Following a strong start to the year, equity markets around the world, having risen by up to 8% in local currency terms, took a turn downwards last week. The fall accelerated in reaction to higher-than-expected wage growth data in the US as this raised concerns of rising inflation. There were also fears that central banks would raise rates faster than expected this year.

Should we be concerned that this might be the beginning of a trickier market phase where interest rates rise and stocks become relatively less attractive? For the following reasons, we believe that such fears are somewhat overdone:

1. global growth continues to be robust and the most synchronous for 20 years, with leading indicators presaging more of the same for some time yet
2. reported corporate earnings and sales continue to be strong and are beating expectations
3. although we are positioned for an uptick in inflation during the first half of the year, we do not expect core inflation rates to pick up significantly, for the well-rehearsed reasons of technological and demographic change, and the pervasive impact of globalisation and low-cost competition
4. following the recent shake out in equity markets, positioning and sentiment has moved from the extremes seen in January towards more normal levels.

What are we looking out for?

Most importantly the response of the bond market is key – if it rallies that would be better for equity markets, but if it sells off too aggressively it would be more concerning.

How are we positioned?

• We have a preference for index-linked over conventional government bonds.
• We are short in duration to protect against bond market weakness.
• We are broadly neutral in equity weighting, against a peer group which generally has a higher strategic allocation to the asset class.
• We are underweight in the UK with a preference for the other regions of the world.

Have we made any changes to our portfolios?

• Following the recent weakness, we are adding to our position in Japanese equities.
  
  

It is fair to say that we are not out of the woods yet – and will continue to watch markets closely.

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