Our Reviews look back at the markets over the last quarter as well as our thoughts on today's major issues.
After such a disappointing end to 2018, which resulted in virtually all of the major stock markets recording a negative return for the year, January brought a welcome respite with both developed and emerging market equities gaining over 7% in local currency terms. The primary drivers for the recovery were the dovish tone from the US Federal Reserve Board in stating that it would be more patient with further rate rises, as well as more helpful rhetoric from the White House towards China. Such was the strength of the recovery in risk assets that a significant portion of the losses made in the fourth quarter were recouped. Against this, political uncertainty remained never far from the headlines and macroeconomic data releases sent increasingly mixed signals about the outlook for the global economy.
Despite these headwinds, investor sentiment remained buoyant in February and equity prices continued to climb across the regions. Much of the impetus came from news of constructive US-China trade talks, with President Trump stating that sufficient progress had been made to avert the increase in tariffs that was scheduled for 01 March. Further support came from the release of the minutes of the January US Federal Open Market Committee meeting which confirmed the Fed’s pronouncement over the likely trajectory of US interest rates. The final ingredient to the mix was news of Chinese policymakers implementing a combination of stimulus measures to support economic growth. Outside of the US, economic data remained soft with industrial activity somewhat depressed, most likely reflecting a downturn in capital expenditure; although the impact of this was to some extent offset by the strength of consumer spending given strong labour markets and the recent fall in oil prices.
The markets continued to climb in March with equities, credit and government bonds all posting relatively strong returns, buoyed by easier monetary policy and less disruptive trade policies than was the case at the start of the quarter. But with concerns over the age of this prolonged period of global economic expansion and with activity slowing, there is a real concern that markets may have got ahead of themselves leaving them vulnerable to a sudden pull back. For these reasons, perhaps investors should begin the second quarter with a degree of caution.
|Asset Class||3 Months||6 Months||1 Year||3 Years|
|FTSE All Share||9.4 %||-1.8 %||6.4 %||31.3 %|
|S&P 500||10.9 %||-2.0 %||17.2 %||58.4 %|
|FTSE World Europe ex UK||8.0 %||-3.8 %||2.6 %||36.7 %|
|TOPIX||4.6 %||-8.8 %||-1.8 %||41.4 %|
|MSCI Asia ex Japan||8.9 %||1.9 %||2.0 %||54.5 %|
|MSCI Emerging Markets||7.4 %||1.8 %||-0.3 %||49.6 %|
|UK Gilts||3.4 %||5.4 %||3.7 %||11.1 %|
|IBOXX Sterling Corp Bond||4.8 %||4.6 %||4.1 %||16.9 %|
|MSCI UK Monthly Property||0.3 %||1.4 %||5.4 %||21.7 %|
|Brent Crude Oil (US$/bl)||22.4 %||-18.0 %||8.9 %||69.0 %|
|GSCI Commodities Index||12.4 %||-11.3 %||4.4 %||32.0 %|
|Gold (US$/ounce)||-1.4 %||8.3 %||4.6 %||12.9 %|
Source: FE Analytics - rebased in Pounds Sterling
Over recent weeks ‘stocks lower over US recession fears’ has been a much-repeated headline. It is, therefore, reasonable to ask whether a recession is a distinct possibility and, if so, when is it likely to happen and how might the markets react? After all, the broad-based rally in risk assets over the last quarter has continued whilst fears over global growth have noticeably increased. In seeking to find the possible reasons for this, it is perhaps the actions of central banks where the spotlight has come to rest. Already in 2019, the three major central banks, the US Federal Reserve Board (the Fed), the People’s Bank of China (PBOC) and the European Central Bank (ECB) have enacted supportive policy.
The Fed has halted its tightening cycle (for now?), and the markets have reacted positively given the impact of the tighter conditions on risk assets in late 2018. But it is interesting to note that investors would appear to be hedging their bets if the demand for gold and US Treasuries is any measure. Although we expect US economic data to continue to deteriorate, should economic strength surprise on the upside the Fed is likely to raise rates which would undoubtedly come as a shock to the markets.
Although the US-China trade dispute has never been very far from the headlines, it is important to keep an eye on what is happening with China’s economy. We have previously reported on the slowdown in the economy that has been taking place over the recent years, but 2018 saw China’s worst annual growth figures for almost twenty years. To combat this, the Chinese authorities recently announced some meaningful fiscal stimulus in the form of infrastructure spending, as well as continuing accommodative monetary policy. The question is: will it be enough?
Closer to home, the situation in Europe is potentially more troubling, irrespective of the outcome of the Brexit debacle. The Italian economy is in recession and the German economy has only managed to avoid slipping into recession by virtue of some government stimulus. It is reasonable to question why the ECB chose not to tighten monetary policy when the region’s economy was performing relatively well, because now it is in the position of having very little ammunition at its disposal given that interest rates remain firmly in negative territory. By way of intervention, the ECB has halted a rate hike and embarked on a third round of Targeted Long-Term Refinancing Operations, which allow banks to fund loans which they in turn distribute to the real economy at very low rates of interest. So far, the markets have not displayed the response the ECB may have hoped for.
But back to the original question: is a recession likely? Much of recent economic commentary has been about the subject of yield curves and whether they are a good indicator of a forthcoming recession. A yield curve is a line that plots the interest rates offered by bonds with the same credit quality but differing maturity dates, and a 'normal' yield curve would rise with time to reflect the additional yield (interest rate) that an investor would expect to receive for making a longer-term commitment.
An 'inverted' yield curve occurs when the yield on longer-dated bonds is poorer than that offered by shorter-dated bonds. This inversion is often interpreted by investors as a signal that a recession is coming, and recently the US yield curve inverted. The Fed's favoured measure is to compare the yield on the 3-month and 10-year Treasuries. In fact, the US yield curve has inverted ahead of every recession over the past five decades.
In other major developed economies (save for Canada), yield curves are not yet inverted, but have flattened considerably. Some economic commentators consider that this pattern reflects regulatory changes that have encouraged banks to hold more longer-dated government securities and the fact that central banks now maintain larger balance sheets than in the past. Consequently, inverted yield curves may now be a misleading signal; and on past evidence, inverted yield curves have certainly not been very helpful in determining exactly when a recession might occur, and for this reason, even if a recession is coming, it could well be a long way off. This means that investors who sell equities as soon as the yield curve inverts could miss out on rising equity markets for a long time.
Consequently, the sensible approach is to acknowledge that the flattening of yield curves over recent months has, at the very least, been indicating a slowdown in global growth. In recent weeks there has been reference in the financial press to “the Goldilocks economy” – a term which refers to a lukewarm porridge of low growth, low inflation and low interest rates. This cyclical slowdown, after several years of strong growth, is likely to result in global growth remaining weak with very little chance of a sharp upturn in the foreseeable future. Clearly, this has implications for the markets and the level of returns that investors are likely to enjoy.
For this reason, we believe that a degree of caution is warranted and that investors should limit the exposure to riskier stocks which are tied to economic expansion, and that portfolios should have a good dose of exposure to more defensive companies. Although the growth prospects of defensive companies are lower, their profits are generally more dependable and, consequently, they tend to offer greater protection when the dark economic clouds hover. (Of course, such a strategy doesn’t necessarily apply to those investors who seek a higher return and are able to adopt a long-term time horizon to iron-out market peaks and troughs.)
As always, diversification is the key and although we continue to favour equities, we balance this with exposure to other asset classes to act rather like a shock absorber in the challenging economic landscape.
In early March, we rebalanced both our core and passive portfolios (but not our Socially Responsible Investing portfolios) and made several changes which can be divided into three categories:
The following tables indicate the relatively small changes made to the asset allocation of our core and passive portfolio ranges:
|Defensive Growth (A)||↑||↓||↔||↔|
|Conservative Growth (B)||↑||↓||↔||↓|
|Conservative Income (B Income)||↔||↔||↔||↔|
|Cautious Growth (C)||↑||↓||↔||↓|
|Balanced Growth (D)||↑||↑||↓||↓|
|Balanced Income (D Income)||↓||↑||↑||↓|
|Adventurous Growth (E)||↑||↔||↓||↔|
|Global Opportunities (F)||↑||↔||↓||↔|
|Key:||↑ Increase||↓ Decrease||↔ Unchanged|
|Passive Cautious Growth (C)||↑||↔||↔||↓|
|Passive Balanced Growth (D)||↑||↔||↔||↓|
|Passive Adventurous Growth (E)||↔||↔||↔||↔|
|Key:||↑ Increase||↓ Decrease||↔ Unchanged|
The specific changes made to the regional equity exposure varied according to the composition of each of our portfolios, and so the following is only an indicative guide:
Following the extreme market volatility in the last quarter of 2018 we completed a strategic review of our core portfolios, having identified three primary objectives:
Our philosophy and process remain unchanged, and we continue to believe that asset allocation is the principal driver of portfolio returns. But in seeking to deliver this core aspect of our process as cost effectively as possible, we concluded that our objectives could be met by blending passive funds with a smaller number of actively managed funds.
To date we have made relatively limited use of passive instruments, such as index funds and Exchange Traded Funds (ETFs) and we consider that the returns achieved have largely supported our approach. However, the universe of passive instruments has expanded considerably over recent years and pricing pressure has also radically reduced the cost of these strategies.
We continue to hold the view that specialist asset classes and gaining access to high-performing investment managers will still be best represented by actively managed funds, but we only select those we consider to be the best in class which are worth the additional cost.
Consequently, the constitution of our core portfolios is now a blend of passive and active instruments, achieving an immediate reduction in costs. We plan to fully utilise our flexibility as active portfolio managers to adjust the blend and choice of instrument as the economic and market outlook changes.
Risk warning: Investors should be aware that past performance of investments is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them may fall as well as rise. The content of this bulletin is for general information and reﬂects the general market view of Parallel Investment Management Ltd. - it should not be interpreted as recommendations or advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of the content.