Market Update - February 2018

Christopher Peel - Chief Investment Officer

 

It has been a volatile start to 2018 and much of January’s gains in global equity markets have evaporated. The overdue correction, forecasted during the last two years, has finally occurred.

This paves the way for further, long-term investment in risk assets such as equities, commodities and property. It is very important to remember that economic fundamentals and corporate earnings drive markets, not the politicians or the media. Global GDP and international trade flows are in the ascendency and this was highlighted in the recent report published by the International Monetary Fund, in which it revised its global growth forecasts upwards in 2018 and 2019 by 0.2 percentage points from 3.7% to 3.9%.

It has been a volatile start to 2018 and much of January’s gains in global equity markets have evaporated. The overdue correction, forecasted during the last two years, has finally occurred.

This paves the way for further, long-term investment in risk assets such as equities, commodities and property. It is very important to remember that economic fundamentals and corporate earnings drive markets, not the politicians or the media. Global GDP and international trade flows are in the ascendency and this was highlighted in the recent report published by the International Monetary Fund, in which it revised its global growth forecasts upwards in 2018 and 2019 by 0.2 percentage points from 3.7% to 3.9%.

The primary catalyst for the recent sell-off in equities lies squarely rooted in the bond market.

Rising inflation, the ending of Central Bank quantitative easing programmes and a tsunami of issuance in the corporate bond market are pushing rates higher. This will continue until investment grade bond yields are greater than the rate of inflation and perhaps even more importantly, higher than the average dividend yield in the stock market. Ten-year US Treasury yields have risen a massive 80bps since September and are now at the highest level since 2014. This trend is set to continue as the migration to a higher rate environment is at a very early stage. The bear market in developed country (G7) government bonds is just beginning.

The correction in equities may persist for a few more weeks or even months, but ultimately the excess leverage that had crept into the markets and contributed to investor complacency will dissipate. The decline means that company valuations have just become more attractive and cash levels remain high. Any further sell-off will be met with buyers seeking to lower their average cost of ownership and benefit from the favourable macroeconomic conditions throughout the world.

The Bank of England and the US Federal Reserve have clearly indicated that they are going to increase short-term interest rates several times this year, placing even more upward pressure on bonds yields.

Our bond holdings across the various portfolios are highly diversified, underweight duration and broadly neutral on corporate credit with an emphasis on carry trades such as emerging market local currency bonds. Our equity positions are also defensive, with an increased allocation to Smart Beta trading strategies, now approximately 18%, split between minimum volatility and multi-factor ETFs. Nearly all of our non-UK investment exposure has been, and will continue to be, hedged back to sterling, especially with the Brexit negotiations entering the next critical phase.

It is always difficult to pick the bottom or the top of an investment cycle. Our approach to risk management and portfolio construction is designed to mitigate for the “unknown” and seeks to deliver consistent, risk-adjusted returns whilst remaining fully invested. The ACUMEN Portfolios have performed well since their respective inception dates and the model portfolios within the Centralised Investment Proposition have also produced returns consistent with their stated objectives.

It can be difficult to ignore the sensationalist reporting arising from the recent correction in equity markets, but investors need to remain focused on their long-term objectives and trust the discipline of the Tavistock investment process.

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This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Tavistock Wealth Limited.

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