Markets continue to gyrate but pinning down the precise cause remains tricky. In a sense though, the cause is only really worthwhile pursuing if it continues to be a force which drives markets. With that in mind, there are two dynamics which are currently dominating, and both are related. One is a tightening of monetary conditions, with US interest rates moving higher and, more generally, central banks exiting quantitative easing and entering quantitative tightening (QT). The second dynamic is a concern about slower growth.
Taking these in turn, we have said for some time that QT heralds a new era for financial markets: a more demanding environment generally, but also one which will see asset class behaviour change, relative to their own history and relative to other asset classes.
Meanwhile, in terms of slower growth, economically sensitive businesses have been underperforming more defensive businesses since the beginning of June this year (see chart). More specifically, since June, materials, financials and industrials are the worst performers, whilst healthcare, utilities and consumer staples are the best performers, and are the only three sectors in positive territory.
Source: Bloomberg, 30/10/2017 – 30/10/2018.
This feels like something more than a whimsical sector rotation, due to its persistency (in terms of duration, and that it continued during both rising markets and through the recent sell-off) and its scale. This suggests markets are worrying about growth and is consistent with evidence of a slowing US housing market and slowing US money supply growth, whilst the global PMI manufacturing survey has been moving consistently lower since April (though remains well above 50, a level which is consistent with recession).
Bringing these two dynamics together, tighter monetary conditions would be expected to provide headwinds for growth. That said, if US growth slows materially that will lead the Fed to raise rates less aggressively, assuming inflation doesn’t tie their hand. Stepping back though, what practical portfolio construction steps can we take if the environment is to be characterised by higher volatility and lower returns?
Within equity, we have been adding to defensive sectors where there is evidence of share price momentum, like pharmaceuticals, infrastructure and utilities. We have a preference for value too, with less exposure to mean reversion risk. Turning to bonds, we continue to believe they will be hurt by rising rates and inflationary pressures, and expect little shock absorption benefit (as yields are already compressed), and so we remain short duration across our bond portfolios. Elsewhere, we have been adding to property, for example in Japan, adding to gold exposure and holding elevated cash positions, until we get more visibility.
The value of stock market investments will fluctuate and investors may not get back the original amount invested.
Past performance is not a guide to future performance.
For funds investing globally, currency exchange rate fluctuations may have a positive or negative impact on the value of your investment.
Forecasts are not reliable indicators of future performance.
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Source for information: Miton as at 30/10/2018 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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