Having passed the half year point of 2018, our investment team have been reviewing the market activity so far as well as looking ahead to what the latter part of the year may have in store for investors.
How far have we come?
In terms of growth, markets ended July not too far from where they finished 2017. The UK equity market is broadly flat while US equities are higher by a little over 4% in local currency terms, but a stronger dollar has added a couple of percentage points to that for UK investors. Asian and emerging markets have suffered the most, dipping into negative territory. Within bonds, some government bond yields have nudged higher, and so prices have fallen given their inverse relationship. Corporate bonds have also been rather lacklustre.
Although the outlook in January was largely positive, with market commentators pointing to the synchronisation of growth, supported by decent profit reports from companies with the added boost of Trump’s tax cuts for corporate America, there remained a rather large elephant in the room: interest rates.
On the rise
Rising interest rates should not be a surprise given that they have remained at a historic low for the best part of a decade. However, the market focused on Central banks announcing the rate at which these would rise rather than accepting that interest rates were on the up and getting on with it. This added to the volatility in the market which was already creeping in given that globally, investors were holding a large amount of equities which cooled slightly on the back of rather overheated sentiment.
Is a recession coming?
Looking ahead, global economic growth looks set to moderate a little, but so too is inflation, and it is hoped that central banks will be mindful of moving too quickly along the higher interest rate path. Recession risk is fairly low in our opinion, and so a movement from concerns over inflation to a focus on growth has reset expectations, and equity markets are in a better shape to respond well to favourable data into the year end. However, political and trade concerns are likely to continue and the effect of these on markets should not be underestimated.
Given the general view that this current economic cycle is maturing, it is right for investors to continue to question the wider outlook. Although this can cause nervousness in asset prices, it is a healthier backdrop than the bull market we saw in 2017.
Our thoughts on the rest of 2018
Within ASAM, we are mindful of the changing dynamics and emergence of tail risks in the markets. We would expect that volatility and geo-political concerns may limit market growth to mid to high single digits for 2018.
Rising uncertainty in pockets of the world, coupled with an acceptance of increased volatility, sets a favourable back drop for investing in quality companies rather than merely following passive, index tracking strategies. Firms with strong balance sheets, proven resilience through market cycles and responsive business models are likely to attract long term investors during temporary dips in market levels. Against that backdrop, we feel well placed given our focus on investing with managers who pay high regard to diligent company analysis in their investment decisions.
Putting our theories into practice
We are not adding to equities at this stage, but maintain our bias to stocks given:
• Valuations are not bubbling over at a collective level
• Corporate earnings growth remains fairly robust
• The global economy is in reasonable shape
We do not see compelling value in government bonds just yet, so are not encouraged to buy those assets. Corporate bonds, both investment grade and high yield, are beginning to look quite expensive. The additional return investors receive over governments bonds has lessened, and so in our view, investors are being paid less for the additional risk to lending to business.
Finally, we continue to hold specific strategies for diversification purposes, for example beneficiaries of falling markets, offering a degree of protection during volatile times.