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Our asset allocation view

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

Our asset allocation view

by
John Redwood

in Features

11.04.2019

When the Investment Strategy Committee met it was a relatively easy task to agree that our base case remains “muddling through”. We still expect there to be growth worldwide this year, at a slower pace than last. We think the main central banks and governments have done just enough to avoid recession in the largest advanced economies, with some recovery from a sharp slowdown later in the year. Italy, it is true, is in recession and Germany is flirting with a downturn, but the US, China, the UK and several EU countries should ensure continued overall growth. It looks as if inflation will remain under control outside a few badly-run emerging economies. The drive towards greater use of digital technology and the growing access to the supply of goods, services and labour from around the world permits low inflation growth. It also causes problems for some traditional businesses who fail to adapt their methods in time to the new ways of delivering and selling.

The more difficult task was working out what might happen from here to share and bond prices. Both have rallied strongly in the first quarter of 2019, recovering from the fears of recession and crisis at the end of December. Interest rates are now universally low in the advanced world, with few thinking there will be any early rises from the central banks or from the actions of bond vigilantes. Share prices seem well up with events, with earnings growth slowing markedly this year, and with individual sectors and companies subject to adverse pressures on cashflow and vulnerable to poor newsflow. The main stimulus to higher prices from here would have to come from further action by the Fed, the ECB and the Bank of China to loosen money policy and credit more. Shares remain good value compared to bonds, with better yields in many cases.

The biggest threat to the outlook of benign-but-modest progress comes from the danger that central banks will still tighten too much, stifling credit for recovery. The US Federal Reserve is presently reviewing its way of setting interest rates, and is more likely to decide to loosen a little more. The market no longer expects rate rises soon. The European Central Bank ended its quantitative easing programme just in time for the slowdown, and has problems supporting the commercial banks to enable them to finance a more vigorous recovery. It could look at abating its 0.4% levy on excess reserves held on behalf of the commercial banks, which acts as a modest penalty on them. The Chinese authorities want both to tidy up weak banks and other financial institutions by reducing debts – and at the same time ensure sufficient new loans for new purposes to assist the structural changes they want from their economy.

Markets expect a decent resolution of the damaging US/China trade row soon. Much of that is in the price already. What we could see is a new trade argument between the US and the EU. The President has placed some extra tariffs on the EU in retaliation for alleged subsidies to Airbus, helping them against Boeing. Mr Trump has been sitting with a report on his desk about unfair trading practises from EU cars which could prompt a tough exchange between the US and EU. Coming at a time of difficulty for the motor car industry anyway it could be a negative for markets. The markets also have to contend with the forthcoming European election, which might show a stronger tilt to populists querying features of the Euro scheme.

Earnings and dividends are not going to rise fast this year as they did in the first flush of the Trump tax cuts. Even the successful technology and communications sectors will face headwinds from more regulation and pressures to pay more tax. We ended concluding that whilst there is no obvious big fear that looks justified, shares and bonds both look quite expensive. Any one of the bad news items we worry about could change the mood and the trend in the markets for a bit.

We changed our ratings on financial and non-financial corporate bonds, high-yield and index-linked from “negative” to “neutral”. We did this despite recent price rises, in recognition of the recent relaxation of US policy, the possibility of a further relaxation from the Fed’s review of monetary policy, and the need for similar moves in Europe. At the same time, we downgraded our view on US sovereign debt after a good period of performance. We still favour US sovereigns over any other advanced country government bonds as they offer a better yield, but now think there is a more of a case for taking a bit of credit risk to get a higher running income at these very-low-yield levels.

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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