Brexit, politics and portfolios
Looking beyond the headlines
The current environment for investors
In this elongated economic expansion, despite various isolated pressure points, the environment for investors has been reminiscent of Goldilocks; not too warm and not too cold.
As the UK continues to fixate on the battle for parliamentary control over the Brexit process, it’s actually the world’s central banks that have delivered the most important messages for investors.
Prospective interest rate rises have been delayed amidst a softer economic backdrop. Both the European Central Bank and Bank of Japan indicated that downside risks have increased as external factors have weighed on economic growth. In particular for Europe, the incoming data continues to be weaker than expected. The Federal Reserve (Fed) recently adjusted its language to reflect that it will adopt a more patient approach. Financial markets have interpreted this as a stop to Fed policy rate increases and even the possibility of them easing in the next two years. It looks like major central banks are turning more cautious and financial markets are now pricing in the prospect of major central banks not lifting monetary policy rates anytime soon.
Broadly speaking, in this elongated economic expansion, despite various isolated pressure points, the environment for investors has been reminiscent of Goldilocks; not too warm and not too cold. Inflation has largely been dormant, with the economy expanding close to trend growth, while corporate earnings have delivered returns to investors. Are markets here to stay and enjoy a bit more of the economic expansion, as lower (energy) inflation supports real incomes and central banks remain patient? Or has the macro environment weakened sufficiently that any further bad news will cause markets to capitulate?
Investors grappled with an economic slowdown and heightened anxiety of possibly tipping into a recession late last year, and although we are now starting to see central banks incorporating these recent developments in their projections, 2019 has started on a friendlier tone for financial markets. Stock prices across the board have gained mid-to-high single digit returns during January. This turnaround is also being picked up in our investor sentiment indicator, which has swung from multi-year lows in December to more elevated levels now, suggesting that investors are excessively bullish in the near term.
In the extremes, a contrarian approach to excessive investor sentiment has historically paid off, as investors tend to herd and consensus expectations get incorporated into prices of financial instruments. Sensing the ebb and flow in investor sentiment can add value for tactical investment opportunities in portfolios. However, it only acts as a proxy for market sentiment and the near term potential for a reversal. It’s up to investment strategists to interpret this in the wider context and look further out on the horizon. The outlook for equities appears more fragile to us than it has been in recent years.
We’ve been adopting a more reactive and nimble approach to our tactical asset allocation compared to previous years. Drawdowns in stock prices happen more often in mature expansions, and investor expectations can swing more violently. It was just a few months ago when financial markets priced in a faster and more aggressive Fed policy, whereas now monetary policy easing has been priced in for 2020.
Corporate earnings underpin equity returns, and while we believe that a global economic recession is not imminent, the recent deterioration in macroeconomic data has made us more concerned as to what extent developed market corporates can generate sufficient earnings growth to meet market expectations.
With US growth set to slow as fiscal stimulus fades, European economic data continuing to disappoint and rising US/European political risk on the horizon, we’re gradually starting to position portfolios to be less exposed to equities. Currently, our tactical positioning continues to lean towards emerging markets equities, with underweights in developed government bonds and investment grade credit.
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The value of investments can fall as well as rise. You may not get back what you originally invested.
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