The volatility and market setbacks of the final quarter of last year mark, we believe, the end of a decade-long period of strong returns in global markets accompanied for the most part by low volatility. Looking ahead, we believe returns are likely to be more modest and bouts of volatility more frequent. That is a key implication of ‘post-peak’ – a world of decelerating economic and earnings growth, where political and policy uncertainty remains elevated.
As ever, markets often overshoot, leading to periods of tactical opportunity. In our view, that is the case at the beginning of 2019. At the turn of the year market pricing was consistent with recession-like outcomes in Western Europe but also the US. To our mind, that is not right. We continue to see supportive factors for growth, such as rising household income underpinned by job formation and rising real wages. Accordingly, expectations for H1 2019 earnings growth are probably too low. Similarly, we believe fixed income pricing that sees the Fed on hold for all of 2019 is probably wrong – the Fed is probably not done raising rates in this cycle. Accordingly, at the beginning of 2019 we prefer modest overweight positions to global equities, alongside short duration positions in fixed income, in anticipation of some reversal of excessive investor pessimism.
Nevertheless, the key message for all of 2019 is portfolio construction. An environment of modest returns and episodic volatility should place a premium on drawdown minimisation. In our view, that, in turn, requires careful attention to correlation and volatility analysis in designing and managing portfolios. We believe non-directional strategies such as hedge fund strategies, alternative risk premia and some illiquid strategies should play a more important role in portfolios. We see opportunity in target return and alternative risk premium approaches within multi-asset portfolios. In equity markets, we opt for quality, minimum volatility and Japanese markets, rather than cyclicals or ‘value’. Among fixed income strategies, we retain a preference for short-duration speciality credit, including mortgage-backed securities and insurance-linked debt.
Lastly, in terms of risk to the base case, the chief concerns remain disruptions via trade conflict and political events, including a ‘hard Brexit’. Indeed, we believe that political and policy uncertainty is a key source of restraint that has already slowed global growth over the past year.
We would be remiss, however, if we did not highlight a potential source of upside risk, namely an unanticipated (and welcome) acceleration of global growth. While unlikely in the near term, we believe growth could pick up if business leaders enjoy more clarity about the state of global trade and capital flows. The chief beneficiaries would include those markets most dependent on trade and global financial flows, namely emerging and European equity and credit markets.