We have been saying for the past six months that the blending and selection of investments for our Investment Portfolios has been challenging with so many global factors conspiring to impact both stock and bond markets. The US tax cuts and infrastructure spending has provided significant end of cycle stimulus to the US economy and stock market this year. These factors are set to continue through to the summer of 2019 when the stimulus is expected to start to fade. Both the IMF and OECD are predicting global GDP growth to hit 3.7% in 2019. They have reduced their forecasts down from 3.9% due to the slowing of many developed countries and China.
The rate of economic slowdown will be affected by the pace of the US Federal Reserve’s asset selling programme, tightening of US$ liquidity, the rate of increase in US interest rates and the resulting yields on 10-year US treasury bonds, the ending of the ECB quantitative easing programme and the extent and duration of a trade war between the world’s two largest economies, China and the USA.
We think that investors should have a lower expectation of investment growth in the year ahead. Most analysts are expecting a slowdown in 2019 and a recession in 2020.
We wish to maintain an acceptable equity exposure in all our risk related portfolios even if funds are feeling bruised after the falls in October and November. We do want to access the IMF and OECD forecasted growth but at the same time take a pro-active defensive stance to protect capital from the growing number of negative events that could potentially hit portfolios next year.
US interest rates are currently standing at 2.00% – 2.25% while the current rate of inflation for the 12 months to the end of October was 2.3%. Core inflation (prices excluding food and energy) which is the measure the Fed used to asses inflation was 2.1%. We are expecting the Fed to raise US interest rates by 0.25% either three or four more times between now and the end of 2019, including a rate rise this December.
We can expect these rate rises to be implemented unless there is a shock to the system or markets react badly to higher than predicted rises in inflation, interest rates and bond yields. If inflation remains relatively modest and behaves as expected, then markets may well have already priced in the expectations for 2019. A policy error by the Fed at this late phase of the cycle will be damaging to equity markets.
We are nearing the end of a magnificent bull run that started back in 2009. Asset values have risen on the high tide of quantitative easing, but now that QE is in reverse and progressively being withdrawn, we cannot be certain the impact this will have on asset values.
Opinion does differ on the prospects for 2019. There are analysts who see strong economic fundamentals such as good corporate earnings, high employment, low inflation and interest rates all supporting global growth for at least the next year. Others see the impact of the raising cost of borrowing, the strong US$, slowing economic growth and protectionism through tariff wars as being issues that could tip the global economy into an early recession.
In January 2018, we first started underweighting bonds and introduced an overweight in cash. Then in June 2018, we progressed this position further. Through the year we harvested the growth in funds when available but also protected portfolios from the worst of the stock market losses. Our portfolios were far more robust in limiting losses as compared to the national benchmarks we measure our performance by.
In our new 30th Edition, we have taken into consideration the key issues impacting performance when deciding both our asset allocation and fund selections, namely, US interest rate rises, US wage and core price inflation, tariff disputes and world trade, Brexit Withdrawal Agreement success, post waivers oil prices, Italian budget standoff and China’s debt and economy management.
We are therefore taking our defensive stance a stage further as we progressively reduce asset risk. We have reduced equity exposure in emerging markets, Japan, Asia and Europe and increased our holdings in short duration high yield bonds, inflation linked bonds and a small exposure to gold funds. We have removed our holdings in target return funds having concluded from both the performance of our holdings and on-going research that this sector has not delivered the returns expected and that these funds are generally more expensive than non-hedged alternatives.
We have however maintained our positions in US equity markets and the equity specialist sectors we like. The US tech sector has been hit by heavy reversals recently so we see this as a bad time to bail and instead will retain for recovery as the US remains the growth economy of the world.
We are very conscience that the Brexit withdrawal agreement may yet have a difficult path ahead but despite this uncertainty, UK stocks look attractive as they are undervalued and offer good longer-term prospects particularly the high dividend paying UK multi-nationals with global reach.
We have limited our exposure to gold and gold mining stocks to no more than 2% in any one portfolio. Gold remains a volatile asset. While the US$ is strong, inflation growth is at acceptable levels and there are no near-term serious stock market corrections expected, then it is not worth holding more at this stage.
There is some opinion that the ECB may continue its QE bond purchasing programme into 2019 due to the weak economic outlook for the Eurozone. The forecast for European growth is not at all strong and we have therefore halved our positions. The slowdown in China is having a meaningful impact on Eurozone GDP growth. We have however retained our holdings in European high yield bonds as we see them as offering relatively good value and think that they will retain their prices.
We remain attracted to both Asia and Japan but have eased back on holdings as part of our overall de-risking strategy.
China is caught between a slowing economy and a fight with the US over tariff levels on traded goods. China is taking the pain with the main Beijing stock market falling 18% this year. We can however see an outcome where stock values recover with additional targeted stimulus and a negotiated settlement over trade. We have retained our positions in both China and India as they are the dominant growth economies in the emerging markets. We have, however, removed our other emerging market exposure. This is mainly a reaction to US interest rate rises, bond prices, the global cost of US$ denominated debt and the regional impact of a slowing China.
We have maintained our full geographic and sector diversification by retaining holdings in healthcare, infrastructure, technology, insurance, gold, financials, and commercial property. This diversification along with a style move to some value focused funds will aid portfolio stability and growth.
Our fixed interest securities are primarily focused upon short dated high yield credit, strategic bonds, longer-dated corporate bonds, inflation linked bonds and gilts. This blend is less affected by interest rate rises and protects against inflation.
We have further increased our cash holdings. While this is costly to performance, it is there as an asset class to underpin portfolios at a time of market volatility.
We have taken the decision to retain all our current risk rating on our nine portfolios but in reality, each portfolio’s underlying assets have had their risk content reduced. For example, our Speculative Alpha Risk 8 portfolio is now a risk 5. Balanced Alpha Risk 6 portfolio is now risk 4. This de-risking strategy is temporary until the outlook for equity returns improves. We hope you are in agreement and comfortable with our actions.