It appears that Central Bank economic policy around the world is at a tipping point and that lowering interest rates further is an unlikely course of action. Declining growth and inflation expectations in the developed world mean that interest rates will remain low for some time, but Central Banks (CB’s) focus appears to be on increasing the Quantitative Easing (QE) experiment and encouragement of Government fiscal policy.
Mark Carney (Bank of England Governor) has suggested that the path to negative rates was the “wrong” course despite cutting to 0.25% in August, in September the Bank of Japan didn’t cut rates any further and all the talk in the US Fed is of when they will raise rates again. Meanwhile the ECB didn’t cut any further but is doing everything it can with regards QE. In truth it appears that CB’s have no other option, but to stay the course and encourage a more active fiscal policy. Time will tell on how well Governments execute this.
China continues to slow
Global growth remains tepid to cold, with China forecast to slow further as it transitions its economy, the US just above 1% and the Eurozone and Japan making slow progress. India is the only highlight growing at 7.1%, above expectations. Whilst, given the loose monetary policy we would like growth and inflation to be higher, there are no recessionary signals. Consumers are still spending, unemployment is on the right trajectory, housing and capital investment across the major economies are rising and there is supportive monetary policies. To counter this energy/commodity markets and China continue to disappoint, hurting the economies that rely on these factors for their growth.
Since the volatility of the early summer, post the Referendum result investment markets have been relatively calm and in the UK they have been assisted by central bank action and a falling Sterling. Equities and Bonds have performed well over the quarter especially Equity Income funds and Index Linked Gilts, as investors ‘reach for yield’. Emerging markets (+12.2%) and Smaller Cap indices (+12.8%) have performed the strongest over the quarter as they played catch up with their Developed Market and Large Cap brethren. Property fund suspensions following the election result, put a damper on valuations but they are in line with values prior to the summer and funds are starting to lift their suspensions as the panic subsides. Over the medium term, performance is still in line with other asset classes.
The biggest political/market risk in the next quarter is that of the US election. Recent events have shown us to expect the unexpected and so whilst it is improbable that Trump will win, recent polls suggest that the margin of difference between Donald Trump and Hilary Clinton is now within a margin of error.
The impact on markets should Trump win would be global. Markets don’t like unease / uncertainty both of which would be delivered with a Trump win and are currently pricing in a Clinton victory. Should she be victorious there is likely to be a ‘relief rally’ in markets as the status quo is maintained. Should Donald prevail, investors would likely demand a higher risk premium for holding stocks, whilst economic policy is foggy, therefore dragging down equity markets. The US$ and Gold would likely rise, as safe haven areas, but US$ rises might be tempered due to the economic and fiscal uncertainty, which would have an impact on emerging market currencies.
Another key political event in the next quarter is that of the Italian Constitutional referendum in December. Whilst this may seem an innocuous, but important constitutional Italian specific event, Matteo Renzi (Italian Prime Minister) should he lose the election, would be under pressure to resign. This is important for the UK as it looks likely, with German and French elections in 2017, that Renzi will take an important role in Brexit negotiations.
Given where we are in the economic/market cycle, we would expect Fixed Income to underperform other asset classes over the medium to long term.
Whilst central banks have continued to stimulate economies via reducing interest rates, quantitative easing and accommodative policies, we believe we are nearer the end of the cycle than to the start.
Our view is that government bonds are expensive, but could get more expensive if global risks materialise. The global hunt for yield has led to certain sectors of the corporate bond market being expensive, but would prefer corporate bond vs government.
Despite expectation of increased volatility, we expect equities to outperform other asset classes over the medium to long term.
Earnings growth is a concern globally and we would like to see more if there is to be any more multiple expansion. Within Emerging markets relative valuations are lower and expect emerging markets to outperform developed over the medium term. We recommend a diversification approach across regions and market capitalisations.
Valuations are above average compared to history.
However, good commercially let property on long-term leases do provide earnings visibility and there is still a limited supply of good quality in the UK. Our interest rates view also supports an allocation to a diversified property portfolio.
In the below average growth world with potential volatility in safer asset classes on the rise, absolute return vehicles are a viable option.
Gold has unique properties in the investment world, with its demand based on its store of value, it is a good diversifier. Although the price is cyclical it is becoming a rarer commodity and at time of market stress is the go to instrument.