The shallowness of market returns so far in 2018 should come as little surprise after two years of extremely strong asset price growth.
Rising US interest rates and the conclusion of European Central Bank’s bond-buying programme, currently planned for December, mark the beginning of the end of easy money. This will inevitably hit asset values.
For this reason, we are taking more cautious stance across our portfolios. We have trimmed our equity allocation, deploying portfolio insurance where appropriate and trimming holdings of high-performing growth stocks.
We have also pared back our allocation to lower-grade credit funds. In short, a steady de-risking in our balanced funds and a move to more defensive stock selection across our equity mandates.
This is not based on fears that a dramatic market correction is imminent. Rather, it is the absence of places to hide that worries us. Most traditional safe havens seem to have rather big question marks hanging over them:
BONDS: After years of central bank distortion, the bond market offers some of the lowest levels of inflation protection in a generation. A 10-year gilt offers a real yield of minus 1% today, just as Brexit again hits sterling and threatens the recent moderation of UK inflation. In the US, supply and demand dynamics undermine Treasuries’ safe haven status. An avalanche of bond issuance will be required to fund President Trump’s tax cuts and public spending pledges, just as the Federal Reserve actively shrinks the mountain of Treasury holdings it built up during quantitative easing.
UK: Brexit continues to cloud the outlook for gilts and for sterling assets in general. The economic risks of a ‘no deal’ are clearly material. Against this backdrop, there is an abnormal degree of uncertainty hanging over traditional safe haven UK assets including commercial and residential property—and of course sterling.
DIVERSIFICATION: During February’s brief, but sharp, rise in volatility, government bonds, credit, equities and most alternatives all fell simultaneously. This suggests that as central banks gradually tighten, asset prices that rose together in the up-cycle could now fall together if we see a down-cycle. The traditional safe haven support provided by asset diversification may increasingly be challenged.
With few safe havens to turn to, we are holding more cash across our balanced funds. This affords portfolio protection and means we can buy into any excessive correction in asset markets should the time come.
We favour equities that pay attractive dividend yields. Dividend increases have been exceptionally strong, with US banks set to release around $170 billion in dividends soon. We find the combination of yield today and income growth tomorrow compelling versus almost any other asset class.
Ultimately, we remain confident in our equity managers’ focus on long-term themes with assured underlying drivers. Multi-year earnings growth as a result of genuine secular trends is the best investment safe haven out there.
Guy Monson is chief investment officer and senior partner at Sarasin