ireland and the Republic of Ireland), and believes that the U.K is trying to ‘have its cake and eat it’ (eg, continued tariff-free access to the E.U’s single market for goods, without formally recognising the rules governing the single market). 

If this week’s meeting does not see a break-through, the risk of a no-deal next March will rise. Today the IMF warned of the ‘substantial costs’ to the U.K economy of a no-deal, and we can expect sterling to fall if the likelihood of such a scenario rises. However, most commentators see a no-deal as having a less than 50/50 chance, with a soft Brexit still the most likely result of the negotiations, perhaps negotiated at a last-minute all-night summit in March.

A multi-asset portfolio for the long term. We favour a long-term multi-asset approach to investing, whereby investors choose a suitable combination of global equities and bonds (depending on their risk profile and investment horizon), and leave the portfolio unchanged. Regular re-balancing ensures winners are sold and losers are bought – which financial history, and common sense, supports. The chart below shows a typical long-term balanced portfolio based around 60% global equities and 40% global bonds. Financial history shows this combination to offer good returns relative to risk (ie, volatility). Investors should try to be as diversified as possible, perhaps using the 60/40 model as their guide. Multi-asset funds based on this principle are available, often with different ratios of bonds and equities depending on the level of risk suitable for an investor. Note that the chart shows neutral weightings for the long-term investor, it does not incorporate any near-term weighting suggestions made in previous paragraphs.

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