Investment Outlook

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December 13, 2018

Investment Outlook

Tom Elliott

Market sentiment. Nervous. Relatively small news items relating to the U.S/ China trade dispute are creating exaggerated movements on global stock markets. Investors nervous over the outlook for U.S and global growth cite the Treasury yield curve, which is flattening and inverted at the 2yr/5yr spread, poor third quarter GDP data from Japan and weak leading indicators in the euro zone. The VIX index of implied one month volatility on the S&P 500 is at 21, relatively high. Meanwhile, Brexit is paralysing both U.K politics and the U.K economy where third quarter growth slowed to just 0.4% q/q. Sterling weakness reflects the bewildering range of scenarios that Brexit could yet take the U.K, and the heightened risk of a no-deal if none of the options are agreed by Parliament by March 28th.

Good news. But investors ignore the market’s and policy maker’s ability to self-correct and to change direction at their peril. In the U.S, the fall in the 10 year Treasury yield from 3.2% to 2.8% in a month has led to an improvement in the relative valuation of equities, particularly given forecasts of continued -if slower- corporate earnings growth. The Fed has signalled that next year’s planned interest rate hikes may be delayed if economic data weakens, which Friday’s relatively modest payrolls data and yesterday’s November inflation data suggests is the case. Low U.S inflation allows the Fed room to manoeuvre: a ‘Powell put’ is perfectly possible, as is more dovish talk from the Bank of Japan and the ECB in light of weaker growth in their regions. 

The arrest in Vancouver of Meng Wanzhou, the daughter of the founder of Chinese tech company Huawei, on an extradition request from the U.S, has opened a new front to how the U.S/ China trade dispute in carried out. But it is not the equivalent of Archduke Ferdinand’s assassination in Sarajevo in 1914. Trump can, and probably will agree to release her in due time as part of a ‘magnificent deal’ with China. Chinese economic growth is slowing as the economy deleverages. This, and a fear of tariffs contributing to still slower growth is putting downward pressure on the renminbi which hurts the Chinese elite and is contributing to capital flight.

In Japan, the 2.5% third quarter contraction of the economy (at an annualised rate) was a result of series of natural disasters. Floods, typhoons and an earthquake, hurt tourism, exports and business investment in particular. But most analysts expect a quick resumption to the strong growth rates of the first half of 2018, buoyed by reconstruction spending. Even Brexit has a sunny-side: U.K assets are cheap for overseas buyers, and with a fair chance of a soft Brexit or no Brexit emerging, their sterling value is likely to rise, as will sterling’s value against other currencies.
Sterling. Sterling traders fear most an accidental no-deal, as a now (slightly) re-vitalised Theresa May continues to push her Brexit deal through a Parliament that doesn’t want it, offering no alternative. The fear of a no-deal by the time Article 50 says we leave the E.U (on 28th March next year) explains sterling’s failure to rally, even as political momentum has favoured a soft, Norway-like deal with the E.U or a second referendum. 

For instance, on Monday the ECJ ruled that the U.K can cancel Article 50 without penalties, so providing a no-penalty exit from the whole Brexit process. And last week Dominic Grieve (a former Conservative Attorney General no less) added an amendment to the Brexit deal bill, which will ensure that Parliament has a future say on Brexit policy should the bill fail to have a majority. This will make a broad range of soft and no-Brexit options available for MPs to vote on. 

But can the government and Parliament explore these options, and find a majority of MPs to support any one of them, in time, or will time run out and a chaotic accidental no-deal happen? 

Why is May’s Brexit deal an exercise in procrastination? Sterling doesn’t like May’s Brexit deal much, either. It is largely based on the Chequers agreement of July, which caused two senior pro-Brexit ministers -Boris Johnson and David Davies- to resign. It tears up several of the red lines that May laid out on becoming Prime Minister, in particular the U.K’s ability to make its own regulations on manufactured goods, and the U.K’s indefinite membership of the customs union until a resolution to the Irish border is found that satisfies the E.U (the so-called Irish backstop). Both of these will severely hinder the U.K in its effort to make trade deals with other countries. 

What next? May appears to be playing a game of chicken with her own MPs. ‘Accept my Brexit, or face the consequences of a no-deal, economic and political chaos, and a general election that the Conservatives will surely loose’. Sterling’s unhappiness is therefore unlikely to end soon. Dollar/ sterling forecasts suggest a range between $1.09 in the event of a no-deal, and $1.50 plus in the event of Brexit being abandoned, perhaps as a result of a second referendum or parliamentary vote. 

A multi-asset portfolio for the long term. We favour a long-term run 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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