Economic Performance & Outlook
Markets and economists have an uneasy relationship with inflation – too much and it destroys savings and dulls economic activity as the exchange of goods and services becomes less certain. But too little can be just as stultifying with people hoarding savings in anticipation that whatever they want to buy will be cheaper next week.
Policymakers on the whole, and most especially since the 2008 financial crisis, have pumped huge amounts of money into the economy in order to ensure that the economic engine keeps turning over. Until now fears that activities such as quantitative easing, where central banks buy bonds in order to inject cash into the market, would send inflation soaring have been unfounded.
However it seems that in first quarter of 2021, with governments still paying the wages of furloughed workers, and the US introducing a record $1.9 trillion rescue package, markets believe there are insufficient assets out there to soak up all this cash. This newfound fear of inflation has pushed down the value of bonds, and also interestingly some equities. Even with hints from those in charge, such as the UK Chancellor in his recent budget, that governments were going to get their books in order, there is a question about what the populace will accept in terms of tax increases and spending cuts.
It is difficult to predict the political effect of all of this. A few governments may emerge with reputations enhanced. However, many will be dissatisfied, be those young unemployed or old with redundant skills. This sounds like a formula for increased populism like the 1930s. However, the rewards will go to the politicians who manage to improve the lot of these unhappy people in a constructive way, another reason for suspecting that government spending is on a long-term rising trend.
The crisis-led change in business habits and activity are of significance. As lockdown unwinds, will staff generally return to the office or will there be some permanent change that sees more people working from home? Goldman Sachs’ CEO has indicated he would favour the former, whereas BP is taking a different approach, encouraging its staff to work some days a week from home even after the pandemic ends. Wherever this discussion goes will have a profound effect on office properties, and on consumer behaviour. A city centre with a significant reduction in the number of people means fewer customers for cafés, restaurants and shops.
Overall, it is worth remembering that what investors feel strongly about one week, may change the next, especially when so much activity is, and has been, dictated by the major decisions of central banks and governments. The March decision of the European Central Bank to ramp up its bond-buying programme to reduce the yields on bonds is one such example. This, of course, has been designed to tackle some of those inflation concerns that have accelerated in recent weeks.
Bond performance over past year
All bonds 10+ years, 11/03/2020 – 11/03/2021, local pricing
Yields on bonds have long been so low as to question how anybody could be enthusiastic about holding them. Concern about inflation has made the fixed income yielded by bonds even less attractive.
As a result, the global benchmark US 10-year bond yield has climbed from below 1% at the start of the year to more than 1.6% recently. More importantly, this affects the price of all other securities and can be seen as the reason for the disruption in equities over the past few weeks.
Equity performance over past year
11/03/2020 – 11/03/2021, local pricing
The lustre of technology stocks has tarnished somewhat over the past few weeks. Shares in Amazon, for example, slid 13% from an early February high to an 8 March low. Why? We traditionally expect some sort of inverse movement for bonds and equities: hope for economic growth drives investors into stocks, while with economic caution comes a preference for lower risk bonds. This past month has seen a fall in value for both bonds and stocks, likely due to our earlier point beforehand about bonds being so unattractive with such low yields. That had lowered the bar somewhat for investing in stocks that were already pretty highly priced. With bond yields rising, that laid bare the overvaluation in equities as well. In addition, technology companies, whose prospects are based on growth well into the future, tend to prosper more in a low rate environment hence their particular exposure to bond yields. The tech-heavy Nasdaq Composite index slid considerably faster than the S&P 500, which has a broader range of shares.
Looking forward, the change in government strategy as we do emerge from the pandemic will mean more major macro – even experimental – shifts in policy, creating a more uncertain future for equities than we have had over the past decade.
It will not come as a surprise that the Covid pandemic and economic struggles have hit the property market severely, particularly in retail. We would therefore struggle to recommend property in the short term – clients who are already below target weight should remain there.
The Irish property market is looking mildly overpriced, but we understand that some clients may want to keep some exposure to the domestic market.
Commodity performance over past year against equities
11/03/2020 – 11/03/2021, US dollars
Commodities are in general used to build and make things and therefore they tend to climb when the economic outlook is positive. We don’t therefore believe we are in a bull market for commodities for a number of reasons, including lower growth expectations for China (which had been the driver of growth in commodities in recent years). It is worth noting though that the oil price has climbed by more than 50% since late October as the crisis recedes.
Hedge fund performance over past year against equities
11/03/2020 – 11/03/2021, US dollars, hedge funds priced monthly
We remain of the view the hedge fund performance has been disappointing but that there are defensive qualities should become evident in market slumps.
We appreciate the diversification potential of currency funds and the continued movements in currencies in recent months have provided opportunities for some gains and losses in the sector.
Global Tactical Asset Allocation Funds
With the outlook still somewhat uncertain these funds do provide good diversification, and we do advise clients to retain some exposure within their portfolios. We are conscious, however of the fact that, as actively managed funds, they generally attract higher fees than funds investing in core beta, and their returns have been considerably below the strong returns delivered by equities and bonds over recent years.
The premium that these securities return over cash is a reward for their illiquidity and credit risks. Again we believe they can provide a valuable source of returns in the current low interest rate environment as well as providing a degree of diversification within a balanced portfolio.
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).
Given the extent of the recovery in markets despite the uncertain outlook for economic and corporate profitability growth we reverted to a negative stance in August. On the basis of the improved outlook for a recovery in economic activity as vaccines begin to be rolled out, and the continued support from political leaders and central banks across a significant proportion of world’s economies we have advised clients to shift back to a neutral position on equities. Our current central expectation is for high levels of volatility to continue through the rest of this year and we continue to advise clients to look on dips in the market as opportunities to rebalance, thereby selling high and buying low around a neutral central position. An environment of low returns and high volatility we continue to advocate the benefits of having a well-balanced and diversified portfolio, and continue to work with our clients on finding attractive investments in credit and infrastructure.