Summer is typically a quiet time for markets. This year is no different.
Markets have very much gone to sleep for the summer lull, with trading light and many participants on holiday. This quiet time is seen as a period of reflection prior to a more active autumn period. It can also be a risky period given the lack of liquidity.
If important events occur during the summer’s thin markets, price movements can be exacerbated. This was seen last December when markets took an especially savage hit when interest rate disappointment coincided with reduced liquidity during the Christmas season.
This summer, there are a number of foreseeable risks as well as the ever-present unforeseen event risk. Among the foreseeable risks is the forthcoming US Federal Reserve interest rate decision at the end of this month. Markets assume that a rate cut is baked in and are mainly debating its size and how dovish the policy statement will be. Clearly, there is room for disappointment if the Fed interprets the somewhat mixed economic data positively. Given how far markets have travelled on the back of expected dovish monetary policy, the risk feels largely to the downside.
Another summer feature is first half and Q2 earnings results from companies and the associated outlook statements. These feel of particular importance this year, as analysts will want to assess how much profits are being impacted by the slowdown and what companies are prepared to say about second half prospects. Thus far, it has been a mixed bag with some particularly disappointing results from very cyclical areas such as transport and commodities.
Outside the purely financial arena, there is plenty going on in the geopolitical sphere that has the potential to have knock-on effects on markets. Next week sees a further round of trade negotiations between the US and China, the US Iran confrontation is ongoing and Brexit negotiations are about to restart, to name just a few.
Overall, markets feel a little complacent given that there is plenty of scope for surprise over the summer. Most importantly perhaps, is how the markets are setting themselves up for the second half. The first half has been dominated by falling bond yields and quality growth in equities, a return to the lower for longer markets of a few years ago. If the trend changes in the second half it will most likely be in one of two directions, a reacceleration or a further slowdown leading to recession. These two scenarios and the likely policy responses that go with, have very different impacts on asset markets. Hence, markets focus on the data over the summer.
Our main recent focus has been to trim some of our most successful positions to ensure the funds remain balanced to benefit from the status quo, but temper the downside should the direction change into the recessionary scenario. Hence, our main equity positions are in quality growth equities which both benefit from falling bond yields but have relatively limited cyclical exposure. These are complemented by longer dated government bonds and some quality corporates. Were the market to slip into a more recessionary mindset, we would expect our government bonds to pay off well and our defensive equity to be steady. We also have hedges through our defensive Yen exposure and REITS. Should the market become more recovery orientated, then we have some more cyclical equity, but would expect to need to rebalance somewhat. As it stands, it would require quite a few data points to convince us of an imminent cyclical reacceleration.
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Source for information: Miton as at 24/07/2019 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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