Last week saw positive newsflow on both Brexit and the trade war, and so risk assets benefited. Brexit news buoyed UK domestic equities, and sterling, while global trade stocks rallied on trade war developments. A relief rally, in more ways than one for some.
Markets like a simple story. Human nature drives the market’s nature and, more than anything, the market wants closure here. But, despite what populists preach, there are few simple solutions to the complex issues that drive these political dynamics and this is unlikely to be the end of either issue.
Of course, Brexit and the trade wars have many similarities. Their roots can both be found in a rejection of globalisation, and an increased preference for self-determination, which have been fed by increased inequality and a sense that politicians are not keeping their side of the social contract. But they are also different in many ways, with very different pressures points and timescales. Therefore, it is wise to separate the two developments, rather than simply enjoying the slam dunk euphoric moment as markets did.
On more sober reflection, the Brexit newsflow is undoubtedly positive and the risk of no-deal has fallen materially. Nevertheless, the latest proposal to solve the complex Irish/British border issue is in itself complex, tip-toeing as it does around many of the red lines of the EU, ERG and DUP. Risks remain. Turning to the trade war, at best we think recent negotiations will lead to a temporary truce, as the world’s two heavyweight economies are likely to continue to jostle for economic and geopolitical position. So, we would argue that the risks of a non-market friendly Brexit outcome have fallen materially, though trade war risks remain pretty opaque.
It was indeed a week of politics, rather than a week of hard data. However, fundamentals have a knack of reasserting themselves, so they are worth a mention here too. From a top-down perspective, there has been no sustained macro data to suggest that we are in anything but a global slowdown, where central banks are in easing mode, and the pressure for fiscal stimulus is on the rise. That said, if we get a sustained “solution” to either Brexit or the trade wars, expect more positive financial market conditions, and positive sentiment more generally, to provide a boost to economic growth. Meanwhile, the third quarter corporate earnings season is now underway and so expect to gain some sense of what the fourth quarter holds from company guidance.
Turning to portfolio construction, we continue to view political developments from a risk, rather than return, perspective, particularly when it comes to currency exposure. In practice, this means we have reduced our overseas currency exposure, by increasing our hedge back into sterling, thereby limiting the impact of a much more volatile sterling on total portfolio risk. It is a view on volatility, rather than on the direction or level of sterling. We have also been adding to our UK domestic equity exposure, including REITs, as risks have subsided and valuations remain attractive.
More generally, reflecting our pragmatic approach, we continue to add slowly to more cyclical equity with positive share price momentum, while trimming defensive equity where momentum is fading. In aggregate though, we retain a defensive bias, reflecting ongoing uncertainty around economic growth prospects. Beyond the macro, portfolio themes continue to provide some insulation from the economic cycle. For example, renewable energy continues to benefit from technological developments that reduce the cost of solar and wind power, against the backdrop of a volatile oil price and the increasing relevance of ESG. As a result, we have also added to the renewable energy theme.
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Source for information: Miton as at 16/10/2019 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
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