The rally in equities that began following the January 2016 China-devaluation shock has proved to be one of the longest ever.
As investors have quickly brushed the sand off political events such as Brexit, Donald Trump and the French election, equity indices have repeatedly registered new record high watermarks.
Meanwhile, the Investment Clock that guides our asset allocation has been in the “Overheat” phase since last July, with markets basking in an equity-friendly backdrop of rising global growth and inflation. However, business survey readings in the US and China have now fallen from recent apexes, suggesting the pace of global growth is now easing, while inflation outside of the UK is peaking, as commodity prices cool.
A slower pace of expansion and lower inflationary pressures are a good climate for bonds, and we have reduced our fixed income underweight in our multi-asset funds, as we may see bond yields fall further.
Correspondingly, we have taken some profits and reduced our overweight position in stocks, as a weaker growth outlook may cause shivers in risk sentiment, and there is clear scope for further geopolitical surprises on the horizon during the summer, including potential setbacks to President Trump’s planned stimulus measures.
Markets tend to be more volatile over the summer trading period, and, just as China was instrumental in triggering the current upswing in global stocks, markets are likely to be particularly sensitive to news from China as the summer progresses; the recent rise in short-term lending rates points to a tightening of liquidity, which could raise red flags.
Nevertheless, whether due to increased job insecurity or technological advances, there is little sign of the surge in wages that traditionally marks the end of an expansion and which might prompt central banks to withdraw monetary stimulus; as long as this lasts, we are unlikely to see an incoming tide of rapid rate rises.
Although the pace of global growth may have slowed, the trend remains positive and we expect to continue to see strong progress in developed markets. As stock returns beat bonds when the global economy sees above‑trend growth, our long-term view for equity markets therefore remains constructive. Should it materialise, a gradual slowdown in China would help to keep inflation low and monetary policy loose, moving the Investment Clock towards “Recovery” phase, which is equity friendly.
So while we would anticipate higher volatility in equity markets in the next few months due to concerns about slowing growth, Chinese tightening and geopolitical risk, we do not believe that the sandcastles are about to crumble and the bull market is over; we stand ready to take a swim and buy dips in equity markets.
Meanwhile, we have established an overweight position in global high yield bonds as an alternative, lower-risk way of maintaining exposure to corporates during the summer. This position should be particularly advantageous if the market manages successfully to navigate any storms or whirlpools that occur over the coming months without launching the lifeboats.
For professional customers only. The views expressed are the author’s own and do not constitute investment advice.
Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. For more information concerning the risks of investing, please refer to the Prospectus and Key Investor Information Document (KIID).
Financial promotion issued by Royal London Asset Management February 2017. Information correct at that date unless otherwise stated.
Royal London Asset Management Limited, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, registered in England and Wales number 2372439. RLUM Limited, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority. Ref: AL RLAM P 0002