Global Markets
Over the next few weeks, investor attention is likely to switch to the US debt ceiling. A deal has to be reached between the House of Representatives, the Senate and the White House to raise the amount of debt the Federal Government can borrow, a process that is likely to prove vexed given the ideological disagreements over spending commitments and, crucially, the fractious nature of US politics at the current time. We will write in more detail on the topic in the coming weeks but realistically the fallout from any US default on its debt obligations (which would follow if it could not borrow more than the current limit) would be so catastrophic for markets (and the careers of some US politicians) that a deal will get done – just as it did in the substantial stand off in 2011. Still, there is plenty of scope for elevated volatility in both the bond and equity markets over the coming months and although we would not position strongly for a particularly negative outcome, it is yet another reason to maintain a cautious stance. It may also throw up longer-term buying opportunities, in which case our cash holdings will come in useful.
The good news for investors recently has been the apparent slowing of inflation and the reasonable chance this is going to be the peak in US (and possibly other countries’) interest rates for this cycle. However, there is still no reasonable expectation that reductions in rates are imminent, and the circumstances that do bring this about will not necessarily be positive for risk assets given that it will probably mean a recessionary backdrop. Markets seem to be range bound and in a holding pattern, and investors are betting that rates will not be able to rise further given the cracks that are appearing in parts of the financial markets and the real economy. Remember too that there is a lagged effect to the rate rises, so the impact seen so far is presumably only a fraction of what it might ultimately be. There are now some weaknesses starting to show up in the economic data, including the jobs market, the robustness of which has led many to believe that we are still far from a recessionary outcome. Initial jobless claims have shown an increase and hours worked have fallen – which is often a precursor to more sustained lay offs. Then we have the persistent inversions across the yield curve, which continue to nag given their predictive record. Perhaps this market is easier to invest in than the confusing messages emerging over the last few months suggest and we are going to get a ‘typical’ recession at the end of a business cycle? For the bulls, betting on the US consumer proving resilient is crucial at this point but clearly this also hinges on the jobs market remaining strong. They must be careful what they wish for – rate cuts might bring some relief to embattled areas of the market but if lower rates come at the cost of a recession, they might not be a price worth paying.
Summary of Positioning
Given current uncertainty and the evolution of our thinking over the last twelve months, it is worth summarising our current outlook. (1) Recession in the US and elsewhere is very possible in the next six months – this has reinforced our cautious positioning. (2) Diversification remains essential – we continue to hold meaningful allocations of cash, gold and assets that we believe will provide some counterbalance if equities endure another leg down. (3) Within fixed income, the emphasis is on quality via Treasuries and high-quality corporate debt. (4) Within equities, though we have trimmed positions, we have avoided dramatic reductions by finessing the underlying characteristics of positions. Our recent inclusion of global equity income is an example of this move to a more defensive and robust positioning. (5) The likely fallout of a recession and the impact of higher rates will present some compelling opportunities for those who can remain patient.
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Investment Line is written and edited by Chief Investment Officer Simon Gibson and Investment Strategist Richard Smith and is for information purposes. It is not intended to be an invitation to buy, or act upon the comments made, and all/any investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. The value of investments and the income from them can go down as well as up, and you may not get back the amount invested. Past performance is not a guide to future returns.
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