2016 and before
Why now is not the time to follow the herd
Multi-Manager fund manager Joe Le Jéhan argues that it’s not time to be following market consensus as the first quarter of 2016 has cast doubts over a number of widely-accepted themes.
The global economy appears to be walking a tightrope of sorts, either side of which are two very different outcomes for investors.
Given the skew of investor positioning, the balance of risks suggests positioning a portfolio away from current common consensus is the right one.
What is the common consensus?
Common consensus, right now, would tell you that we are in a world of secular stagnation; where global growth hobbles along and deflation is ever more baked-in.
A world where ongoing monetary easing and competitive currency devaluations from central banks allows the playbook of recent years to carry on undisturbed:
- The dollar remains strong
- Defensive, quality companies exhibiting stable growth will be continually re-rated.
- A slowing China puts only downward pressure on all things energy and commodity related.
But we think there are question marks over these themes after an eventful start to 2016.
Will the dollar remain strong?
Reaction to new policy initiatives this quarter (negative interest rate policy among others) has not followed the "obvious" path – one where domestic currencies are forced down in the hope of engendering a competitive advantage.
Indeed, the strength of both the Japanese yen and euro – and weakness of the US dollar – in the wake of yet more monetary easing, has caught many by surprise.
A comparison to 2011 is an interesting one. Back then, everyone “knew” the US dollar would remain weak. Until, of course, it didn’t - despite ongoing money printing in the US at the time. Now investors are convinced of the opposite.
But, where once a strong US dollar was considered good for the global economy, we are now in a phase where a strong US dollar is more harmful. The market appears to be sniffing this out.
If the bull market in the US dollar is diminishing – even if it signifies more muted US growth - many investors will need to re-evaluate their positioning, skewed as they are.
A more stable dollar is easing current funding pressures on emerging markets and thus softening the deflationary fears that have dominated. At some stage, it may warrant selective exposure to those areas that have suffered most in the wake of its strength - principally energy and commodity-related sectors.
Is deflation baked-in?
We have a great deal of sympathy with the longer-term concerns about global growth. The constraints of demographics and ever-increasing debt burdens will undoubtedly create tougher conditions ahead, both in economies and markets.
However, there is a case to say that inflationary pressures on a near-term cyclical basis are picking up. Ongoing wage increases in the US and a tentative bottoming of the oil price both point to this risk. Indeed, the oil price is now up near 50% since its February lows.
With the Federal Reserve seemingly intent on being “behind the curve”, inflation could well continue to rise unchecked. Should investors eventually respond, it will likely be through purchasing “real” assets such as commodities.
At some stage, the pressure to raise interest rates will reappear. This does not bode well for many asset markets at current levels. Bond-proxy equities and low-yielding bonds – both areas which feature heavily in most portfolios - would likely suffer.
Where are the investment opportunities?
We are not saying that the above scenarios of rising inflation and a weaker US dollar are inevitable.
Nothing is certain at this stage. However, they are not beyond the realms of possibility over the next 12-to-18 months.
In that sense, the degree to which investor positioning has become meaningfully skewed away from these areas and towards beneficiaries of low growth and deflation is significant.
The crowded areas appear fully valued; the recent pariahs at levels that seemingly reflect many of the associated risks.
At some point, all of this could tee up a fantastic opportunity in the things investors don’t currently want to own, such as energy and commodity-related assets.
Extended market cycle
The above all sounds relatively positive. So, why do we on the Schroders Multi-Manager team continue to favour an underweight exposure to equities and a sizeable cash balance?
Principally, because we are mindful that we are seven years into this already elongated cycle. The global economy appears to be walking a tightrope of sorts, either side of which are two very different outcomes for investors.
Equity markets offer pockets of value. However, for the last seven years investors have bought into the idea that expansive monetary policy will generate economic growth; a perception that has helped to prop up broad markets. Market reactions to policy initiatives this year suggest this may no longer be the case.
Meanwhile, bond markets remain at extreme valuations. We have reached a stage where some $9 trillion of government debt (over 20% of the total market) now sits with a negative yield.
Government bonds at these levels may have some short-term benefit in periods of panic. The longer-term return profile, though, remains deeply unattractive should we see any (even modest) cyclical upswing in economic conditions or inflation from here. As we have noted, it appears investors are ignoring the potential for this scenario, however small, at this stage.