Staying Focused On The Facts – The Risks Remain In Place

The recent modest relapse and rise in volatility in global equity markets since the beginning of August has highlighted yet again the headwinds of the US/China trade standoff, slowing global economic momentum, and Brexit. The moves in bond markets over the same period have arguably been more significant, reflecting fears the US Fed, in particular, is lagging behind events. The US 2y/10y yield curve slope is once again close to zero, indicating bond investors sense a coming recession.

Doing nothing is always a valid option in portfolio management, after having carefully considered all other possibilities. We have been suggesting a relatively cautious portfolio positioning since mid-year as market sentiment had improved significantly while economic fundamentals turned more negative as the known risk factors of Brexit and US/China trade proved increasingly intractable.

At this point, it is not valuation concerns which drive our cautious positioning, as equity valuations outside the US are becoming less demanding following a multi-year period of sub-par returns. Especially in the context of very low or negative long-term bond yields, free cash flow and dividend yields on many European and UK equities are at levels which may attract long-term value investors.

However, for the immediate future, we are still concerned that downgrades to 2019 estimates are continuing at a pace which, if sustained, would imply zero profits growth for 2019 compared to 2018. In the circumstances, equities are likely to struggle to deliver meaningfully positive short-term returns, absent a surprise resolution US/China trade or Brexit. Furthermore, central banks in Europe and the US are now widely expected by markets to continue to ease monetary policy over coming quarters, which means that monetary stimulus is already largely discounted within market prices.

The recent increase in market volatility observed during August reflects the well-known but still wholly unresolved risks which investors had chosen to ignore or downplay during Q218. Overly-ambitious expectations for a 50bps US Fed rate cut were not realized and the wait-and-see approach of Fed policymakers has caught momentum traders off-guard. Further increases in US tariffs on Chinese goods quickly followed, confirming that US/China trade talks have stalled. Yesterday’s deferral of US tariffs on consumer goods for the US Christmas season does not reassure but instead reminds us that there is an ongoing political pantomime with some quite serious economic repercussions.

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Disclaimer: Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. This material is being provided for informational purposes only and ...

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