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A Brexit bounce-back

Economic growth in the midst of trade wars and Brexit

21 May 2019

1 minute read

Our Chief Investment Officer discusses the world’s economic growth, escalating trade wars and Brexit uncertainty, and what this means for your investment portfolio.

The current landscape

The recovery in economic growth has been accompanied by a relatively benign inflationary backdrop to date. This has allowed central bankers to refrain from raising rates too aggressively, which has provided support for both stock and bond markets. As the trade spat between the US and China continues, we see a potential for negotiations to escalate further from here. While we remain confident that a deal will be reached, investors should expect some volatility in markets in the short term. If, as we expect, the UK leaves the EU with some form of a deal, this outcome is likely to deliver a bounce-back in UK economic activity.

Phil: Hello and welcome to another edition of Monthly Market Insights, I’m Phil Attreed, Head of Investment Consulting, and today I’m joined by Will Hobbs, our Chief Investment Officer. So Will, another steady month for risk assets, in particular stocks. How are we feeling about the world?

Will: The world economy looks all right; it certainly has managed to confound those who believed that a recession was imminent. There are some parts that are limping a little bit. Europe: the economy is listing there a little bit. You’re not seeing the recovery in manufacturing lead indicators that you might want to. Overall the world economy looks all right. The interesting thing that’s happening from a capital markets perspective is that that recovery in economic growth is not being accompanied by much inflation. Now that’s allowed central bankers to continue to be relatively easy on the world and not talk about raising interest rates any further. So you’ve found that bond markets have done well and stock markets have done well.

Phil: So we’ve come quite a long way this year in terms of how markets have performed, again, particularly in stocks. In fact, actually only last week we were seeing all-time highs being hit on the US equity indices. However, we have started to see tensions creep back in with China and the US this week. We’ve seen a little bit more volatility creeping into markets. How are we feeling about that trade deal between the US and China and what might come out of the back end of that?

Will: The clouds seem to have been gathering a little bit and when you get deadlines in negotiations that tends to be the case. Most negotiations, the path of most negotiations, you find they do all the easy stuff first and then they get towards the thorniest issues right at the end, where there’s most buy-in needed from all parties. It’s the most difficult bit and you perhaps need some time pressure to get over the line. That seems to be what we’re seeing at the moment. There is the potential for this to escalate a bit further, to be honest. Our suspicion is still that a deal gets done but certainly we are prepared for markets to be a bit wobbly in the near term as tariffs get increased and threatened and there’s a bit of back and forth on that front.

Phil: Our positions, our portfolios are obviously very diversified in nature that’s obviously helped us in the last six months with all of the turbulence that we’ve seen. But how are we positioned if things get a little bit more difficult with that trade deal? How are we positioned within the portfolios? How should our clients be feeling?

Will: As you rightly point out, when you look at it in aggregate, we always try and split the portfolio up in to two sections. But looked at in aggregate, it’s a very diversified portfolio, it’s leaning towards equities overtime for our medium-risk clients. But like I say, split it up into two sections: you have got your strategic asset allocation, which is really that bit of diversified, capital markets exposure you deploy to harvest the financial fruits of future innovation; then you’ve got your tactical portfolio, which is really aimed to add little cherries on top of that performance if possible, trying to harvest any short-term opportunities. Now within that short-term portfolio we’re a lot less positive on equities than we were– relative to one, two years ago, we’re now flat equities, we think they’ve travelled far enough. We’re actually underweight in developed market equities and a little bit overweight in emerging market equities. But that’s really the way we’re positioned at the moment, so a lot more cautiously than we were.

Phil: Just looking at bonds as well. A relatively enduring trend that we’ve seen this year is actually government bonds actually doing quite well, particularly global government bonds within portfolios. I know the team has been a little bit more skeptical around that particular asset class. What factors are coming into play? How should we be viewing government bonds as an asset class generally?

Will: I think one of the interesting things about government bonds, indeed a lot of assets that have a “safety” tag assigned to them. What I mean by that is: when things get bad economically or in capital markets they tend to do a little bit better. So parts of the equity market, parts of the bond market, those bits that are seen as having a bit more safety attached to them have done very well in this cycle. And particularly as people feel you’re getting towards the end of the cycle, they do a little bit better still because that premium, the value of that safety seems to go up a little. We think that that value has been exaggerated at the moment, I’ve got to admit. The other things that we think is that the growth and inflation outlook implied by bond yields at the moment, particularly in the US, just looks a bit below where we’d expect it. So we’re leaning against that in portfolios, that another thing we’re positioned for: the bond yields to rise, bond price to fall a little bit.

Phil: We can’t get through a whole month without talking about the “B” word, so Brexit. It’s definitely going to be on the minds of a lot of our clients. Even as we talked about before, it doesn’t actually impact a lot of our global portfolios an awful lot. Where are we on Brexit and the whole leadership contest?

Will: Yes, I mean the UK’s political back drop is probably a little bit too interesting for some people’s requirements right now. But what you are seeing from a Brexit potential, if you’re looking at that broad range of probabilities that we’ve always talked about: exit with some form of deal is still most likely of those scenarios. Probably an exit without a deal has got a little bit less likely and taking a little bit more increases is no Brexit at all, via a second referendum. The chances of a second referendum seem to be rising a little bit. Like I say, exit with some form of deal is the most likely scenario and that’s one where you should find a bit of a bounce back in UK economic activity once some of the uncertainty is resolved, let’s say.

Phil: Brilliant, thanks so much for the update, Will. Really insightful as always. Thank you too for joining us and we hope to see you again next month.

A Brexit bounce-back?

Phil Attreed, Head of Investment Consulting, talks to Will Hobbs, Chief Investment Officer, about the recovery in economic growth, trade wars, and what to expect from Brexit.

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