Investment Outlook

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August 28, 2019

Investment Outlook

Tom Elliott

Market sentiment: Nervous. Leading economic indicators are pointing downwards, particularly in the eurozone. Slowing jobs growth in the U.S, and downward revisions to past month’s numbers, suggest caution over the outlook for U.S growth. Investors sense policy paralysis in the event of a global slowdown: many central banks are at the limit of what they can do, while the Fed risks being accused of giving cover for Trump’s aggressive trade policies if it cuts rates. Trump’s strange Tweets over Greenland highlighted the slightly surreal nature of policymaking in the White House, ditto with Boris Johnson’s decision to prorogue Parliament to silence opposition to a no-deal Brexit in Westminster. Core government bond markets, predictability, thrive in this environment of economic and political uncertainty. But stock markets have struggled, with the MSCI World index down 3.6% in local currency terms (down 3.8% in dollars). The VIX ‘fear index’ stands at 20, relatively high.

A multi-asset approach to investing. With core government bond markets on a roll and risk assets plagued by uncertainty, the logic of a multi-asset approach to investing is very strong. The bonds will reduce volatility in the portfolio, while equities provide capital growth over the long term. Regular rebalancing helps ensure that one ‘sells high and buys low’, and that the investor will have suitable exposure to risky assets when they once again have their time in the sun.

Government bond markets look well supported. The Fed is expected to cut interest rates, and the ECB to announce a mix of interest rate cuts and a bond purchase scheme, both in September. Lower short-term interest rates (the type that are set by central banks) are usually positive for bond markets. In the U.K, the Bank of England sits on its hands, waiting to see what Brexit brings. 

However, rate cuts by the Fed and the ECB will be controversial. In the U.S, Bill Dudley -former head of the New York Fed- has warned the Fed not to provide monetary stimulus to the economy if it helps Trump pursue trade disputes that will do long-term damage to the economy. The Fed is being drawn into politics, whether it likes it or not. Meanwhile, many economists question the wisdom of further monetary easing in the eurozone. Negative interest rates and flatter yield curves damage banks’ profitability, and in turn their ability to lend and so stimulate growth. Surely, critics ask, it is time for fiscal stimulus: all eyes on Germany, which has the ability, if not the willingness, to spend its way out of the current economic downturn and so lift European demand in general.  

Brexit. U.K Prime Minister Boris Johnson has announced today that he intends to prorogue Parliament from early September until 14th October. This is a type of temporary suspension, usually done for administrative purposes, and the government is within its right to do so. However, it has not been done in recent history either 1) for so long (outside of a general election campaign period), or 2) with the apparent purpose of preventing Parliament from discussing, and possibly frustrating, government policy. Boris denies that Brexit has anything to do with it, and instead talks of ‘exciting’ plans for increases in public spending in education, health, and law & order. But by starving the opposition of debating time in Parliament, he makes it harder for legislation stopping a no-deal Brexit to be passed by MPs. Trump must be looking on with envy. Sterling has weakened in response, and gilt prices have risen (with yields falling) as investors seek safe-haven assets.

If this goes to a judicial review, the judges must surely find in favour of Parliament. This looks and smells less like a prorogation, and more like a full suspension of Parliament by the government, which is unconstitutional. In Britain, the government exists at the will of Parliament, not the other way round. Some civil wars have been fought on this point.

Interestingly, Boris has apparently made it clear to E.U leaders that the Irish backstop is the only part of Theresa May’s Withdrawal Agreement (W.A) that he is seeking to change. While this will infuriate members of the European Reform Group, a body of hardcore Eurosceptic MPs within the Tory party, who object to the £39bn exit bill, the two year transition period, and a host of other issues in May’s W.A, it will make him seem more reasonable to E.U leaders. A modified version of the Irish backstop may yet emerge, although how the two entrenched positions on the Irish backstop can reach a compromise is anyone’s guess. If it does, it would allow Boris to put to Parliament in the last two weeks of October a W.A that would, currently, probably have enough support to pass and so avert a no-deal. However, the odds must surely now favour a no-deal Brexit.

A multi-asset portfolio for the long term. Many long term investors favour investing in a combination of global equities and bonds since the two asset classes have a relatively low correlation with each other and so offer diversification benefits. Below is an illustration of a typical 60% equities/ 40% bonds fund. The exact ratio of equities and bonds will reflect a client’s risk profile and investment horizon.

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