A renewed rally has taken US and global stocks close to all-time highs set earlier in the summer. This rebound reflects improving optimism over the outcome of trade talks between the US and China, along with action from central banks to protect growth. But we believe that it is too soon to increase exposure to equities. The outcome of the trade talks, which have been the main driver of markets, remains hard to predict. Meanwhile, monetary policy appears to be reaching the limits of its ability to support growth in many parts of the world. As a result, we are tactically underweight stocks until we see greater clarity on US-China talks.
Faced by geopolitical uncertainty, and with the outlook for equities looking muted, many investors are tempted by the stability of cash. But we think it is a poor response. Sitting in cash while waiting for a better entry point – timing the market – is a poor strategy for most investors. With interest rates below inflation in most major economies, cash deposits are losing purchasing power. Unlike bonds, cash deposits do not rise in value to help offset falling stocks. And since stocks rise over the long term, cash also has a high opportunity cost. Instead, we recommend other strategies to store liquidity, lower drawdowns, and ensure long-term returns.
The Federal Reserve cut interest rates by 25 basis points on 18 September, as part of a broader global effort by central banks to insure against economic risks and revive flagging inflation expectations. We believe that Fed easing and strong consumer demand can help avert a 2020 US recession. But risks are tilted to the downside amid escalating trade tensions. Unless the US and China de-escalate, we see limited upside for stocks over the short term.
US President Donald Trump delayed a planned tariff hike on USD 250bn of Chinese imports by two weeks as a "gesture of goodwill." Markets have recently been buoyed by positive headlines regarding trade and Brexit, but in our view we need to see actual progress in talks before increasing our equity exposure. Flare-ups in tensions are common; President Trump has previously delayed tariffs only to then escalate tensions through tweets. And an exemption to agricultural imports from the US may reflect economic necessity for China. So with global growth still slowing and other risks on the horizon, we continue to underweight equities.
The bond markets are signaling increasing concern over the economic outlook. For the first time since the financial crisis, the 10-year US Treasury bond yield fell below the 2-year bond yield, a development seen by many as a precursor to recession and a sell signal for equity investors. Meanwhile, the yield on the 30-year Treasury hit a record low, below 2%, suggesting investors are expecting low rates to persist long term. We believe that recession fears are overdone. But investors should prepare for a more sustained period of lower interest rates.
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