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Recession fears overdone

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

Our asset allocation view

John Redwood

in Features


The Charles Stanley Strategy Committee reaffirmed its view that the modest and long economic recovery would continue in the advanced countries. The Committee was pleased that its decision to recommend more investment in shares around the turn of the year in anticipation of more stimulatory measures worked out well. The Fed has changed its stance considerably, favouring patience instead of a series of further interest rate rises. It is also being more careful about the pace and duration of its plans to shrink its own balance sheet. The Chinese authorities have embarked on a series of measures to supply more credit to private sector business and to allow a continued fast pace of change from an industrial and export led model economy to one where services and new technology plays an increasing role. We have seen a strong rally in Chinese shares, a recovery in the US technology sector and the wider market, and some upwards progress in European markets too.

The main thing that spooked markets at the end of last year was a fairly universal monetary tightening which threatened to end the recovery. There were also fears of the trade war between China and the US, with the danger that President Trump would go ahead with his big tariff hike to 25% on 1 March. We took the view that it was greatly in the interests of both Presidents Xi and Trump to reach an agreement. Since our previous meeting, the US has announced a postponement of the tariff increase, and there have been more positive noises coming from the talks. There is now serious engagement at a senior level on both sides, as they seek a wide ranging agreement that would cover intellectual property, tariffs, industrial subsidies and enforcement of fair trading laws. The likelihood of a decent outcome is now in the market, but there could be a further upwards move, if and when a final settlement is produced that covers these main issues.

The Committee spent time asking if the rally we have seen now meant share markets were at fair value. The Committee recognised that earnings growth this year will be considerably slower than last, and that the one off effects of the big tax reduction in the US is now discounted by the market. From these levels it is more likely returns will be modest, and we may well have seen the bulk of the gains for the year in the first two months. We still favour more emphasis on emerging markets in general. In the case of China, the economy has more scope to improve whilst the share market did halve from its 2015 high to the low late last year. The Chinese economy will probably suffer a further slowdown in the first half of 2019 which should intensify efforts to find a way to stimulate it. The dollar is likely to be less strong than last year, which will help all those emerging market economies with dollar debts.

The Committee does not expect much by way of interest rate action in the developed world. The European Central Bank is discovering that ending quantitative easing is headwind enough for their Eurozone economy without inflicting higher rates. Japan is likely to continue with a zero ten-year interest rate with negative short rates. The US is going slow on rate rises. There is no need for a rate rise in the UK. The yield curves in the advanced markets are relatively flat, with interest rates for longer dated loans not offering a big premium over short rates. This normally implies recession risk, but may have more to do with the impact of large quantitative easing programmes in the past and the absence of a serious inflationary threat in the advanced world. There is more credit risk around as many corporates increase their debt levels. Markets in particular worry about the big issuance of debt to companies with the lowest Invest grade rating BBB, implying more future risk of downgrades. We favour US Treasuries amongst the safer bonds for their better yield levels than European or Japanese paper. Where people can take more risk emerging econ

omy sovereign debt also offers a better running income, though there remain currency and individual country questions that need managing in a bond portfolio.

The Committee made two changes to its ratings. It went neutral on the duration of bonds, given the low probability of any short term rate rise, but also given the flatness of yield curves. Positive on duration means hold more longer-dated bonds, whilst negative means expect rate rises with falls in longer-dated bonds. It reduced its view on Japanese equities from “positive” to “neutral”. Japan has rallied from the lows as hoped, but not as strongly as some other markets. There is a continuing overhang from problems in the worldwide motor sector and from the difficulties over corporate governance in some Japanese companies. This seems to be holding back better performance.

It is always difficult deciding what to do when your forecasts for the year of higher single-digit or low double-digit returns for shares have been achieved in the first two months. Our clearly stated preference for shares over bonds earlier this year is tactically tempered for the moment by the good returns in January and February. For the longer term, shares remain better value, with better prospects.

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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