Growth more fragile, valuations no longer cheap
How we are positioning portfolios in the face of persistent political risk and slowing global growth
As we reach the midpoint of the year it is a worthwhile exercise to take a step back and review what has changed in the first six months of 2019.
From an economic point of view, the major change is the pivot by the US Federal Reserve from its previous positon of increasing interest rates, to a position now where there is a widespread expectation of cuts to US interest rates in the second half of the year.
This has happened for two reasons: growth has been weaker than previously expected, while inflation has also been lower. We continue to see positive economic growth for the next six to twelve months but it does feel a little more fragile.
Valuations of risk assets (both equities and credit) have clearly recovered from the oversold position seen at the end of last year to the point that they are both now above their 15 year median. Earnings growth forecasts for this year are in single digits, but there is a concern that earnings could contract next year in the US.
Sentiment in markets has been hit by the recent escalation in the use of the threat of tariffs to secure political ends, with Donald Trump turning his (f)ire on Mexico in an attempt to secure an agreement to try and staunch the flow of immigrants crossing the border in to the US.
Although the threat was rapidly withdrawn, it has left a clear mark in investors' minds. The two key risks to our outlook are, firstly, an escalation in the trade tensions we are currently seeing. All forecasts assume a trade deal agreed between the US and China at some stage this year, but the concern is that the Chinese are not bound by electoral cycles in the way that Trump is.
We do expect a pick up in inflation from the low levels seen in the first half of the year, and it feels as though central banks would tolerate inflation being slightly higher than their target at this stage in the business cycle, but the second concern is that bond and equity markets are in no way prepared for a sharper than expected acceleration in inflation.
We remain broadly neutral in our equity weightings and have remained steadfast in the positioning in the face of the sell off seen in May. We continue to be underweight fixed income in portfolios given that the yields on offer from government bonds are below prevailing inflation rates in the UK. In the third quarter of last year we did add to our position in government bonds for our US dollar clients when yields were above 3% but we will still retain that underweight position unless the economic situation changes.
As a consequence of being underweight to bonds we continue to hold an overweight position in alternatives (a catch all term that encompasses gold, structured products, infrastructure and property) and cash.
Finally an observation on less liquid assets such as direct property or private assets. We do believe that less liquid assets have a place in portfolios, but only when held in structures that properly reflect the liquidity profile of the underlying assets and when clients are clearly advised of the locked-up nature of certain investments.
For many years we’ve cautioned against open-ended property funds and in general against the holding of illiquid assets within funds which are priced daily. Liquidity is not a given.
Chief Investment Officer
Caspar Rock joined Cazenove Capital in September 2016 and is Chief Investment Officer. He joined from Architas Multi-Manager Ltd, a part of the AXA group, where he was Chief Investment Officer and responsible for all aspects of the investment activities, including investment philosophy, process and team. He also oversaw portfolio management at two of AXA group’s private banks. He previously headed up the multi-manager business at AXA Framlington from 2006 to 2008. Prior to that, he managed a range of directly invested equity and bond portfolios, and was Head of European Equities at Framlington as well as a member of the Healthcare team. He has 33 years’ investment experience.
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