The power of balance
Following on from the first two quarters of the year where global equity and bond markets rallied, the third quarter of 2019 saw gains too, although they were modest. While it continues to be an excellent year for investment returns – an equity bull running towards an eleventh year; a bond bull nearing four decades – a sense of alarm is rising for some. This is predicated on an undeniable deceleration in global growth, with fears of a trade war increasingly being manifested in lost output. This is particularly acute for manufacturers, where survey data has shown contraction in industrial production and capital expenditure. It is reasonable to worry whether it could spill over into services.
A number of geopolitical tensions are also flashing ominously. In early September, about half of Saudi Arabia’s daily oil output was briefly halted by an attack. This raises the risk of armed conflict in the Middle East, and potentially skyrocketing oil prices. This could lead to the current economic deceleration turning into an outright recession. Closer to home, the “Brexit” conflict rumbles on seemingly without end. Parliament and Downing Street are at loggerheads – the latter suffered quite a bruising rebuke on its prorogation of the former from the Supreme Court – and tensions are rising. Sterling is trading with a volatility typical of emerging market currencies.
The factors above include some of the triggers that may lead the ongoing equity bull run to come to an end. However, there are also mitigating factors. In regard to growth, consumers remain well anchored for now and are providing critical impetus. Confidence and spending are both robust, and wages are well above inflation in most major markets. Moreover, China and the US have struck a more conciliatory note in recent statements, raising hopes of a temporary ceasefire in the trade war. Both have more to gain than lose by striking a deal, which could prove an important fillip to the world economy.
Markets also continue to receive powerful support from central banks. Over the quarter, the European Central Bank announced wide-ranging easing. The US Federal Reserve cut rates again too. The Bank of England may well also join the party, depending on how “Brexit” unfolds. While monetary policy is admittedly suffering from diminishing returns, there is evidence that fiscal policymakers will be increasingly more active.
It is important to remember we are in the ‘slowdown’ phase of the current business cycle, where global growth is still positive. This tends to be a favourable environment for risk assets, and slowdowns can last for years. In addition, while equity valuations are between fair to expensive, the asset class remains in an uptrend but surrounded by negative sentiment, which we view favourably as a contrarian signal. It is also far more attractive than cash or government bonds.
We also tend to ignore the noise generated from geopolitics. Financial history is replete with evidence of such factors rarely helping determine overall risk allocation. Nonetheless, “Brexit” clearly has implications on sterling, which can seriously impact portfolios referenced in that currency. Instead of guessing unknowable political outcomes, we have chosen to make sure our portfolios can deal with, or indeed benefit from, large swings in sterling. Depending on the portfolio, this can include using hedging selectively or maintaining a higher than usual global exposure.
We remain neutrally positioned. Equities remain our most significant allocation in balanced mandates. However, over the course of this year, we have been steadily bolstering our defences, notably by lengthening the duration of our government bonds and increasing our allocation to gold.
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