Despite a burst of volatility early in August – not uncommon in markets – the equity bull run barrels on for an eleventh year with the MSCI All-Country World index of global equities into double-figure territory year-to-date*. Simultaneously, central banks’ monetary policy continues to anchor the latest leg in a multi-decade bond bull market. The Bank of Japan is actively buying bonds and other assets. The European Central Bank is running a negative base rate and has signalled it will reverse its seven-month hiatus on its quantitative easing program in September. The US Federal Reserve reversed a string of nine rate increases, cutting its base rate late in July. Market expectations are for the Bank of England to do much the same. Indeed, rising asset prices underpin what has been a great year thus far for investors.
But the mood is far from buoyant. The current equity bull run has been seriously challenged when fears of a sudden slowdown in the Chinese economy have risen. That risk is clearly exacerbated by the ongoing trade war, with market ructions in early August a recent testament. The developed world remains under the cloud of weak growthand anaemic inflation – shocking considering the current monetary paradigm and low levels of unemployment. Closer to home, Brexit remains as unresolved as ever. A new occupant in Number 10 Downing Street will certainly act as a catalyst, but to what end? Sterling volatility has shot up higher than that of some emerging market currencies, a clear sign of uncommon stress. This list is far from exhaustive.
Nonetheless, we remain sanguine: equities are still our most significant allocation. Why? First, the discomfiting backdrop is itself a reason to be invested. While equity valuations now stand between fair to slightly expensive, the asset class is in an uptrend, but without the over-bullish sentiment which would be a red flag. And while the absolute valuation case is mixed, the relative valuation case is far clearer: other core alternatives – cash and government bonds – are hideously expensive.
However, we recognise equity bear markets can be upon us with staggering speed – thus we continue to have significant allocations to government bonds despite record low yields. Earlier this year, we increased the duration in our government bond holdings – going from short to neutral. While yields have fortuitously fallen further since, these safe-haven assets are held primarily to diversify away from equity risk. In a similar vein, we have also decided to increase positions in gold. While it has rallied by about 15% thus far this year*, and is trading at a six-year high, the commodity has been a crisis hedge for thousands of years.
To be clear, we are not expecting a crisis, or a sell-off in equities: it remains the most compelling asset class from a valuation perspective. However, there is plenty to test that view. Thus, we are content to hold a variety of safe-haven assets, even as we recognise their cost.
Moreover, we remain comfortable with our mix of Sterling and non-Sterling exposures given Brexit-linked currency volatility. There are a range of outcomes possible, and the future is impossible to predict with certainty. Should further Sterling weakness occur, globally-oriented strategies should benefit. Should Sterling strengthen, globally oriented strategies should face a currency drag; thus we “hedged” part of the non-Sterling exposure earlier in the year and may do so again. As we have always done, we will stand by our investment process to navigate the uncertainty.
*As at 5 August 2019. In accordance with the applicable regulation, we inform the reader that this material is qualified as a marketing document. CA223/AUG/2019