While our panellists expect the global recovery to continue, fears of an escalating trade war are pushing them into more defensive positions.
The strength of the dollar coupled with president Donald Trump’s sabre-rattling soap opera on trade war has put our panel of asset allocators more on the defensive. The global growth numbers remain too strong to persuade any of them to call an end to the long bull market in equities. But cash levels in their portfolios are rising, and the average score for global bonds (mostly US Treasury bonds) has edged higher.
In equities, average scores have moved higher in US and UK equities but have been lowered in emerging markets, Europe and Japan. Aberdeen Standard Life’s Richard Dunbar is betting against the crowd – sometimes quite a good idea in fund management – and has pushed his score for emerging markets up from 5 to 6. Throughout the equities mix, however, there are only a couple of underweight scores: both Connor Broadley’s Chris Wyllie and F&C’s Rob Burdett keep their scores for European equities at 4.
The strength of the dollar has been the main influence on financial markets and is easy enough to explain. The US economy has been going gangbusters, with year-on-year growth running at around 4 per cent, while inflation has so far shown little sign of picking up. This has allowed the US central bank to pursue its policy of gradually raising interest rates without much fear of damaging growth.
Meanwhile, in the eurozone there is no sign of a rise in interest rates because the economy has proved more sluggish than had been hoped. In the UK, too, the Bank of England has been hesitant about tweaking up interest rates. This widening gap in monetary policy between one side of the Atlantic and the other has pushed the dollar higher, making the holding of dollar-based assets and companies with big dollar earnings (including a number of our own UK stocks in the FTSE 100 index) more attractive.
The key debate now is about how long the dollar will stay strong. Monique Wong of Coutts admits: ‘It is very difficult to call the timing on currencies, but I think the strength of the dollar is not sustainable because of America’s twin deficits on trade and on the budget.’
Keith Wade at Schroders is not so sure: ‘The strength of the dollar cannot go on for ever, but it could persist for longer than expected because of the divergence in monetary policy between the US and the eurozone.’
Divergence in monetary policy means getting used to a stronger dollar
Wyllie thinks, however, that the dollar’s supremacy may be a more permanent feature that we are going to have to get used to. ‘The strength of the dollar has been the big game-changer in the last three months – and a lot of people still don’t believe it. I am not sure what will happen, but I would not be short of dollars right now.’ But he is worried that a prolonged period of dollar supremacy might bring still higher US interest rates, and at the same time higher oil prices. ‘That is a pretty toxic combination for the global growth outlook,’ he warns.
‘The world economy still looks set fair,’ points out Burdett, ‘and the growth is incredibly broad-based, with only about eight countries in recession. But if anything is going to upset markets, maybe trade wars or trouble with the euro might do it.’
Staying overweight us equities on hopes trade war will have a happy resolution
However, Burdett has finally ended his underweight position in US equities, admitting: ‘I don’t want to be underweight in US equities at the moment. The American outlook seems to be getting better and better and the Trump tax cuts have only just started to have an impact.’
A strong performance by Wall Street since March has prompted both Wong and Dunbar also to raise their scores from 5 to 6, but Wade has decided to take some profits there and moves his score down from 6 to 5.
Wong argues: ‘Inflation is bang in the 1 to 3 per cent range in the US and that is the sweet spot for equities.’ She regards the pace of interest rate changes as mattering more to markets than the level of interest rates, and is upgrading her US score ‘because the market is cheaper now than it was at the beginning of the year, after a rise in earnings’.
She also believes the Sino-American trade disputes will eventually be settled, ‘because Trump is pro-business and president Xi is pro-business’.
Dunbar backs up his increased exposure to the US by pointing out: ‘At the moment the engine of the global economy is running a bit better than it was before, with global trade and global investment picking up speed. Time will tell whether the actions of Donald Trump are enough to stall that engine, but the benefits of global trade are one of the few things economists agree on.’
Dunbar is proving to be a bit of a contrarian among the panel members this time around. While others have raised their scores for cash (see below), he has lowered his score, giving him room to raise his score for emerging markets from 5 to 6. In contrast, Wong, Wade and Burdett have all lowered their scores this time around, while Wyllie lowered his score for emerging market equities from 7 to 6 in May and now admits: ‘I wish I had lowered it more.’
Dunbar argues that the case for at least some of the emerging countries’ equity markets is still intact. ‘It is probably not at all fair to see them as a homogeneous group,’ he says. ‘It is better to look at them country by country.’
He says you can always find examples of emerging market countries that are cracking up. ‘But on average they are now better financed than they have been in the past and their central banks are better respected. And although the stronger dollar has the effect of sucking liquidity out of the developing world, it is the growth in global trade which is particularly benefiting emerging markets.’
At the European Commission in Brussels, troubles are sprouting in practically every direction. The crisis in Italy, immigration and Germany’s uncertain political climate keep adding to the Commission’s woes. And then there is the little matter of Brexit.
Not surprisingly, European equities have gone out of favour this year. Panel members began lowering scores in February, while in May both Wyllie and Burdett went underweight. It is still the only equities sector where anyone is underweight. This time around there are no changes at all. Nobody is quite ready to start buying back in yet, though there are positive noises in some quarters.
A weaker euro could give european equities a helping hand, but political risk rising
Wade takes a balanced approach. ‘The Italian budget at the end of September could easily become a source of new conflict with Brussels. But if we do get a weaker euro, that could help get the eurozone economy to perk up.’ ‘
I still like Europe,’ says Wong, keeping her score at 7. ‘Everyone was too optimistic in the synchronised growth phase last year and then everyone got too pessimistic in the first half of this year.’ Dunbar supports her: ‘There has been a slight air pocket in economic growth, but we expect a bounce back.’
Burdett is less sure: ‘Unlike the UK, which is unloved, global investors have liked European equities. So there may be room for more selling on any bad news.’ Burdett is also tempering his enthusiasm for Japan – lowering his score from 8 to 7. However, he insists: ‘The sector still has a lot of things going for it.’ Other panel members keep their scores unchanged, but they seem to agree with him, as the average score for Japanese equities is the highest of any sector on the scorecard.
Meanwhile, the noisy trade wars rhetoric is denting investor confidence and prompting somewhat more defensive postures among the panel, with Wade and Burdett both raising their cash scores. Indeed, in the last six months, average cash scores have risen from 3.8 to 4.4.
As Wyllie says: ‘Putting funds into cash is not an investment at such low interest rates. It is just a method of keeping dry powder.’
While all the panel members remain underweight in global bonds, gilts and corporate bonds, there has been more interest in the US Treasuries as part of a dollar asset mix and on the back of rising yields. In Europe, meanwhile, the ending of quantitative easing in the eurozone in the New Year is, according to Wade, likely to put more upward pressure on bond yields.
Interest in the commercial property sector is slightly on the upturn. All but Wade now hold neutral positions. Wade remains bearish on the back of broader pessimism about the outcome of the Brexit negotiations, scoring a 3. ‘The UK growth story does not look very good, and that is very important to the outlook for property rentals,’ he says.
At the moment the interest in commodities is focused on the oil price. With global growth almost rampant, demand for oil is rising. Meanwhile, the threat of new sanctions against Iran and disruption in supplies from Libya and Venezuela are threatening the ability of the oil industry to keep production in pace with demand. ‘We have to remember also that the oil industry has not put a lot into investment in recent years,’ says Wong. ‘The industry does not have loads of spare capacity. That is going to keep prices on the high side.’
The price of oil brings us neatly to the $64 question: when is the long bull market going to end? Mostly our panel think such a prospect is a year or more away. But one possible trigger could be the oil price. As Wong says: ‘Only 18 months ago an oil price of $100 was inconceivable. If it happened it would be a tax on world growth – petrol, air fares, plastics and lots of other things would be impacted.’
Wade is also circumspect: ‘We have now seen all the surprises on the upside and a lot of the good news is now behind us.’ He thinks the impact of Trump’s tax cuts will begin to fade during 2019. ‘With higher US interest rates, the upswing in the economic cycle will begin to look very tired.’