Investment Views Hero

Thoughts from Our CIO

12 Oct 2018

Martyn Surguy, Chief Investment Officer

Summary

  • The catalyst for this week’s events comes from the United States. Specifically, the looming trade war combined with rising bond yields and interest rates.
  • Our investment strategy is rooted in our long-term belief in well diversified multi-asset portfolios and avoiding emotional responses to short term developments.
  • The fundamentals do not suggest that a wholesale change in strategy is appropriate – growth is firm, liquidity conditions are supportive, while valuations are not overly stretched relative to earnings prospects.
  • On a tactical basis, our strategies are fully weighted in equities, relative to longer term targets, and skewed toward a more defensive value-oriented style. Fixed income markets are not preferred.

Current markets

Recent market behaviour has been unsettling with sharp falls in equity markets, rising volatility and concerns over the possible end of a cycle that has lasted for almost 10 years. Should we be worried? How are we positioned and what are the prospects from here?

What is happening?

The catalyst for this week’s events comes from the United States. Bond yields have risen sharply in response to the strength of the economy and rising inflation. The Federal Reserve has raised interest rates, and there are concerns that they are heading higher than is currently anticipated. Corporate earnings have been strong but, with the latest earnings season upon us, there are fears that earnings will find it hard to stay strong as wage pressures impact margins.

These concerns have been joined by ongoing uncertainty surrounding US trade with China, together with moderating growth in China that has created a difficult backdrop for Emerging Market investments. Within markets, the rise of computer-based trading creates a further unknown dimension to market behaviour.

Should we be worried?

Our job is to be worried on behalf of the money that our clients and their advisers have entrusted to us. However, the role of an investment manager is also to stay calm in the face of market setbacks and avoid the emotional responses to market developments, which are typically not a recipe for success. Our analysis and decision-making processes are rooted in an assessment of the fundamentals that affect markets (growth, liquidity conditions, valuations and sentiment).

Large market falls are usually associated with recessions, so this is a key focus for us. An industry has grown up in recent years predicting the end of the current economic cycle and the imminence of a US recession. We are not convinced. US growth remains strong supported by fiscal policy, inflation is picking up but not unduly, and the Federal Reserve has been clear on the path of future interest rates. Elsewhere, growth is moderating but still firmly positive in Europe and Japan while Emerging Markets are facing some idiosyncratic challenges but are generally in good shape.

Globally, we still consider liquidity conditions to be supportive, notwithstanding recent rate rises, and are certainly far from restrictive. Central banks outside of the US are likely to err on the side of caution, given moderating growth and subdued inflation.

Equity valuations are certainly not cheap but nor are they worryingly expensive, when set against forward earnings prospects. There are pockets of extreme overvaluation, notably in tech, which is being unwound to some extent at present and where our portfolios are not significantly exposed. However, equity valuations are not far out of line with long term averages. On the fixed income side we continue to believe that most sovereign markets are unambiguously expensive, while credit offers only modest prospects from here.

Investor sentiment at present is generally cautious, with recent market developments reducing the complacency of the last few months.

In conclusion then, our assessment of the fundamentals does not reveal a particularly worrisome picture – but we remain vigilant for signs of deterioration.

How are we positioned?

Our investment positioning and strategy is derived from a fundamental belief in diversification, as the key to long term investment success and the delivery of attractive inflation-adjusted returns. Multi-asset strategies are well diversified through asset class, geographical region, sector, investment style and underlying holding. Active managers are blended with passive approaches and traditional asset classes are complemented by alternative ones.

On a tactical basis, our strategies are fully weighted in equities relative to longer term targets, but tend to be skewed toward a more defensive value-oriented style. We have been underweight the expensive technology space, which has been beneficial during the current episode, but hurt as the sector has soared over the last few years. We are not minded to change this view and believe that the current rotation from growth sectors to our preferred value areas should continue.

“The role of an investment manager is also to stay calm in the face of market setbacks and avoid the emotional responses to market developments.”

Elsewhere, our Emerging Market positions in both debt and equity have not been helpful this year, given the prospect of a trade war, a stronger dollar and concerns over Chinese growth. We remain confident in the prospects here, driven by valuation support, stimulus in China and the likely feel-good factor associated with a US-China trade deal, which we believe will come.

Our fixed income positioning has remained unaltered throughout the year, with very limited exposure to sovereign markets. We are concerned about the impact on capital values as yields normalise from historically low levels. Credit markets, too, offer only modest prospects, as credit spreads are low with little scope to fall further.

Our alternative asset holdings continue to be managed as a counterbalance or buffer to riskier areas of the portfolio, and have an important role to play in diversifying our multi-asset class strategies.

What are the prospects from here?

We believe that the investment environment has not been altered by the recent drop in equity markets and rising volatility. We have consistently emphasised that volatility is to be expected as markets digest higher rates and rising inflation. The fundamentals do not suggest that a wholesale change in strategy is appropriate, and there’s little sign of recession. We expect that our strategies will deliver attractive inflation-adjusted returns from here, supported by a strong corporate sector and solid, but moderating, economic growth.

Martyn Surguy
Chief Investment Officer

 

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The value of your investments and the income from them may go down as well as up, and you could get back less than you invested.
The value of your investments and the income from them may go down as well as up, and you could get back less than you invested.

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