Investment Outlook

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May 03, 2019

Investment Outlook

Tom Elliott

Market sentiment: Firm. The tech-led NASDAQ and the broader S&P 500 U.S stock market indices reached new all-time highs earlier this week. Stronger than expected U.S, Chinese and European first-quarter GDP growth and a generally good set of U.S corporate earnings results have all helped maintain investor appetite for risk. The MSCI World Index of developed stock markets rose 3.6% in April in dollar terms and is up 16.5% since 1st of January. Core bond markets have been flat in recent weeks, but year-to-date the Bloomberg Global Investment Grade index is up 2%. Emerging stock markets continued to slightly underperform their developed market peers, as a strong dollar, strengthening oil price and country-specific issues impact on investor sentiment. 

Overall, it has been a great four months for a traditional 60/40 balanced portfolio approach to investing, with equities providing the returns and bonds limiting the portfolio’s volatility.

A period of consolidation in risk assets would be a good thing. It is not only global stock markets that have enjoyed a strong four months. The Bloomberg Global High Yield bond index is up 7% year-to-date, as investors no longer fear rising Fed interest rates and Treasury yields undermining the riskier part of the fixed income market. 

After such strong rallies, a period of consolidation is to be hoped for. A continuation of enthusiasm for risk would generate fears of a ‘melt-up’ in asset prices, of inappropriate investment decisions, leading to an inevitable fall in markets when a piece of bad news triggers a reversal of sentiment. But a summer of not much progress for risk assets, against a background of further improvements in global growth expectations and dovish central bank policy, would lead to improved valuations and add resilience into capital markets. 

Strong dollar. The recent strength of the U.S currency looks set to persist if recent upbeat economic data from America continues. 

At the end of January, the dollar looked set to weaken over the rest of 2019. The Fed had confirmed it was putting its interest rate-raising policy on hold as U.S economic growth slowed, while an expected pick-up in growth in Europe and elsewhere was expected to lead to rate hikes elsewhere. The Greenback would weaken, so the thinking went, as investors sought growth opportunities elsewhere and as the interest rate differential between the dollar and other currencies shrank. Analysts began talking of an interest rate cut at the end of this year, if economic data remained weak, which would put additional pressure on the dollar.

Three months on and the dollar is at a two-year high on a trade-weighted measure, and up 2% since 1st January. What happened? First, the U.S economy did not see nearly as significant a deceleration of GDP growth in the first quarter as had been feared. GDP growth came in at 3.2% annualised (in late February some of the more miserable forecasts had been predicting just 0.5% growth). This has largely ended speculation of a Fed rate cut this year. Second, China and the eurozone both saw better than expected data…but their central banks, along with the Bank of Japan, have spoken and acted as if the opposite were the case in order to protect growth. The ECB and the BoJ have announced there will be no rate hikes this year. The People’s Bank of China has played its part in the recent stimulus package led by Beijing, by relaxing bank reserve ratios. The result has been a surprisingly sprightly dollar.

If the U.S economy continues to deliver better-than-expected results the dollar will strengthen further, bad news for America’s exporters and for the many emerging market economies reliant on cheap dollar-denominated debt. Friday’s new jobs data release -if stronger than the consensus expectation of 187,000 new jobs - has the potential to trigger another burst of interest in the dollar.

Brexit. There has long been a suspicion that the on-going Brexit talks between the Conservative and Labour parties are a sham. The Conservatives, it is said, will never concede to a customs union with the E.U (which Labour is demanding), or to a referendum vote on any deal that is eventually agreed. Meanwhile, the Labour leadership wants to be seen as willing to help solve a national crisis, but does not want to be associated in any way with what it has dubbed a ‘Tory Brexit’.

However, Prime Minister Theresa May’s statements yesterday in Parliament suggest she is moving towards the customs union idea. No doubt to the fury of Conservative Brexiters, since a customs union will effectively end their dream of the U.K doing independent free trade deals. But these are the same politicians who refused to vote for May’s original deal three times, and she perhaps feels she owes them little in return. If the Conservatives do agree to a customs union, Labour will have to decide whether can back it without losing face amongst its many Remain supporters, if a new Conservative leader (Boris Johnson?) can be trusted to honour the agreement, and whether they should insist on a confirmatory second referendum to get public backing for any deal. 

I continue to believe that the most likely outcome is a second referendum on a Brexit deal that includes a commitment for the U.K to remain in the customs union, alongside both Theresa May’s original withdrawal agreement and the future relationship document. This is then rejected by voters, in favour of remaining in the E.U. Sterling will rally. 

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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