Investment Perspectives 2019 | Mid-Year Review & Outlook

Executive Summary

In this mid-year publication, we review our January expectations and analyse some current key economic indicators before outlining the asset allocation that we recommend for the second half of the year.

Our equity exposure has been reduced since the beginning of the year

Our assumption that markets were overpricing risks of a recession during the December correction led us to start the year being overweight equities, as we had not cut our equity allocation despite the high level of market stress. This proved to be rewarding as the strong rebound observed in the first four months of 2019 contributed to the strong performance of the portfolios, especially with bond markets also rallying.

We took advantage of the strong rise of equity markets to reduce our equity allocation significantly from overweight to underweight, reflecting our cautious outlook in view of the rising level of uncertainty. Whilst we had not expected government bond yields to climb much, the year-to-date collapse of yields has been a big surprise and a major contributor to the strong returns of fixed- income exposures

U.S. policies are a source of increasing uncertainty for markets

The high level of market stress observed at the end of 2018 was quickly replaced by a four-month period of declining volatility where markets proved to be relatively immune to negative headlines. This changed significantly in May when the optimism over a trade deal between the U.S. and China gave way to concerns over a major breakdown of trade talks following a series of “tweets” by Donald Trump. This was compounded by restrictions placed on business between U.S. companies and the Chinese tech giant Huawei and tariff threats on imports from Mexico. This list of destabilising market factors is far from exhaustive but their common point is that they all originate from the White House which has been flexing its muscles to achieve some of its objectives. With the launch of the U.S. presidential election campaign, this is likely to continue to represent a source of uncertainty and of volatility for the markets.

Markets have been boosted by the end of monetary policy normalisation

The 180-degree turn of the Federal Reserve, in announcing a pause of its cycle of rate hikes and the
end of its balance sheet reduction, has been one of the key drivers of the bond and equity markets this year. Under the end-2018 pressure from the markets, the Fed abandoned its pre-set path of one rate hike per quarter and announced that the shrinking of its balance sheet would formally end in September, much earlier than planned. At its June 18-19 meeting, the Fed turned even more dovish and opened the door for a rate cut as early as July. The European Central Bank President Mario Draghi has also been trying to reassure market participants about the bank’s ability to act amid growing doubts on the real effect of monetary policy in case of a recession. Another key driver of the markets’ rally has been the huge provision of liquidity by the People’s Bank of China (PBOC), equivalent to 60% of the creation of credit over a 12-month rolling period.

We have a cautious positioning ahead of the second half

At the onset of the second half we have modest underweight allocations towards debt instruments and equities and an overweight cash position. We feel that markets are on a sugar high as a result of increasingly dovish central banks. They also appear to be consciously ignoring a number of risks including, but not limited to, disappointing corporate outlooks, weaker economic trends, delayed central banks’ actions and a deterioration of the relationship between the U.S. and the rest of the world. At the risk of missing some short term upside we prefer to focus on the management of risk, especially when considering the appreciable year-to-date portfolio returns.

In the next section of the document, we will evaluate the macro environment and the prevailing financial conditions by highlighting several key indicators that we observe. Following a brief overview of the first half returns of the different asset classes, we will outline our current market outlook and asset allocation.

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