After a decade of work, it all came down to an “ignore, adjust, or abort” decision in the final moments. As Neil Armstrong and the Apollo 11 crew prepared for their final descent to the moon’s surface, an alarm sounded. A quarter of a million miles away, Mission Control worked the problem, and deduced that the alarm could be safely ignored. The result was the historic lunar landing, 50 years ago this month.
Markets had a successful lift-off in the first half of 2019, and overall it was the best start for balanced portfolios since 1998. But now a number of alarms are sounding, and investors must decide if they should ignore these risks, adjust accordingly, or abort from their current investment strategy altogether.
Long-term rate expectations have fallen dramatically
A record USD 11.7tr of global debt now has a sub-zero yield. And markets are pricing an average annual inflation in the Eurozone of around 1.1% over the coming decade. The combination of low growth, inflation, and yields is drawing comparisons with Japan’s experience after the collapse of its asset bubble at the end of the 1980s. While we think it’s too early to say that the rest of the world is destined to repeat the Japanese economic experience, we may need to prepare for an extended period of low returns on safe assets.
With safe asset returns likely to be limited, we hold a large underweight position in low-yielding high-quality bonds, and overweight various higher-yielding carry strategies to generate income.
Markets may be overestimating central bank rate cuts
A key catalyst for the adjustment in rate markets this year has been the shift in central bank policy away from “normalization” and toward easing. The market now expects the Federal Reserve to cut rates by at least 25bps at its next meeting, and the European Central Bank to ease as well. This policy shift has investors wondering if they should be positioning more aggressively for capital gains in equities. While looser monetary policy is more supportive of stocks, and stocks look attractively valued versus bonds, we are conscious that expectations for loose policy are already high, and markets could be vulnerable to repricing. Also, low earnings growth expectations may limit the scope for upside.
We think equities will move higher from here and remain overweight equities, but combine this with countercyclical positions in case central banks disappoint expectations.
Broader US-China trade conflict looks set to continue
The G20 summit last month saw the US and China reach a truce in trade negotiations, and both sides have strong incentives to avoid further rounds of retaliation. That said, uncertainty over trade is already disrupting business investment, and has slowed global growth. JP Morgan's Global Composite PMI reading for May softened toward a new three-year low. The realization that the dispute could continue is prompting more companies to change their supply chains to mitigate the risk of future restrictions.