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Current Market Conditions and Positioning - July 2016
CURRENT MARKET CONDITIONS
The global economy remains anaemic, with central banks in most of the world’s developed nations facing a liquidity trap. Unprecedented low levels of interest rates have resulted in multi-century low yields across most major bond markets (with some now trading at previously unimaginable negative rates). But record-low interest rates have failed to spark any meaningful economic recovery. Outside of the US, the one economy that we are optimistic about, stagnation and deflation remain very real threats.
The global economic outlook in the aftermath of Brexit has deteriorated further as investors and consumers delay spending decisions amid the uncertainty. Reduced spending is always bad for economic growth, and the very pedestrian growth we were expecting will now be even lower in our view. Furthermore, increased levels of frustration among the working class around the globe about the lack of economic growth and rising unemployment levels will continue to add pressure on politicians to use whatever tools they have at their disposal to improve the growth outlook and avoid being voted out of power.
Our base case remains that the pace of interest rate normalisation will be gradual and that interest rates will remain at historically low levels for even longer. The large-scale monetary stimulus and record-low (in some cases even negative) interest rates are continuing to inflate financial assets worldwide as investors search for yield. While we must be close to reaching the limits of further monetary stimulus, most governments are still able to deploy fiscal stimulus (i.e. an increase in public spending or reducing tax to encourage economic growth).
The prospect of continuing monetary stimulus and the potential for fiscal stimulus will provide some tailwind for risk assets in this increasingly uncertain and volatile environment.
CURRENT FUND POSITIONING
From an asset allocation point of view, we continue to favour equities within our international multi-asset class funds. While equities are no longer as cheap as they were in the aftermath of the global financial crisis, relative to the other major asset classes they remain attractive and offer the best hedge against the threat that financial repression poses to the savings industry. Off the current base, we expect global equities to deliver mid-to-high single-digit long-term returns (in US dollars), which is much higher than we expect from the other major asset classes.
Although some indices have recently reached record highs, we continue to find pockets of value:
- in the US, where there has been meaningful return dispersion;
- in high-quality UK-focused assets which saw dramatic price declines in response to the Brexit vote; and
- notwithstanding the challenges that many emerging markets face today, we remain optimistic about the long-term prospects of many of these countries. We also believe that the current negative sentiment has resulted in many high-quality companies with fantastic management teams and good long-term prospects trading at bargain prices (much as developed market equities did following the global financial crisis).
As a whole, listed property is fully valued with many real estate investment trusts extending their rally in the second quarter of 2016 as bond yields plumbed new lows. This has pushed a number of stocks above our estimates of fair value; however, the clear outlier is the UK. Despite an uncertain backdrop, we feel that certain good quality, well-located UK assets can now be acquired at attractive prices.
Our negative view on government bonds remains unchanged. Negative yields are becoming more and more prevalent, with many of the biggest bond markets in the world now trading at negative yields. These yields would have to rise materially before we would be interested in the asset class. Within the income portion of our international multi-asset class funds, we maintain exposure to selected corporate credit and cash.