Already time to take stock

Asset allocation strategy - 12/17/2018

2018 is not yet over but it is already time to take stock. We have been most struck this year by the fact that market falls have been so widespread. In fact, we have to go all the way back to 1994 for such negative returns on both bonds and equities.

Despite political and geopolitical tensions, neither gold or cryptocurrencies have proved resilient. This year, as in 1994, safe havens and diversification, with the exception of money markets, have been of no help. Comparing the situation to 1994 will raise vivid memories. It might also been seen as pure coincidence but we think not: the massive and unexpected monetary tightening in the 1990s has been mirrored this year by progressive, well-flagged interest rate hikes, but back in 1994 there was no question of shrinking the Fed’s balance sheet. In 2018, global liquidity has slowed significantly as both the ECB and Bank of Japan have also been trimming balance sheet expansion. And although these moves have been clearly announced since day one, it is very likely that they have weighed more on markets than expected. Insofar as quantitative easing helped promote asset inflation, falling liquidity clearly represents an obstacle. We have in fact moved from a half-full to a half-empty glass. 

In this respect, and looking beyond uncertainties like US-China relations, Brexit, Italy, oil prices and geopolitical tensions, the Fed’s future action will play a key role. Jerome Powell's latest statements sought to introduce more optionality in the current tightening process, encouraging us to reduce US dollar exposure in our portfolios. If investors think US monetary tightening is nearly over, the dollar could be hit and emerging country equities should gain. True, the emerging zone is still struggling with a number of worries like slowing Chinese growth and the US-China trade war, but we believe growth in China and emerging countries could recover a little in 2019 while developed countries will slow to a certain extent. Investors are sceptical over the outcome to the ongoing US-China trade talks but we feel the issue is a little more open. Emerging country equities are clearly trading at a discount and we believe there are more and more scenarios to suggest that they could enjoy a significant rebound.

No advanced indicators of a recession

Recent market upheavals and further flattening in the US yield curve have triggered worries of an approaching recession, suggesting portfolios should reduce risk exposure. But as far as yield curve inversion is concerned, the short end -the Fed’s preferred gauge of a cycle’s strength- has not yet seen any inversion. And in any case, the period between an inversion and an actual recession can vary significantly. We take the view that today’s yield curve simply suggests that the US cycle is mature. But we see no advanced indicators of a recession such as falling margins, higher inflation and tougher loan conditions from banks. 

Key points
  • Slight equity overweight
  • Emerging equity scores upped
  • Reduced US dollar exposure

We agree that the economic slowdown could have a bigger impact on the second half, especially in Europe, but we do not share the view that a recession is looming. Today’s market volatility essentially reflects tighter financial conditions because of central bank action. These conditions could deteriorate a little further next year, due to further balance sheet shrinking from the Fed and the end of the ECB’s asset purchasing programme, but the shift should be more modest than this year. The Fed’s new optionality over tightening might even result in easier monetary conditions. As there is a chance global growth could suffer only a slight slowdown in 2019, we remain invested and slightly overweight equities.

    Our convictions for December Our convictions for December
  United Kingdom
Emerging countries
Investment Grade
High Yield
Money market
Convertible Bonds
Next headline events
  • Next ECB meeting: December 13
  • Next Fed meeting: December 18 & 19
  • Next Boj meeting: December 19 & 20


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