Outlook 2019: Multi-manager
Outlook 2019: Multi-manager
- Slowing US growth in 2019 should not come as a surprise as the fiscal impulse fades and the effects of higher interest rates strike the economy.
- For now, we think the Federal Reserve will continue hiking rates until the economy slows below trend, which may not appear obvious until the second half of 2019.
- In the meantime, markets are left discounting a tricky combination of slower global growth, higher interest rates, quantitative tightening and falling profit margins.
Capital preservation has been the name of the game so far in the fourth quarter of 2018, and we expect that to remain the priority for much of 2019 too. To that end, we are deploying four main strategies:
- Taking advantage of lopsided positioning by leaning against crowded trades
- Emphasising value over growth
- Giving precedence to defensives over cyclicals
- Owning gold for when the Federal Reserve (Fed) eventually turns dovish
Bonds behaving badly
An obvious omission from the above list is going long government bonds. To be clear, in more normal times, we would be long the asset class by now. Equally, in pretty much any other cycle before this one, government bonds would be behaving far better than is currently the case. Historically, as the economy slows, the fundamental argument for owning core government bonds improves. The problem however, as mentioned in our recent quarterly, remains principally one of price.
Before the financial crisis, a country’s 10-year yield traded roughly in sync with its trend rate of nominal GDP growth. This relationship broke down with the advent of quantitative easing (QE). The table below, with data courtesy of the OECD, presents where we are today:
Admittedly, QE is not the only reason why this unnatural gap now exists, but it is the most significant one in our view. This policy is now being unwound in the US, is dormant in the UK and ending in Europe and Japan. That means there is a meaningful counterbalance to the forces that would ordinarily see bond yields decline and prices rise (another is boosting the fiscal deficit to over $1 trillion at a time of full employment). To our mind, this goes a long way to explain why bonds scarcely helped investors in October when equities tumbled.
While we are not ruling out buying government bonds next year, we prefer at present to compensate for the role they would have traditionally played via other means. The Fed turning justifiably more dovish is one reason we would reassess this stance. Equities falling and the oil price crashing have yet to really move the needle.
The political playbook
Clearly, geopolitics will continue to have a sizable impact on sentiment both domestically as well as internationally.
How will Brexit evolve? Will there be a trade deal between the US and China? What are the implications of a Democratic House on Trump’s presidency? The answers to these questions will inevitably have a profound bearing on how the year ultimately pans out. The impact of a rising cost of capital on US buybacks will also be important.
Avoid the crowds
Something we have felt for some time is that in spite of the outlook appearing unusually uncertain, investors have seemed pretty sure about which assets would outperform. The extreme degree of capital concentration in a shrinking number of securities was testament to this view.
We have written before of how US assets this cycle have re-rated against all others to such an extent that they represent more of a risk than an opportunity today. In the long-term, that stands in meaningful contrast with assets both in the UK and internationally outside the US. We continue to position the portfolios for capital dispersion as opposed to further capital concentration in the US, not least as its growth rate, one way or another, is likely to converge somewhat with the rest of the world over the next 12 months.
In summary, markets everywhere are in the process of repricing for a classic period of late-cycle stagflation. We think this is appropriate. How the Fed responds will inevitably be important, as will the investor response to the Fed. To be clear, pausing on rate hikes will be as good as it gets in our view. This is absolutely not an environment that justifies a rate cut or further QE. The unemployment rate is simply too low and deflationary pressures non-existent. Furthermore, the Fed under Jerome Powell’s leadership seems far less responsive to market volatility than under his predecessors Yellen, Bernanke or Greenspan.
A sterling effort
For the time being, we expect crowded trades to remain under pressure as extreme positioning is unwound. For UK investors, the performance of sterling adds a further layer of complexity to asset allocation. On conventional measures such as Purchasing Power Parity (PPP), sterling is c.20% cheap relative to the dollar. That implies a 25% move to reach fair value, assuming it doesn’t overshoot. This highlights an additional risk to owning unhedged assets overseas when your domestic currency is one of the cheapest around. We currently have little exposure to the US in part for this reason.
Not that we are convinced of a favourable Brexit outcome necessarily, more that we consider an unfavourable outcome as being already reasonably discounted. We anticipate increasing our exposure to the UK over the course of the year.
For more on our views regarding some of the other themes outlined above, please refer to our recent quarterly ‘Rising yields don’t matter…until they do’.
Find out more about about Multi-Asset Solutions strategic capability here.
This is the twelfth article in our Outlook 2019 series, please check back for more over the coming days and weeks. The first eleven in the series can be found here:
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