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.
We think we are in for a period of fluctuating markets with some serious risks to the downside. Not an attractive background for investors, who are swinging between optimism and pessimism. This oscillation is likely to drive high volatility in markets which are unlikely to make major forward progress in the short term.
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
Comparing a snapshot of markets at the end of March with six months prior would suggest little change. But for equity markets in particular, this hides a nosedive in the last quarter of 2018 followed by an equivalent rebound this year.
Rewind to September last year, and central banks were broadcasting a return to more normal interest rates. The Fed upped rates in December, responding to a tight labour market and a long period of economic growth. In Europe, the ECB was withdrawing from its bond buying with the expectation that it would start to push up rates from record lows at some point in 2019
The economic outlook has clearly changed over the last six months. A forecast of higher interest rates and trade wars gave investors the collywobbles that we were reaching the end of a normal economic cycle and heading for unknown territory. Interest rates have fallen, most sharply in the US, where the 10-year yield on Treasuries has fallen by over half a percent.
Central banks have taken note. The Fed has backed off sharply and markets now believe that there will be little if any further rise in rates in 2019. The assumed pull back from intervention in Europe and Asia is also presumed to have slowed down if not halted.
Currently, therefore, we have a US economy which is towards the top of its cycle, with little capacity for further fiscal stimulation if growth does slacken off. If the economy does move forward, the Fed is likely to resume interest rate rises; if it heads towards recession, presumably those rises will not take place. Neither scenario looks positive for markets.
Outside of the US, economies look generally less attractive with Europe slowing and China probably worse than official figures tell. Again, not a great background for stronger equity markets.
Being long-term investors, we can generally ride out short-term volatility, but on a five- to ten-year time frame we remain concerned about the rise of populism and the related possibility of trade wars. While it is understandable that the West should wish to stop China stealing technology, the response should not be a war of increased tariffs. History provides a warning of the hazards of trade wars and their disastrous effects on economic growth.
Taken overall, there have to be substantial risks in markets after such a prolonged period of upward movement. But predicting exactly when there will be a major break is not a rewarding exercise – it is sufficient to be cautious and to look for relative value where it exists.
Bond performance over past year
All bonds 10+ years, 12/04/2018 – 12/04/2019, local pricing
German 10-year bond yields hit negative territory in March for the first time since October 2016 amid growing concern about the outlook for the euro zone’s largest economy. A succession of weak data in recent months is stoking bets that Germany could be heading for recession.
Yields remain low everywhere: 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 the past decade, 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 within a reasonable time scale is waning, given the recent deterioration in economic data.
Equity performance over past year
12/04/2018 – 12/04/2019, local pricing
The last quarter of 2018 saw falls of up to 15 per cent, more than wiping out gains made in the first three quarters of the year. Most of this has, however, been reversed in early 2019, with quarter one seeing the biggest quarterly stock market increase since 2010. The US has experienced more dramatic volatility than elsewhere, driven by changing messages emerging through economic data, the White House and the Fed.
The medium-term experience of the euro investor had been better than that of a dollar-based investor, but this has now sharply reversed because of currency movements. In these circumstances, hedging has become far more important. Our recommendation that clients – who had benefitted from being unhedged – should consider changing their stance has proved worthwhile.
Property values have been reasonably stable or rising – apart from in the UK since the Brexit referendum – 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, looks slightly expensive and we are recommending clients to start to disinvest in favour of more diversified European holdings but we recognise that some clients may prefer to retain their property exposure in this market.
Commodity performance over past year against equities
12/04/2018 – 12/04/2019, US dollars
2019 has seen commodities experience a relatively smaller bounce back than equities. Whether trade disagreements are resolved or not may significantly affect commodity prices, with China the largest consumer of most global commodities. We retain a modest exposure for its diversification benefits.
Hedge fund performance over past year against equities
12/04/2018 – 12/04/2019, US dollars, hedge funds monthly priced
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 hedge funds better 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 can provide good diversification benefits because of their broader investment universe. However, we have been disappointed with the absolute performance from the asset class over the past number of years. We continue to closely monitor the universe of products available but remain cautious as to the ability of the asset class to produce the level of returns required over the long run. With equities at current levels, however, we believe now is not the time for clients to reduce holdings in this space.
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 source of diversification.
Short-term interest rates remain low and sit either negative or barely positive throughout 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 GTAA funds, short duration sub-investment grade credit, commodities and property. 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.