January 2020: how we are positioning portfolios

The initial reaction to last month's significant Conservative victory in the UK election was much as we expected. Sterling and domestically-exposed UK equities rose sharply. Overall, this helped portfolios.

In the last quarter of 2019, we moved from an underweight position in UK stocks to a more neutral one, as the risk of a “no-deal” Brexit receded. Our holdings have a bias to small, mid-cap and domestic UK stocks. There is probably scope for these segments of the market to rally further as international investors increase allocations to the UK in the coming months.

The benefit will be partially offset by the somewhat reduced sterling value of our overseas holdings. However, we expect the extent of moves in both domestic equities and the currency to be somewhat limited, as the UK’s trading relationship with the EU will remain a source of uncertainty.

Gold holdings remain significant

Our relatively large allocation to gold is a distinguishing feature of our investment strategy. Gold has performed well for us, though it retreated from its highs of the year as bond yields rose. However, it still ended 2019 up 19%.  We retain our holdings heading into 2020.

The performance of gold is highly correlated to bond markets. As one of my colleagues memorably put it, gold is a way of owning bonds “through the back door.” In 2019 we saw gold, bonds and equities all rising in tandem.

Stocks and gold have both rallied this year

Performance of S&P 500 and gold (rebased to 100)

^{Source: Cazenove Capital, Refinitiv Eikon, December 2019}

On balance, however, we think gold is currently more attractive than government debt. Yields on government bonds are still below inflation in many major markets, and this does not suggest to us they will deliver attractive real returns in the long-term. We are underweight government bonds in most multi-asset portfolios. Our significant gold position makes us more comfortable with this approach.

Other areas within fixed income are more attractive. For instance, we recently increased our allocation to emerging market debt. While there have been pockets of distress in specific markets – such as Argentina – the fundamentals in larger emerging economies look attractive.

Staying neutral on equities... but aware of the risks

Our equity position remains in line with our long-term target allocations. There are several reasons to stick with shares. Some form of a US-China trade agreement is now looking likely, which should further support the uptick in global growth expectations we have seen in the last quarter. Central banks also remain highly supportive.

As ever, there are risks stacked against these favourable developments. A trade deal is likely to be only a partial one. And with a US election coming up next year, President Trump may take a tough stance in subsequent negotiations with China as he seeks to re-establish his credentials as the “America First” choice.

Increased regulation is another US election-related risk. Finally, while equity valuations are not extreme, the recent rally leaves US stocks looking more stretched than they did at the start of the year.

A “neutral” position does not mean we are inactive. Our manager selection team has made allocations to some interesting new funds this year. One of these is a specialist in mid-cap US growth stocks. Another is a long-short hedge fund that aims to generate attractive risk adjusted returns in all market conditions.