Our portfolios outperformed their respective national benchmarks on 36 out of 42 occasions

Investment returns have been predominantly very good since the turn of 2019 with significant growth in both equity and bond markets. Despite these returns, it has not felt like a bull market due to so many impending uncertainties. Stock markets around the world have been weighed down by different risks. These uncertainties have come in the form of on-going trade tensions, escalation in tariff rates, fears over a hard Brexit, a global slowdown, a US treasury yield curve inversion, the collapse of Italy’s coalition government, riots in Hong Kong, oil price spikes and the threat of the impeachment of Donald Trump. With these distractions and weak economic data, it is no wonder some economists expect a recession in the coming months. Others are far less downbeat. Several of the global headwinds are set to fade in the months ahead. There looks to be growing optimism for an early Phase 1 trade deal between the USA and China. Britain could be leaving the EU with an agreed deal by January 2020. Oil prices are stable and expected to fall back. Bond yields are historically low and are likely to reduce further before they may rise.

The economic outlook remains tricky to navigate. Political outcomes in the UK offer different investment implications. A Brexit deal could see sterling strengthen adding some currency risk to overseas assets, while a delay will offer the reverse.

While the world is captivated over these threats, central bankers have taken direct action to reduce interest rates and supported looser monetary conditions in both the developed and emerging markets. These actions, along with lower bond yields, have given some encouragement that an imminent recession can be averted.

In October, the European Central Bank (ECB) cut interest rates and restarted its €20bn per month bond purchasing QE programme. The Bank of Japan (BoJ) is expected to cut rates in December. The Bank of England (BoE) is also expected to cut rates but not until after the outcome of Brexit is known.

The US Federal Reserve has changed its policy dramatically over the past 12 months, moving from rate rises to rate cuts. We have seen three rate cuts of 0.25% so far in 2019, the same number of rate rises that Jerome Powell previously predicted he would make this year. Markets are now expecting a further two rate cuts in the first half of 2020. This will leave US interest rates at around 1.25% by the time of the US Presidential Elections in November. The Fed now look as if they are happy to see a rise in inflation rather than to try and dampen it as they did this time last year.

Consumer spending, particularly in the USA, is now the only real driver in the world economy. American shoppers are proving to be resilient while their wages improve and employment is at record highs. Despite this consumer boom, some economic data is providing contrasting signals such as manufacturing data which is poor and consumer and labour data which is strong. Production and order books look better than the business surveys. Overall, global growth is weak and investors need to be aware of to this. One clear economic signal to watch throughout 2020 is US consumer spending and new job numbers as they are unlikely to continue at above trend levels.

American companies added 128,000 new jobs in October ahead of the 85,000 expected. This increase came in a month when thousands of General Motors workers were on strike and removed from the official employment numbers as striking workers are treated as unemployed in the USA. The average number of new jobs created per month in Q3 was 143,000 per month. However, forward looking employment surveys do suggest a downward trend in jobs growth with only 50,000 new jobs per month by the end of 2020. These job numbers do support the Federal Reserve’s view that the US economy is in good shape. GDP growth recorded a rise of 1.95% year-on-year in Q3 up from the forecasted 1.6%.

Manufacturing survey data remains weak with PMI confidence values below 50 in Q3. We have since seen a significant and widespread easing of monetary policy and the launch of new fiscal stimulus which will take time to have an impact on the real global economy and to counter weaker growth.

Inevitably, analysts have been downgrading their forecasts for global growth in 2019 and 2020 due to the soft economic data and on-going trade tensions. There has been some improvement in the outlook over trade, global GDP growth is now expected to hit 2.6% in 2019 and forecast to be 2.4% in 2020. Analysts are saying that the business cycle hit a low in Q2 2019 and has been improving since. In November, sensing a turning point in global activity, equity markets moved to new highs after rate cuts, easing trade tensions and improved growth expectations.

In general, the global economy looks to be withstanding the uncertainties it faces. The fears of an imminent recession look a little overblown for now and into 2020. Overall our portfolios are tilting towards caution but are exposed to risk assets in order to tap into late-cycle growth. We see equity as fair value but bonds as expensive and while a recession may not materialise, we think it makes sense to maintain our conservative positioning.

We have maintained our overall asset allocations but have moved some money into the UK assets in order to take advantage of a post Brexit Britain and reduce our exposure to international currency in case sterling were to strengthen further. We will retain our holdings in the US as their stock market remains the most dynamic. We will also maintain our emerging market holdings which will be impacted by a slowing world but aided by any US-China trade resolution. We remain underweight in European equity markets even though they have performed well in 2019. While we missed out on this growth, we did capture better returns elsewhere. We are not attracted to the outlook for Europe or the ability of the ECB to prevent a slowdown.

We are neutral on Japan, even after a fantastic world cup and entertaining running rugby. We have maintained our modest positions. Japanese equity valuations are attractive, but export weakness and a strong ¥ remain a headwind on growth. The recent increase to the consumption tax or VAT may present a problem with reduced consumer demand.

With global growth slowing, one theme that seems to have been developing since early 2019, is the convergence of sovereign bond yields as interest rates have been cut and inflation remained subdued. As yields fall, capital values should rise and purchasers will now get very poor value for money due to such low yields. The most attractive sovereign bonds are US treasuries. As far as corporate credit is concerned, we have moved up the quality ratings in our credit holdings with more UK investment grade corporate bonds. Although we do not see global interest rates rising, we have reduced some exposure to long dated credit and the associated duration risk. New levels of quantitative easing from the Fed and the ECB will keep high yield credit default rates stable and therefore both US and UK short-dated high-yield look favourable. Emerging market bonds will maintain a modest position in the portfolios due to their higher yields.

A low interest rate future gives a boost to equity and high-yield credit. However, with a slowdown anticipated, we will move in part to larger dividend paying stocks ahead of smaller companies. As the yield curve has flattened, investors who are concerned about duration risk can get about as much yield on short-term liquidity as on 10-year treasuries. We are aware of the impact of currency risk so have sought more credit and gilt exposure from the UK. We retain our UK conventional long-dated gilts as an insurance on recession.

While monetary policy will act to cushion the downside, it is debatable whether monetary easing will avert any recession on its own. This late into the expansion cycle, central banks need governments to step in and start some fiscal stimulus as well. In the UK, irrespective of the outcome of the general election, we are likely to see increased government spending as well as the Bank of England cut interest rates. However, elsewhere in the world the likelihood of similar government actions is limited. With a Democrat dominated US Congress, President Trump is powerless to get government spending increases through. Japan is facing a new VAT increase that may impact consumption and most European governments other than Germany have very high debt-to-GDP ratios.

With little scope for new government spending, the Fed may have to cut rates even further and grow its balance sheet by more than the current US$ 720bn per year that it is currently acquiring and the ECB may have to do likewise.

Heightened trade tensions and expensive import tariffs were the biggest threat to the global economy in 2019. If these are reduced then this concern can be resolved and central banks can engineer a soft landing. As we move into 2020 investors will need to ride out some elements of volatility. Our expectations are for subdued but positive growth, low inflationary pressure and lower interest rates.

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