Q4-2019 Quarterly perspectives

Tavistock Wealth - Investment Outlook

Welcome to the Q4-2019 ‘Quarterly Perspectives’ publication

Q3 Review

In the third quarter, the global economy slowed and Central Banks reduced interest rates. Developed market equities made modest gains and government bond yields fell amidst the US-China trade negotiations. Emerging markets felt the effects as equities underperformed the MSCI World and currencies broadly weakened versus the US dollar. Against this backdrop, the ACUMEN Portfolios delivered strong performance in both absolute terms and relative to the benchmark. During the period, we took profit on our overweight allocation to emerging market local currency debt, invested in Chinese bonds and initiated a new satellite position in inflation-linked securities.

Key Themes

The global economy and financial markets are caught between two opposing forces. On one side is slowing economic growth and ongoing trade tensions, denting investor sentiment and raising questions of an impending global recession. On the other side are Central Banks, doing all they can to extend the economic cycle. The US Federal Reserve has cut interest rates twice this year and is likely to reduce rates further over the coming year. The arrival of Christine Lagarde at the ECB also signals a likely continuation of easy monetary policy. Dovish Central Banks have caused a significant decline in rates across the yield curve and record volumes of negative yielding debt. With low nominal and real interest rates and bloated Central Bank balance sheets, we may have reached the limits of monetary policy. A shift towards fiscal stimulus would represent a significant change in government policy and could have catastrophic consequences for bond holders.

Chart of the Quarter

Over the last 5 years, the share of developed market government bonds by market value, with negative yields, has increased from zero to 35%. Buying bonds with a negative yield means investors can only make positive returns if someone is willing to pay more… like a classic Ponzi scheme.

Fixed Income

The global economic slowdown and the lack of an agreement in the US-China trade talks last month resulted in a sharp decrease in developed market government bond yields. We believe the bond market is overly pessimistic and government bonds are significantly overvalued. As a result, bond yields may rise going forward. This dynamic will be reinforced by the transition from monetary policy to fiscal stimulus funded via increased bond issuance.The global economic slowdown and the lack of an agreement in the US-China trade talks last month resulted in a sharp decrease in developed market government bond yields. We believe the bond market is overly pessimistic and government bonds are significantly overvalued. As a result, bond yields may rise going forward. This dynamic will be reinforced by the transition from monetary policy to fiscal stimulus funded via increased bond issuance.

Bond market volatility is also likely to rise going forward and will be exacerbated by record-low dealer inventory. This is consistent with a steepening of the yield curve. Within our core fixed income exposure, we prefer a broadly neutral allocation to government bonds with a preference for short-dated maturities over the long-end. Within credit, we prefer the highest quality of the high yield sector known as the Fallen Angels. 

We are currently invested in emerging market debt and inflation-linked securities. Within emerging markets, we favour a targeted approach investing in Chinese local currency bonds over a diversified index. The rationale for this position is underpinned by the fact that Chinese securities will gradually become a larger allocation within blue-chip global bond indices and the People’s Bank of China is easing monetary policy. Our bullish view on China also makes part of the case for inflation-linked securities. Inflation is increasingly driven by global factors, and in particular, inflation/disinflation emanating from China. Chinese factory gate price inflation has historically been a strong leading indicator for global inflation. The increase in this index points towards a pick-up in inflation from current levels.

Equities

Our core equity allocation is invested in smart beta trading strategies comprised of global single factor and regional multi-factor ETFs. Smart beta has a proven track-record relative to traditional market capitalisation weighted indices. In Q3, the regional multi-factor ETFs performed particularly well, outperforming the MSCI World by approximately 2.5%.

Three months ago, we highlighted how supply chains had started to shift from China to other emerging markets and as a result entered a new position in Mexican equities. This was the best performing EM satellite last quarter, outperforming the benchmark by approximately 2.50%. Three months ago, we highlighted how supply chains had started to shift from China to other emerging markets and as a result entered a new position in Mexican equities. This was the best performing EM satellite last quarter, outperforming the benchmark by approximately 2.50%. 

Russia was our second-best performing EM satellite in Q3, and we continue to like the trade given attractive valuations and high dividend yields. We also like Chinese equities and believe there is significant upside potential following the successful trade negotiations with the US. Moreover, the government’s continued efforts to open-up their financial markets bodes well for our China position.

This chart shows the monthly performance of our core allocation to regional multifactor equity relative to the MSCI World. Since 2004, the strategy has outperformed the MSCI World by 0.3% on average per month, or 3.9% on an annualised basis.

Following several years of rising rates, we have recently seen a sharp increase in the number of Central Banks cutting interest rates (as shown by the blue line above). Lower rates will boost risk assets and keep the economic recovery on track. This is a good environment for emerging market equities, especially with a weaker US dollar.

Commodities

Our allocation to gold producers has been one of our best performing satellites this year. The position has performed well as a hedge against slowing global growth and lower for longer interest rates. There has been a recent spate of consolidation within the sector, driving cost efficiencies and promoting economies of scale. This trend is expected to continue through 2020 with further mergers already in the pipeline.

The chart shows the performance of the gold producers ETF relative to the MSCI World. It has outperformed the benchmark by 27.5% and we continue to see further upside in the position given the macro environment.

Foreign Exchange

We continue to believe the US dollar is significantly overvalued and likely to weaken going forward. The interest rate differentials that have been supporting the greenback are likely to narrow and liquidity issues in the US financial system will weigh on the currency. We continue to believe the US dollar is significantly overvalued and likely to weaken going forward. The interest rate differentials that have been supporting the greenback are likely to narrow and liquidity issues in the US financial system will weigh on the currency. Last month the repo market, which is used for short-term lending, ran into difficulties, sending borrowing costs soaring. In response, the Fed announced a series of long-term measures to boost liquidity. This should increase excess reserves of US depository institutions, boosting the supply of US dollars and weakening the currency. 

ESG Investing

‘Doughnut’ economics proposes a radical alternative to the traditional model of development, which focused for decades on economic growth as the sole means to improve the wellbeing of societies.

The Doughnut is an attempt to bring together social and environmental concerns, recognizing that economic growth is important but that it often neglects other fundamental elements of development, namely those relating to the environment and human rights. The Doughnut is an apt analogy for sustainable investing, which is designed to widen the focus of investors to include Environmental, Social and Governance (ESG) considerations on top of a traditional emphasis on financial return.

There is already significant demand for ESG investments, and AUM with an ESG mandate is expected to balloon to $40tn by the end of next year. What’s more, a UK government survey found recently that 68% of UK savers want for their investments to consider impact on people and planet alongside financial performance. Interest is even higher for high net worth individuals, millennials and women. ESG represents a ‘New Normal’ for investment professionals, an environment in which the conversation has shifted from ‘why’ to ‘how’ to get on board.

The Doughnut depicts the two boundaries – social and ecological— that together encompass a sustainable model of development. The inner boundary is a social foundation, below which lie shortfalls in wellbeing. The outer boundary is an ecological ceiling, beyond which there is an overshoot of Earth’s life-support systems. Between these two boundaries lies the ideal model of development, the ecologically responsible and socially equitable space.

Source: Kate Raworth, Senior Visiting Research Associate at Oxford University’s Environmental Change Institute https://www.kateraworth.com/doughnut/

Final Thoughts

It has been a very good year for investors with exposure to both bonds and equities. Positive performance has been driven by the return of the Goldilocks scenario in which interest rates and inflation remain low, thereby enhancing equity market valuations. There is no doubt that the global economy has slowed, but it still remains very far away from recession territory, with Europe being the only exception. Central Banks around the world have adopted precautionary, dovish monetary policies to safeguard against any further slowdown. This will extend the life of the record setting bull market in equities and delay the bursting of the bond bubble for several more quarters. Emerging markets are particularly attractive given the progress that has been made on a range of global trade agreements and our bearish view on the US dollar. The risk environment remains favourable and the portfolios are fully invested with a highly diversified mix of asset classes and regional exposures.

This chart shows the year-to-date performance for the four sub-components of our market composite benchmarks. Despite the economic slowdown, returns from financial markets have proven to be remarkably strong. Low interest rates look set to extend the record setting bull equity market for several more quarters.

Q3 Review

In the third quarter, the global economy slowed and Central Banks reduced interest rates. Developed market equities made modest gains and government bond yields fell amidst the US-China trade negotiations. Emerging markets felt the effects as equities underperformed the MSCI World and currencies broadly weakened versus the US dollar. Against this backdrop, the ACUMEN Portfolios delivered strong performance in both absolute terms and relative to the benchmark. During the period, we took profit on our overweight allocation to emerging market local currency debt, invested in Chinese bonds and initiated a new satellite position in inflation-linked securities.

Key Themes

The global economy and financial markets are caught between two opposing forces. On one side is slowing economic growth and ongoing trade tensions, denting investor sentiment and raising questions of an impending global recession. On the other side are Central Banks, doing all they can to extend the economic cycle. The US Federal Reserve has cut interest rates twice this year and is likely to reduce rates further over the coming year. The arrival of Christine Lagarde at the ECB also signals a likely continuation of easy monetary policy. Dovish Central Banks have caused a significant decline in rates across the yield curve and record volumes of negative yielding debt. With low nominal and real interest rates and bloated Central Bank balance sheets, we may have reached the limits of monetary policy. A shift towards fiscal stimulus would represent a significant change in government policy and could have catastrophic consequences for bond holders.

Chart of the Quarter

Over the last 5 years, the share of developed market government bonds by market value, with negative yields, has increased from zero to 35%. Buying bonds with a negative yield means investors can only make positive returns if someone is willing to pay more… like a classic Ponzi scheme.

Fixed Income

The global economic slowdown and the lack of an agreement in the US-China trade talks last month resulted in a sharp decrease in developed market government bond yields. We believe the bond market is overly pessimistic and government bonds are significantly overvalued. As a result, bond yields may rise going forward. This dynamic will be reinforced by the transition from monetary policy to fiscal stimulus funded via increased bond issuance.

Bond market volatility is also likely to rise going forward and will be exacerbated by record-low dealer inventory. This is consistent with a steepening of the yield curve. Within our core fixed income exposure, we prefer a broadly neutral allocation to government bonds with a preference for short-dated maturities over the long-end. Within credit, we prefer the highest quality of the high yield sector known as the Fallen Angels.

We are currently invested in emerging market debt and inflation-linked securities. Within emerging markets, we favour a targeted approach investing in Chinese local currency bonds over a diversified index. The rationale for this position is underpinned by the fact that Chinese securities will gradually become a larger allocation within blue-chip global bond indices and the People’s Bank of China is easing monetary policy. Our bullish view on China also makes part of the case for inflation-linked securities. Inflation is increasingly driven by global factors, and in particular, inflation/disinflation emanating from China. Chinese factory gate price inflation has historically been a strong leading indicator for global inflation. The increase in this index points towards a pick-up in inflation from current levels.

Equities

Our core equity allocation is invested in smart beta trading strategies comprised of global single factor and regional multi-factor ETFs. Smart beta has a proven track-record relative to traditional market capitalisation weighted indices. In Q3, the regional multi-factor ETFs performed particularly well, outperforming the MSCI World by approximately 2.5%.

Three months ago, we highlighted how supply chains had started to shift from China to other emerging markets and as a result entered a new position in Mexican equities. This was the best performing EM satellite last quarter, outperforming the benchmark by approximately 2.50%.

Russia was our second-best performing EM satellite in Q3, and we continue to like the trade given attractive valuations and high dividend yields. We also like Chinese equities and believe there is significant upside potential following the successful trade negotiations with the US. Moreover, the government’s continued efforts to open-up their financial markets bodes well for our China position.

This chart shows the monthly performance of our core allocation to regional multifactor equity relative to the MSCI World. Since 2004, the strategy has outperformed the MSCI World by 0.3% on average per month, or 3.9% on an annualised basis.

Following several years of rising rates, we have recently seen a sharp increase in the number of Central Banks cutting interest rates (as shown by the white line). Lower rates will boost risk assets and keep the economic recovery on track. This is a good environment for emerging market equities, especially with a weaker US dollar.

Commodities

Our allocation to gold producers has been one of our best performing satellites this year. The position has performed well as a hedge against slowing global growth and lower for longer interest rates. There has been a recent spate of consolidation within the sector, driving cost efficiencies and promoting economies of scale. This trend is expected to continue through 2020 with further mergers already in the pipeline.

The chart shows the performance of the gold producers ETF relative to the MSCI World. It has outperformed the benchmark by 27.5% and we continue to see further upside in the position given the macro environment.

Foreign Exchange

We continue to believe the US dollar is significantly overvalued and likely to weaken going forward. The interest rate differentials that have been supporting the greenback are likely to narrow and liquidity issues in the US financial system will weigh on the currency. We continue to believe the US dollar is significantly overvalued and likely to weaken going forward. The interest rate differentials that have been supporting the greenback are likely to narrow and liquidity issues in the US financial system will weigh on the currency. Last month the repo market, which is used for short-term lending, ran into difficulties, sending borrowing costs soaring. In response, the Fed announced a series of long-term measures to boost liquidity. This should increase excess reserves of US depository institutions, boosting the supply of US dollars and weakening the currency. 

ESG Investing

‘Doughnut’ economics proposes a radical alternative to the traditional model of development, which focused for decades on economic growth as the sole means to improve the wellbeing of societies. ‘Doughnut’ economics proposes a radical alternative to the traditional model of development, which focused for decades on economic growth as the sole means to improve the wellbeing of societies. 

The Doughnut is an attempt to bring together social and environmental concerns, recognizing that economic growth is important but that it often neglects other fundamental elements of development, namely those relating to the environment and human rights. The Doughnut is an apt analogy for sustainable investing, which is designed to widen the focus of investors to include Environmental, Social and Governance (ESG) considerations on top of a traditional emphasis on financial return. 

There is already significant demand for ESG investments, and AUM with an ESG mandate is expected to balloon to $40tn by the end of next year. What’s more, a UK government survey found recently that 68% of UK savers want for their investments to consider impact on people and planet alongside financial performance. Interest is even higher for high net worth individuals, millennials and women. ESG represents a ‘New Normal’ for investment professionals, an environment in which the conversation has shifted from ‘why’ to ‘how’ to get on board.

The Doughnut depicts the two boundaries – social and ecological— that together encompass a sustainable model of development. The inner boundary is a social foundation, below which lie shortfalls in wellbeing. The outer boundary is an ecological ceiling, beyond which there is an overshoot of Earth’s life-support systems. Between these two boundaries lies the ideal model of development, the ecologically responsible and socially equitable space.

Source: Kate Raworth, Senior Visiting Research Associate at Oxford University’s Environmental Change Institute https://www.kateraworth.com/doughnut/

Final Thoughts

It has been a very good year for investors with exposure to both bonds and equities. Positive performance has been driven by the return of the Goldilocks scenario in which interest rates and inflation remain low, thereby enhancing equity market valuations. There is no doubt that the global economy has slowed, but it still remains very far away from recession territory, with Europe being the only exception. Central Banks around the world have adopted precautionary, dovish monetary policies to safeguard against any further slowdown. This will extend the life of the record setting bull market in equities and delay the bursting of the bond bubble for several more quarters. Emerging markets are particularly attractive given the progress that has been made on a range of global trade agreements and our bearish view on the US dollar. The risk environment remains favourable and the portfolios are fully invested with a highly diversified mix of asset classes and regional exposures.

This chart shows the year-to-date performance for the four sub-components of our market composite benchmarks. Despite the economic slowdown, returns from financial markets have proven to be remarkably strong. Low interest rates look set to extend the record-setting equity bull market for several more quarters.

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, Lipper for Investment Management and Refinitiv Datastream. Date of data: 16th July 2019 unless otherwise stated.

Want to know more about the Equity Markets?

Please contact us here:

15 + 2 =

Recent blogs