Global Markets
October was a truly awful month for risk assets, with investors taking fright over the move higher in bond yields and uncertainty surrounding events in the Middle East. It is difficult to overstate then the sense of relief being felt in markets as the first two weeks of November have seen a strong rally in both equities and bonds. Ultimately, this is being driven by investors moving closer to the conclusion that the Federal Reserve (and indeed other central banks) is through with raising interest rates in this cycle. Recent inflation numbers on both sides of the Atlantic have shown very significant progress and some weakness in the employment market has emboldened market participants to bet that not only have rates peaked for this cycle but also that we will see rate cuts sooner than previously expected. This is a very major turnaround in sentiment and has seen an especially strong response from those areas of the market that were most beaten up on concerns over rates staying higher for longer – property, tech and US smaller companies have been notable beneficiaries along with mid-cap names here in the UK. Having said that, there are still significant valuation anomalies around…
Despite the almost exclusively good news in the paragraph above, it is important to realise that the dramatic falls in bond yields and pick up in equity markets represent a form of loosening of policy, which in itself might make the Federal Reserve less likely to cut rates. There have been many times in the past year when investors have bet that central banks have reached the end of their tightening cycle only to be disappointed and this could yet happen again. Even if rates were to fall by a couple of percentage points over the next year, the effects of the higher rates regime we are in means we are likely to see further consequences for the real economy. Rate cuts are not a miracle cure for markets if the economic backdrop is deteriorating and there is still enough of a case for a slowdown, if not outright recession, to justify caution. We still think it is too early to add risk given the lessons of economic and market history. When the time arrives, we know where we want to be positioned to best capitalise but for now the sensible course of action is to hold steady. Now is the time to enjoy the sense of relief but not to swing to a more risk-on stance based on reaching a premature conclusion.
Gilts
We have explained in recent months how we have been moving closer to introducing a gilt allocation in the portfolios and this month sees us make our initial move. To a significant degree, this is about diversifying the sovereign debt holdings, but it is also encouraging to see the progress made on reducing inflation in the UK. Though Treasuries remain our preference, there are concerns over the US budget deficit and this merits holding some non-US government debt. The possibility of interest rates falling both here and in the US means there is an opportunity for capital gain as well as a respectable level of income from the bonds. This said, the ongoing macroeconomic uncertainty and concerns around the levels of debt issuance means we will keep the exposure to interest rates at a modest level. If our conviction grows that the UK is continuing to make progress in the fight against inflation, we have the option of extending the duration of our holdings to capitalise on the opportunity further.
Click here to read our thoughts on asset allocation.
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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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