A number of factors have eroded investor confidence, particularly the politics and policy of populism. Investors have become increasingly concerned about an escalation of trade conflict with corresponding adverse impacts on global growth and earnings. While tariffs would impact specific industries and sectors, the larger concern is a spill over to corporate confidence, capital expenditures and hiring, which are the underpinnings of the global expansion.
IMF Managing Director Lagarde and Fed Chairman Powell have noted this potential risk for the global economy and markets. That message, despite signs of a mid-year rebound in growth and a good start to the Q2 earnings season, has reinforced doubt and caution among market participants.
Elsewhere, Brexit uncertainty remains elevated. Narrow votes in the House of Parliament on related issues suggest the absence of a clear majority in the Commons for any agreed upon Brexit solution, which will make it difficult for the UK government to achieve a negotiated outcome with the EU. With an autumn deadline looming, sterling is again on the defensive in currency markets as investors consider the probabilities of a ‘no-deal’ Brexit. The coming weeks and months are likely to see continued uncertainty weigh on the pound.
How to invest in troubled markets? We remain convinced that engagement is the correct course of action. But we feel that, in contrast to the ‘classic’ 60-40 allocation between stocks and bonds, a 30/30/40 approach is most suitable: 30% where we see opportunities in global equities, 30% in short duration credit and 40% in non-directional strategies.
In equities, we prefer a combination of thematic positions, for example in select areas of information technology, in quality stocks likely to deliver earnings and in secular transformation, for example parts of Japan. Fixed income allocations are concentrated in short duration, uncorrelated positions, for example off-the-run mortgage-backed securities or subordinated debt. Finally, a larger chunk is devoted to non-directional strategies, which generate return from security-specific risk, long/short opportunities or special situations (for example, merger arbitrage).