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Diversification remains the watchword

Is next recession edging closer?

02 October 2019

Our Chief Investment Officer talks about trade wars, Brexit, and the likelihood of a recession.

The current landscape

There has been a further escalation in the trade war between the US and China, as President Trump raised tariffs yet again. However, with the US campaign season for the 2020 elections now underway, we expect the president to dial down the rhetoric to avoid tipping the US economy into recession.

The Brexit situation remains fluid and uncertain, resulting in sizeable swings for sterling. While we cannot be certain of the eventual outcome, we expect the rate of UK trend growth to fall in the short term.

Despite a rate cut by the Federal Reserve and a global manufacturing sector feeling the strain, we aren’t seeing the major imbalances that were apparent before the last recession. Although we expect growth to continue, we’ve taken profits and reduced risk in portfolios over the past six months.

Toby: Hello and welcome to another episode of Monthly Market Insights. I'm joined today by our Chief Investment Officer, William Hobbs. Will, the last month has been pretty tumultuous, certainly from a political perspective and after a really nice start to the year for global markets, things have been coming off a bit. Perhaps you can give us some insight?

Will: Yes Toby, there's a bit of politics and economics in here and we’re sort of unsure of the mix I guess. So what you saw in August was that the trade war escalated again, President Trump both raised tariffs and threatened more and there seemed to be no real end in sight. And so markets have started to look with more concern at some incoming data and you have found that the world's manufacturing sector does seem to be feeling a bit of the strain, particularly in places like Germany and those areas are feeling the strain from a Chinese economic slowdown as well. Maybe that's got less to do with the trade war and more to do with structural factors, so this is the moment when the world's markets started getting a bit more ready for a recession and from that perspective we'd certainly argue that the risks of recession have risen a bit.

Toby: So the risks of recession have risen but that doesn't necessarily mean recession is imminent. Would that be correct?

Will: Yes, we always want to be wary of "fence sitting" in this situation but we've got to be wary of over-confidence as well. As we look at the world, some of the things that are still giving us a little bit of encouragement, let's say, are the health of some of the most important actors out there. There just doesn't seem to be the major imbalances that were apparent before the last recession and so if there is a recession or the world is stalling a little bit, it feels more of the technical variety at the moment rather than something era-ending, game-changing, an economic heart attack or liquidity seizure as such. But what we can't predict necessarily or predict with great confidence is where the political winds are going to blow. What we are, to a certain extent, reliant on is a degree of political self-interest on many of the world's major actors. The campaign trail is going to shortly be heating up in the US for the 2020 elections. One of the things that President Trump still scores well on with the population is the economy and from that perspective many are arguing that he won't want to mangle that campaign trail message by helping the economy into a recession with further continuing escalations in the trade war.

Toby: So worth bearing in mind then that when you talk about a technical recession you're referring, of course, to two negative quarters of growth and that doesn't necessarily translate back into era-defining changes like we had in 2008. So all recessions are not created equal I guess?

Will: They are not and one of the problems with predicting recessions actually is that there have been so few of them and so we don't have much of a sample size to compare against each other. The truth of the world economy is that growth is the norm, not the exception. Recessions are the exceptions so that's still how we're positioned from a long-term perspective, that growth will continue, but in the short term we have taken quite a lot of risk out of portfolios over the last six months. We've been selling into equity market strength and so we've got a much more cautious tactical book as they say, a short-term investment book.

Toby: Now unless you were fortunate enough to have had a holiday on Mars that lasted for more than four weeks, it would have been impossible to escape all of the machinations of what's going on with Brexit. As that deadline looms ever closer what are the things that investors need to know about the last month but more importantly what might be coming down the pike?

Will: The Brexit situation, the outlook remains quite cloudy on this front, many things are still on the table. You've seen sterling move around quite violently throughout the summer, based on all sorts of things. We're constantly breaking new constitutional and political territory at the moment, which is really a very interesting situation and again we would remind people of the idea that you should be wary of over-confidence here. There's no one who has a crystal ball on how Brexit turns out. Our suspicion is, from a medium-term perspective, the UK economy can handle it, that the trend growth rate will be reduced but not destroyed but in the short term remember that confidence plays a huge role in economic outcomes and so we can't really guarantee what happens if the UK exits without a deal, no one can. The role of the UK public will be determining how much or how little to panic.

Toby: Hence the importance of diversification. So we have heard from you about instability and volatility within currencies. We've had a lot of volatility in equity and bond markets. How about interest rates? Is there some stability in the outlook for interest rates? We're hearing more positive language from central banks all around the world actually. All of whom are inclined to manage this because they want a stable, economic climate within their jurisdiction. What are your views on interest rates?

Will: Yes, the US Federal Reserve has recently cut interest rates and now the expectations in the markets are that there are over 100 basis points of cuts still to come, that’s 1% out of the current level of interest rates. The rest of the world is more uncertain so Europe and ECB is getting busier, no doubt about that. But the new ECB or the incoming ECB president has made hardly a thinly veiled attack on governments to say 'you need to do your bit too’, that monetary policy can't save these economies, that there needs to be a fiscal side so governments need to get their act together on this front and prepare for the next crisis.

So central banks have a role to play here but in most places interest rates are already very low and there is a feeling some of the governments that haven't been using what's called fiscal space, their room to spend a bit more, they need to do so and that's something that could help the economy as well.

Toby: So continued volatility, central banks are managing as they should be, managing prudently for growth, and diversification seems to remain the watch word. We know that you and your team will keep a watchful eye on this as we rely on you to do and of course, you can keep up to date with Will and his team in between these episodes with our weekly podcast, "Word on the Street", published by Barclays UK Investments. Will, all that remains is to thank you for joining us today and to thank you for your time and we look forward to catching up with you again, next month.

Diversification remains the watchword

As part of our aim to keep you informed of our current investment views and how these themes affect your discretionary portfolios, Toby Cross, Head of Client Investment Solutions, talks to Will Hobbs, Chief Investment Officer, about trade wars, Brexit and the likelihood of a recession.

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