What should we worry about most – the vulnerability of equities, or the bursting of the bond bubble?
It’s rare in financial market history when bond and equity markets rise together, but this is what we have recently experienced. And with real rates on government bonds now negative and media fretting over the consequences of Brexit for UK companies, there are reasons to worry about the outlook for both these asset classes now.
How blind we have become on the recent signs of strength in the US economyBill Jamieson
Little wonder that the headline on Money Week editor Merryn Somerset Webb’s weekend FT column was headed “Beat negative rates and invest with a safe”.
Will future investor roadshows now comprise competing pitches from Yale and Chubb on the best household safes to install? Demand may slacken on discovering the price of a reinforced steel box with hefty combination dials to stash your pension can range to £3,000 and beyond.
Fortunately the latest investor presentations in Scotland last week avoided this excursion into alternative assets. John Haines, head of research at Investec, treated clients in Glasgow and Edinburgh to a detailed analysis on the outlook for markets. A large notebook and refillable writing utensil was thoughtfully provided.
There are three advantages to presentations of this sort. First, they put events and current concerns such as Brexit in wider context: what is happening in the rest of the world and how is the UK market and its economy faring vis a vis others?
Second, they provide a historical perspective, enabling us to see how far we are conforming or diverging from previous experience. And third, they provide pointers to current ‘house’ thinking on where markets are likely to go from here.
John Haines’ masterclass performance did not disappoint and my Biro was going down with nervous exhaustion by the end. The bottom line of his narrative is that Investec with some £83 billion under management has moved “slightly underweight” on fixed interest and equities and a little more into cash: “technically more negative” post-Brexit from a UK perspective. That still leaves a hefty proportion in shares, and current favoured areas are overseas equities, Japan and emerging markets in particular.
For all the acres of coverage on “what Brexit means for investors” it was an altogether necessary and welcome corrective to see how little this has impacted on global markets. Since the Brexit vote, UK equities have registered a total return of 6.1 per cent, while world indices have gained almost 14 per cent. Star performers have been emerging markets, which have registered a total return of more than 24 per cent since 23 June. As for the economic outlook, while forecasts of UK growth for 2017 have been cut from 2.6 per cent to 0.2 per cent, the needle for global growth has hardly moved at 3.5 per cent.
And how blind we have become on the recent signs of strength in the US economy – still the global growth locomotive. It’s been easy to lose sight of this amid the noise over the US presidential election contest and the fixation of the two least-favoured candidates in decades.
The US economy has been doing rather better than this highly disputatious contest might suggest. Unemployment has fallen steadily since the 2008-09 financial crisis, with the jobless rate down from 8 to 5 per cent. Now latest Census Bureau data points to a resurgence of middle class incomes.
Yet headlines and TV coverage have been dominated by American woes - the decline of the middle class, the rise of angry discontent and raucous populism: voters are far from convinced by the Obama-Democrat economic success story.
But what of the outlook for interest rates, and for how long can the bull market in bonds continue? Goldman Sachs forecasts a rise in US ten-year bond yields from 1.5 per cent currently to 3 per cent in 2018, bringing with it a corresponding fall in bond prices. As Haines reminded us, the recent period of underperformance of equities compared with bonds is comparable to the Great Depression both in time and in magnitude. And as his longer-term charts of performance demonstrated, when inflation has become embedded, shares outperform fixed income.
While the global growth story for now remains intact, there is a clutch of risk events – notably the US election and critical elections in France and Germany next year – that could hit investor sentiment. The advice for now is to maintain weightings in overseas stocks, emerging markets in particular, and build cash. You may still want to buy that household safe, but perhaps not from the jumbo range.