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Our asset allocation view

John Redwood, Charles Stanley’s Chief Global Economist, rounds up our latest views on asset allocation.

by
John Redwood

in Features

06.12.2018

Charles Stanley’s Investment Strategy Committee confirmed that the prospects for the world economy were still relatively good. Meanwhile, equity markets worry they are going to get worse. Does this mean equities are good value again, or does it mean share markets can sense a downturn and will do their best to reduce confidence levels and help talk us into a slowdown? How seriously should we take the threat of an end to this prolonged cycle in the advanced world?

At the back of the tensions between equity markets and the economic reality lies the steady tightening of monetary policy. The US is well into a programme of quantitative tightening. It is reversing some of the large bond portfolio the Federal Reserve had built up, buying the bonds with created money. This provides an offset to the build-up of cash and credit in the private sector through the normal action of banks lending to consumers and to businesses to finance an expansion. The European Central Bank is about to end its quantitative easing programme, whilst the UK has already done so. It means there will be less newly-created money around in the advanced world to buy up bonds, with spill over to the purchase of shares. One of the ideas behind the quantitative easing programmes was the likely purchase of riskier investments as the Central Banks bought government bonds off investors.

The share markets are sending a signal to the Fed and to the other Central Banks that they could overdo their various tightening measures. They have certainly caught President Trump’s attention, as he seeks to expand the US economy at a faster rate. He is impatient with the Fed, as he sees their monetary actions deliberately offsetting the expansionary impact of the tax cuts, increased spending and bank deregulatory moves he has been making. The third quarter of 2018 probably saw the peak growth rate for the US for the time being. All year we have seen home sales declining and car sales below best levels, as these two sectors are particularly exposed to the impact of higher interest rates.

If we want to understand the difficulties of a central bank getting back to “normal” on interest rates and money policy after a banking crash, we need to look at the experience of Japan. It is true they had a far larger crash at the end of the 1980s than the US and Europe experienced at the end of the first decade of the current century, and it is true that their model of development with little migration is very different to the US and the UK. They remind us, however, that after a big crash interest rates can stay very low for a very long time. In Japan’s case zero interest rates are the new normal. Each time Japan has tried to increase taxes a bit to reduce the deficit, or has tried to edge longer-term interest rates up slightly, there has been a bad reaction in markets and an economic impact from the changes. Whilst the problem is far less acute in the west than in Japan, central banks need to allow for the Japan tendency after a credit crunch and banking collapse.

We decided to shade our overall world growth figure for next year, which we expect to come in lower than this year. We will become more worried if the Fed remains too wedded to many more rate rises. We decided to upgrade US Treasury bonds now they are yielding so much more than other advanced country sovereign bonds, on the grounds that this December the Fed may well  make more dovish noises implying we are near the peak of this rate rising programme.  We downgraded our view on high-yield bonds. The extra interest you can earn on them has been reduced over this cycle so far, and there is a danger that credit quality is starting to deteriorate further as stressed companies get away more bond issues.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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