By Michael Stanes, Investment Director at Heartwood Investment Management
The global growth impulse continues to be positive, with survey data remaining at elevated levels and consumer confidence well supported by improving labour markets. Central bank thinking has evolved to a more balanced tone, following a prolonged period of accommodation, and there is a sense of more concern around price developments as we move through the year, particularly in the UK. Nonetheless, while inflation risks are rising we expect this trend to be transitory due to the distortion of energy price effects.
Equity and corporate credit markets have performed well since the US election, but we are now in the “show me” phase for markets. In other words, expectations of improved US fundamentals need to be backed up by actual policies. Corporate tax reform is likely to be implemented over the medium term, with the support of a Republican Congress, and there has been some movement on proposals to deregulate parts of financial services and energy. However, plans for major infrastructure spending have yet to be fully articulated and there appears to be more focus on the politics of trade and US protectionism, which has been a disappointment.
In consequence, it would not be unreasonable to expect a further pause in equity markets, although not serious enough to cause us to de-risk portfolios. We made no changes to current positioning, retaining our modest overweight to equities, select positions in credit and short duration position in government bond markets. Our view of stronger global growth, slow normalisation of interest rates and gradual reflation remains intact. That said, we acknowledge that regional risks will be at the forefront of global investors concerns. Europe’s electoral cycle is likely to continue to create headline noise, but overall recent economic improvements, which should help to ameliorate populist forces, and light investor positioning reinforce our more positive view of this region. Elsewhere, we maintain our view that China will achieve a soft-landing, but recognise the authorities are facing greater challenges this year as the effects of previous stimulus measures fade, added to the need to address high corporate debt levels. We are not inclined to add to our emerging market assets, equity or debt, at this point, although retain a positive longer-term view.
• Equities: We made no changes to current positioning. We believe we are now in the “show me” phase for US equities and that confidence in the US will lead equity returns elsewhere for now. We retain our positive view on US equities beyond the immediate future, maintaining our slant to cyclical stocks. However, we accept that in the very short term that the Trump pro-growth view might be questioned, particularly if political rhetoric continues to focus on protectionism rather than US growth-friendly policies. Elsewhere, we feel it is too early to shift back into the UK, although we might find the opportunity around the time Article 50 is triggered and would potentially look to invest in UK smaller companies. We remain overweight in Europe and Japan. In Europe, we feel that investors are overly negative on growth as the fundamentals improve and while politics seems like a big threat, we not convinced that politics will derail our positive view. We expect Japanese equities to benefit from improvements at the micro level, as corporates focus on boosting profitability. In emerging markets, we maintain our overweight position but would not add to it at this point, given the near-term headwinds of further US dollar strength and risks around China policy.
• Bonds: Despite the pullback in yields, the trend in 2017 remains one of higher yields due to stronger growth and rising inflation expectations. In this environment, credit markets are benefitting from the more positive backdrop and we have select exposures to shorter-dated investment grade corporate bonds, specialist lenders and emerging market sovereign debt. In the conventional government sector, we are maintaining our long-standing short duration position, given a modestly higher inflation trajectory and limits to central bank tolerance levels if inflation overshoots targets set by policymakers.
• Property: UK property developers have been weak and in the near term it is hard to see a catalyst in their favour. Our underweight in UK commercial property remains intact based on the supply outlook, especially in the South East, and uncertainties around Brexit. Our portfolios are invested in diversified and select parts of the market. Across sectors, we continue to seek income opportunities in industrials and offices. On a regional basis, we are invested in cities outside of London, which are less exposed to the ‘Brexit’ fallout. Outside of the UK, we are also looking at opportunities in the US REIT (real estate investment trust) market, where valuations have cheapened but are not yet compelling.
• Commodities: An improving global economic environment, reflation and a tighter supply/demand balance leads us to hold a more positive view on commodities in 2017, particularly for oil and base metals. That said, the oil price continues to trade in a tight range and industrial metals’ strength has plateaued in recent weeks, given questions around China and that makes us more cautious. Direct access to this market is through owning futures contracts rather than the physical assets and while the risk/return profiles are looking more attractive across some parts of the complex, they are not yet at levels where we are ready to invest. We have, though, a position gold in some strategies for diversification.
• Hedge funds: While we have held a limited allocation to hedge funds in recent years on concerns around performance, we believe that a more differentiated environment across major economies should create more opportunities going forward. Our preference remains for macro/CTA strategies, but we are also taking a more positive view on equity hedge strategies, given the greater likelihood of increased stock dispersion (i.e. between winners and losers), as well as credit long/short strategies.
• Cash: We have reasonable levels of liquidity across our portfolios both in cash and short-dated bonds, which we are ready to invest as and when we see specific opportunities.