Our Investment Committee meets on a quarterly basis to consider market conditions and the relative values of asset classes. Its views – looked at in more detail below – are then used to guide the strategies that are applied to each of our clients by their expert advisers, in accordance with their unique circumstances.
The divergence between US markets and the rest of the world this summer has been explosive – with the US outperforming emerging markets by almost 15% since the end of April. Fed chairman Jay Powell is dampening fears of US overheating, but Turkey’s current woes bring into sharp focus the dangers of a sizzling economy going over the boil.
If you would like to discuss any of this, please do not hesitate to contact me or any of the Acuvest team.
Economic Performance & Outlook
Long-term US investors sailed past a landmark in August with the S&P 500 recording its longest bull market in history. Lasting almost a decade and throwing off many setbacks along the way, the milestone has been driven by a combination of low interest rates and inflation and, more recently, corporate tax breaks and the boom in certain tech stocks.
Contrast the US with Turkey, which until recently reaped the benefits of similar growth. With an overheated economy, unrestrained borrowing and mounting interest rates and inflation, Turkey is now floundering under a mounting burden of overseas debt, a plummeting stock market and a rapidly weakening lira.
In short, Turkey is an extreme example of what one would expect from an over-stimulated economy. The concern is whether larger economies, in particular the US, may eventually follow suit.
Developed markets are currently clinging to the presumption that potential issues such as overheating and Brexit are solvable, or at least will not cause major disruption. Outside the US however, markets over the last year are flat. This lack of movement reflects the tension between the longer-term risks of political instability and economic overheating and the short-term outlook of low inflation and strong profit growth.
It seems likely that this tug of war between short-term prosperity and long-term risk will go on for some time longer. If this is so, then we may not see any major change in markets through 2018. However, we are long-term investors and must look beyond the current period. On balance, we think that increasing risk and a slowdown in the US economy will start to loom larger over the next year. Whether the slowdown is in 2019 or 2020, it is hard to imagine that markets will not go through some correction in that period.
Bond performance over past year
Source: Merrill Lynch, Irish Governments 10+ yrs, German Governments 10+ yrs, EMU All Non-Sovereigns 10+yrs, US Governments 10+yrs, 04/09/2017 – 03/09/2018, locally priced
Bonds have traded within a fairly narrow range over the past year. Italian yields have recently reduced as the new populist government seeks to reassure lenders on budget restraint.
Yields remain low overall: where bonds are being used for matching and it is possible to take some risk, it seems sensible to either shorten duration or move into alternative investments. Over the long term, interest rates are likely to rise, having been kept artificially low for nearly 10 years, and we are seeing central banks ease up on this pressure. It is very hard however to predict over what time scale interest rates will rise to more normal levels. Our confidence that this must happen in a reasonable time scale is reducing.
While bond yields may be slow to rise, we believe that there is not much scope for them to fall further.
Equity performance over past year
Source: MSCI standard core data, 04/09/2017 – 04/09/2018, local pricing
Markets in 2018 have shown wildly differing performance. While the US ploughs forth on an upward track, the rest of the world looks vulnerable to shock. Europe is moving sideways, while emerging markets have suffered: particularly Turkey, but China, Korea, Indonesia and the Philippines are also significantly down.
We think that the relative values of the US and of emerging market equities may have moved by too much. The risks in the latter are stark but they do seem to be reflected in the price, and the massive relative price movement has to give pause for thought.
Investors generally are nervous to ‘leave the party’ while it is still going on but, one way or another, we are now in a period where markets are subject to higher risk.
A characteristic of the last couple of years has been swings in sentiment for and against particular sectors – we have seen this in tech stocks, in commodity stocks and in financials. This does suggest that there might be opportunities in enhanced index funds, particularly those which are sector-specific.
Property values have been reasonably stable or rising – apart from in the UK since Brexit – with relatively high yields offsetting reduced economic confidence.
We continue to believe that property exposure is sensible, and the long-term outlook for European property appears sound, as markets recover from a period of rental weakness. The Irish commercial market, where some of our clients’ money is, has had a good run and may no longer offer excess returns in the short to medium term.
Commodity performance over past year against equities
Source: Bloomberg Commodity Index, MSCI ACWI equity index, 04/09/2017 – 03/09/2018, US dollars
Fundamental strength in the global economy has been no match for apprehension over commodity tariffs, creating a volatile trading environment. Concerns over slowing emerging market growth continue to dampen growth prospects, although recent major price rises in oil and other forms of energy show a return to levels at which production economics are more balanced. Whether trade disagreements are resolved or not may significantly affect commodity prices.
Hedge fund performance over past year against equities
Source: Credit Suisse Hedge Fund Index (priced monthly), MSCI ACWI equity index, 04/09/2017 – 03/09/2018, US dollars
Absolute performance has been disappointing through the past couple of years and fees remain high, but the diversifying qualities of hedge funds and their ability to generate alpha are more apparent with current levels of market volatility. Higher interest rates may also give better hedge fund opportunities.
Sharp movements in currencies over the past year have given some opportunities for gains (and losses). These funds continue to be a useful diversifier.
Global Tactical Asset Allocation Funds
These funds provide good diversification benefits because of their broader investment universe.
These are floating rate sub-investment grade instruments with a strong covenant and a term of between six and nine years. The premium return over cash rewards illiquidity and credit risks. The class offers another diversification.
Short-term interest rates remain low and sit either negative or barely positive everywhere in the eurozone. The ECB is under no pressure to increase rates, even though economic prospects look better. We continue to advise clients to include yield-enhancing alternatives to cash in their portfolios when this can be done at an acceptable risk.
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 diversifying growth and managed risk assets such as property and GTAA funds. Balancing this, we are underweight equities.
- In a low-return environment, keeping fees low is particularly important.
- In building a portfolio, getting exposure to the equity risk premium efficiently is key. Given its low cost and avoidance of manager risk, passive investing should be considered as a baseline against which to assess the best way to gain exposure. Acuvest does, however, recommend using active managers where we believe they can add value, for example by exploiting their skill or where markets are less efficient.