Good growth, poor politics
Developments in trade tensions, emerging markets and European politics may determine the trajectory of markets over the coming months.
In our more active multi-asset funds, we have held Greek sovereign debt since mid-2016. This has been a particularly successful investment so far. In the last few months, the risk-reward trade-off has become more finely balanced, as yields have dropped sharply. However, the broader market implication is that we do not see Greece as a potential source of systemic risk any more.
Two countervailing forces have kept markets in something of a holding pattern since March: growth in the global economy and company earnings, versus the ascent of populist economic policies. We are due to learn soon which one will gain the upper hand.
Though short-term recession risk remains low, global growth is likely to stutter over the longer term. Indeed, we expect the US to suffer a recession around 2020, by which point the world’s largest economy will have enjoyed its longest post-war expansion. The fiscal stimulus that will probably pep up growth this year and next will wane by this point, as the US Federal Reserve continues to march slowly towards a more restrictive policy stance.
But other factors are likely to sway asset prices over the coming months, not least the nascent trade war triggered by the Trump Administration, the resilience of emerging economies and the evolution of political risk in Europe. We delve into each of these issues below, albeit the last one through the lens of Greece – which is becoming a good-news story, while crises in the far more systemically important nations of Italy and the UK vie for investor attention.
Given the backdrop of a mid-to-late cycle economy, with healthy profits growth, we have been long risk assets over the past few years. And within our allocation to risk assets we have favoured equities over credit due to the tightness of spreads in the latter and the more symmetric return prospects in the former. Both positions have worked very well as equities have enjoyed a fantastic rally, while corporate bonds have underperformed recently.
It is tempting to start taking profits on this trade, but we believe it is too soon for such a move. Rather, we see the trend as a warning: weakness in credit markets often presages weakness in the real economy. Much of the spread-widening is likely due to tightening global liquidity conditions, which our CIO has recently reiterated will probably exacerbate market volatility in the months and years ahead, as well as impacting business sentiment.
While we believe it is still too early to turn overly defensive, we are likely nearing the end of the spectacular bull market that started in 2009. We remain alert to the risk of late-cycle asset bubbles as interest rates drift higher, the yield curve flattens and nauseating market gyrations become more commonplace.