Economic Performance & Outlook
There’s no doubt that it has been an unusual and often confusing time in markets. The benign equity markets of 2019 defied the challenges of geopolitical uncertainty. Inflation remains unlikely to rear its head in the near future, even while factors such as a tightening labour market would normally push wages and consequently consumer prices higher. While the unpredictability of markets in recent years makes it difficult to say for certain that the threats we see will knock growth assets lower, it is safe to say that there are significant down-side risks.
The rise in equities through 2019 was a surprise given the mixed messages emanating from other parts of financial markets, with interest rates so low as to indicate the economy is in real trouble. At the start of this year things look even less encouraging. We have become used to the prospect of increased protectionism since the election of Donald Trump and the success of the Brexit referendum in the UK. However, increased bellicose behaviour from politicians in early 2020 have indicated what could be possible, with the killing by the US of Iranian General Qasem Soleimani increasing investor nervousness. At present all eyes look fearfully east as China posts its slowest growth in almost three decades, and as the rapid spread of the coronavirus, and the resulting slowdown in trade and tourism, looks likely to dampen economic growth in the second largest economy.
Again though, it’s worth remembering that markets are not following traditional patterns, and in any case we have to be careful when using past economic history as a guide. What we can be fairly certain of is that we are close to peak for most bond markets and thus a nadir for interest rates. Inflation doesn’t look to be moving upwards in developed countries any time soon, and any talk of increased interest rates from central banks last year seems to have dissipated again. While profit margins in 2019 were particularly healthy, on most measures there does not seem to be substantial room for equities to rise much further. For the longer term, those healthy profit margins may be a sign of growing inequality that feeds through to the political disruption that we have all faced in recent years.
In short, economic growth is slowing and made even more uncertain by the early geopolitical events of 2020, inflation isn’t an issue now and interest rates are unlikely to rise in the near future.
Bonds
Bond performance over past year
All bonds 10+ years, 28/01/2019 – 28/01/2020, local pricing
German 10-year bond yields remain well below zero. US yields have behaved similarly but have tended to be at least two per cent higher. Within the euro zone, the spread between German and peripheral yields, such as those of Italy and Greece, has narrowed, with little short-term opportunity within this class. We believe there may be opportunities in emerging market debt which has moved less than other forms of fixed income.
Overall we are either short in duration or moving into alternative investments, with interest rates having nowhere else to go but upwards over the long term, although the increased risk of economic slowdown associated with the coronavirus could lead to further tightening over the short term, as central banks try to offset the adverse effects through increased QE or other monetary stimulus.
Equities
Equity performance over past year
28/01/2019 – 28/01/2020, local pricing
2019 was a relatively good year for equities, with the US market performing particularly well. With a rush of bad news from China in 2020 the outlook for equities has dimmed somewhat. Each new chunk of bad news in relation to the coronavirus is likely to get analysts to reappraise lower their forecasts for the economic activity that will drive stocks lower.
For our clients, we believe that hedging has become far more important, as the dollar has strengthened against the euro reversing an earlier trend. As global uncertainty increases there is every chance of a further strengthening of the US dollar.
European Property
The popularity of the asset class in recent years has driven prime yields to record lows in core regions, that said we believe that particularly on a relative basis the asset class has a sound long-term outlook. Managers are forecasting income driven returns of 5%-7% in the coming years for core European property and the focus is very much on rental growth and asset management initiatives as a means of generating enhanced returns. While we are recommending our clients maintain a full weighting to European property, we have been advising clients to reduce their exposure to Irish property for some time, as we feel the domestic property cycle is at a considerably more advanced stage.
Commodities
Commodity performance over past year against equities
28/01/2019 – 28/01/2020, US dollars
We don’t believe there is much short term potential in commodities for a number of reasons. Most importantly weaker economic demand, particularly in China which has been the driving force in raising commodity prices over previous decades, will lean on prices. Further, increased commodity supply and no great desire at present for safe haven investing in assets such as gold, means that we do not recommend a specific allocation to commodities at present.
Hedge Funds
Hedge fund performance over past year against equities
28/01/2019 – 28/01/2020, US dollars, hedge funds priced monthly
Absolute performance for hedge funds has been disappointing given conditions – their ability to move swiftly through assets identifying mispricing opportunities should be useful in volatile conditions. Still, their defensive quality may become evident in any market downturn that we may be due.
Currency Funds
Currencies have moved sharply in recent months on geopolitical sentiment, giving opportunity for both gains and losses. As a diversifier these funds are useful, but we are not recommending a specific allocation to them at this time.
Global Tactical Asset Allocation Funds
As a diversified set of assets, these funds provide good diversification due to the very wide investment universe.
Senior Loans
These vehicles, which invest in floating-rate instruments with a strong covenant, are sufficiently attractive to be included in the managed risk element of our default growth fund portfolio at present.
Cash
Short-term interest rates continue to remain low throughout the euro zone, with the ECB under pressure to loosen policy further as economic prospects weaken. We continue to advise clients to include yield-enhancing alternatives to cash in their portfolios when this can be done at an acceptable risk level.
Portfolio Structure & Risk Management
- It is very important that clients have a disciplined management framework for determining how to structure portfolios and how to adjust that dynamically over time.
- Acuvest recommends that portfolios comprise a diversified mix of asset types which balances the desire for high returns with management of the associated risks. For this purpose, we group assets into three categories: growth (including equities and property), managed risk (including global tactical asset allocation funds, certain types of hedge funds and sub-investment-grade credit risk) and defensive (including bonds and cash).
- Within clients’ portfolios, we currently advocate an overweight position in emerging market debt, hedge funds and non-property real assets. We are negative on equities and commodities, while we remain neutral on property, currency, global tactical asset allocation funds and senior loans.
- In a low-return environment, keeping fees low is particularly important.
