We took the view in the first quarter of 2018, that continuing global economic growth in a climate of very low Gilt yields, merited continuing full equity deployment. Volatility rose sharply, however, and this could largely be laid at the door of the US president on the political front. A potentially trickier issue could be a more robust attitude by the newish US Federal Reserve chairman than his predecessor. There is a feeling that he is playing ‘catch up’ on raising interest rates to prevent inflationary pressures in a strong economy getting out of hand.
Markets have been relatively sanguine in the second quarter, and indeed the 10 year Gilt in the UK yields around 1.3%. While the economy continues to grow, this permits equity and bond investments that offer higher total returns, which reflect reasonable risk premia, to prosper.
That said, we now have several real challenges to face. Donald Trump seems determined to tackle the Chinese trade deficit with the US, and he is pressing hard on NATO allies to increase their defence spending. In the UK, the Brexit date is approaching and is not only causing internal strife in the Conservative party, but is really beginning to worry industry.
However, the Chinese probably have less ammunition than the US, as the trade balance is weighted so much in their favour. They have also tilted their economy much more to their own people, and domestic consumption has taken priority over exports. Mr Trump believes in negotiation. His overt pressure on Mrs Merkel is probably intended to bring Germany’s defence expenditure up to a targeted figure of 2% of GDP, despite his stated objective of 4% for European NATO allies.
We continue to pay more attention to the global economy than the political noise. Here again, there are notes of caution and we have certainly moderated the expectations we had in the Spring. As long as recession is avoided in the UK, the relatively low comparative benchmark of Gilt yields remains a major positive feature. It is the robust US economy that is a possible concern. With long term interest rates relatively low at present and the Fed continuing to raise interest rates, there is a danger that short term rates rise above long-term rates. This has historically heralded a recession if the trend continues much further, and yet inflation cannot be allowed to become out of control.
Where is the balance? A much-respected and independent US research house with an excellent long term track record, has become more cautious on the market. They have moved from an overweight equity recommendation to a market weight one, and that feels about right to us.
Equities still look more attractive than bonds, and they in turn, have an edge over cash. Our view is that while a favourable tide lifted most boats in the recent past, we will now concentrate more on individual stock selection when seeking to add value to portfolios.
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