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The clock is ticking

5 April 2019

John Stopford reviews a cautiously optimistic first quarter of 2019 for developed markets but with a warning that the clock is ticking.



Lindsay Williams: We are into the second quarter of 2019 and it is definitely optimism that abounds and risk-on abounds as well in many asset classes, certainly in the developed world. With me now is John Stopford, Head of Multi-Asset Income at Investec Asset Management in London. Optimism has been going on since probably the end of December, John.

John Stopford: Yes. I think you can put it down primarily to policy-makers. So I think the day the market turned in December, Mnuchin, the US Treasury Secretary, made some positive comments. We have clearly had central banks rolling back pretty aggressively from taking the sort of punchbowl away. We have had fiscal easing in China. We have got endless reports that the trade negotiations between China and the US are going well and so on. 

I think policy was one of the things that took markets lower in Q4 and I think that the sort of dramatic swing in the policy rhetoric and policy action is one of the main reasons for the market to cheer coming into 2019.

Lindsay Williams: So it is all down to the US Federal Reserve. We can trace it back to the time they said there is not going to be 2 or 3 interest rate rises in 2019, which at one point last year the market was expecting. It is all down to that even though the macro picture isn’t quite as rosy as it might have been.

John Stopford: That is certainly true but I think it is not just the US Federal Reserve. I think it is also optimism that the Chinese have taken significant action and so the risk of a hard landing in China is being diminished. So it is US and China particularly. I think those have been the big two demand engines for the world and we have seen (you are right) some very, very poor data, much worse than expected. 

We are now seeing one or two green shoots, notably in China itself. So we saw both much stronger credit data as a sign of easing and then recently better Purchasing Managers’ Indices and other survey data, sort of leading indicators and other markets also suggesting that maybe the worst of the global slowdown is near and a period of better trade and manufacturing data may now be on the cards. 

I guess what isn’t clear is whether this is a durable recovery or more of a temporary upswing within a maturing business cycle and I think that is what the market is trying to wrestle with now but clearly the sort of downside risk has diminished in the near-term and it looks a bit glass half-full I think for the moment rather than glass half-empty or completely empty.

Lindsay Williams: Yes, I mean there are some green shoots, as you quite rightly say. Not so much in Europe though. The German data that was recently released was pretty poor and I suppose when you come to the United States all eyes will be on the Non-Farm Payrolls data which is out tomorrow because the last month was pretty poor, with only 20,000 jobs being created. How important is that release tomorrow do you think?

John Stopford: I think it is very important. Just quickly on Europe, I think Europe is typically a lagging indicator. Europe takes demand (it is very export-driven) from the rest of the world. It is more important that the economies where that demand is coming from are picking up. 

In terms of job data, I think it is pretty significant. You know one thing that is I think leaving people cautious is that, even though there is optimism, we saw the market, the US yield curve in the US, the bond market invert, so with longer-dated bonds yielding less than cash deposits. Historically, that has been a very reliable precursor to a recession within about 18 months. That is a clear orange or red flag for markets and then the jobs data is pretty important. 

It is a good contemporaneous indicator of how the economy is doing but also we have seen the sort of improvement in the unemployment rate bottom out a bit and historically, if the unemployment rate rises materially (it doesn’t actually have to rise that far), that has also been a very consistent indicator of an approaching recession. So watching the unemployment rate for any sort of signs that that is deteriorating on a sort of trend basis I think is pretty key.

Lindsay Williams: Yes, indeed. There is a dichotomy here because we are talking about everyone being optimistic, the punchbowl being back on the table and being drunk from heartily by market participants. On the other hand, the inverted yield curve (which I spoke to Michael Power, your colleague in Cape Town, about a couple of weeks ago), that is suggesting that there will be some kind of recession and surely, if it is 12 or 18 months away, markets start to anticipate that already.

John Stopford: Yeah, I think it is all about timing. I think some of the near-term optimism also reflects that investors got pretty cautious last year and so investor positioning is still tentative and that is creating some room for markets to rally. People are essentially being sucked in. They feel too sure, too under-invested. Valuation has also obviously retraced quite a lot and they are now probably [moderately] expensive rather than dramatically expensive, so not a huge constraint. 

There are opportunities on better data for the market to improve. I think the clock though is ticking. It is late in the cycle. Historically, equity markets peak sort of 6 to maybe 9 months ahead of a recession. So if it is 18 months away, there is maybe a little bit of party left but you need to be looking for the exits and thinking about how you do it and the kind of mix of assets that you hold. 

I think also we have seen a big rally in government bonds in developed markets and I think that will come more into focus. If policy-makers are now shifting away from just tightening whatever happens to a much greater focus on swings in data and on swings in financial conditions, then bonds are going to revert more to being negatively correlated to equities, which they weren’t last year, and that makes them a more useful diversifier, a more useful component within portfolios, particularly government bonds that pay some sort of yield, so US treasuries for example.

Lindsay Williams: How are you positioning yourself? You are Head of Multi-Asset Income at Investec Asset Management in London. Are you still cautious because there have been a couple of cautious chats between myself and your colleague, Philip Saunders, and a couple of other people as well but are you positioning yourself to take advantage of this optimism?

John Stopford: I think we are trying to do a bit of both so, overall, I would say we are relatively cautious. This isn’t the time in the cycle to get sort of rampantly bullish. I think reward versus risk looks less compelling than it has earlier in the cycle. 

At the same time, I think there are some good opportunities. So we do think it is interesting that the bond markets are now maybe a more useful component of portfolios. It allows you to run a little bit more equity by having a little bit of duration as an offset. 

We think options remain very interesting, that you have still markets implying very little risk of uncertain outcomes in the future, which is what options basically insure you for. So you don’t pay much for that insurance but you can use them to allow you to participate in market upside if it happens but avoid market downside and it seems to me you could easily paint a picture where equities could be up 20% in a year or down 35-40% and so options are a perfect way of playing that uncertainty at relatively low cost.

Lindsay Williams: We have to end with something called Brexit because there was a vote last night in the Commons at round about 11 o’clock London time and the ayes had it for a change. The no’s have had it for ages but the ayes had it by one vote, 313-312. I don’t quite understand what it was all about but has the UK market responded, whether it be sterling or gilts or the stock market?

John Stopford: Yes, I think to an extent. I think the market is sort of watching and waiting. The general theme has been the market I think is pricing in an increasingly low probability of a hard Brexit because clearly parliament has limited appetite. So the vote yesterday was about forcing the Prime Minister to extend Article 50 if nothing has been agreed by next Friday and so the market I think is relatively hopeful or confident that we are not going to get a hard Brexit although accidents can still happen and, clearly, the Prime Minister is a little bit more open to variants of a softer Brexit. 

So we will have to see but I mean it is extraordinary that the eleventh hour keeps getting – you know we pushed the clocks forward in the UK last week. The government keeps trying to hold the clock back because nobody can make a decision and parliament is as divided as government and each of the political parties is ridden with division. I mean it is the most extraordinary period to live through. I just rather wish I wasn’t sitting in the UK watching it. It is better to watch it from outside than in I think.

Lindsay Williams: Yes, I agree. John, thank you very much for your time. That is John Stopford, who is the Head of Multi-Asset Income at Investec Asset Management in London.


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