By Graham Bishop, Investment Director at Heartwood Investment Management
The global economy benefited from a synchronised expansion in 2017 and momentum has accelerated over the last few months. While the legislative approval of US tax reform appears to be re-energising animal spirits, other forces are also playing their part: strengthening domestic growth in Europe, rising global capital expenditure levels, and the positive impact of stronger global demand for Chinese exports. Inevitably, questions are being asked about the sustainability of the current stronger global growth profile. We expect that a virtuous cycle of rising economic momentum, positive investor sentiment and supportive financial conditions will sustain the current cycle in the near term. In particular, US domestic growth prospects have been lifted by the temporary boost from fiscal stimulus, which arguably goes further than many had expected. While it is still early days, the impact of tax cuts is likely to be felt through higher wages and/or stronger corporate earnings.
However, we are also mindful that ten years on from the Financial Crisis this extended business cycle is reaching a mature phase. Several headwinds have held inflation down in the last few years, notably the euro sovereign crisis, which crippled demand in Europe, and tighter financial conditions in emerging market economies during the period when commodity prices collapse between 2014 and 2016. As these disinflationary headwinds diminish, we believe that the nature of the current extended cycle of low interest rates and low inflation is changing. Cyclical inflation pressures are rising moderately. While the boost from higher oil prices is likely to impact headline measures, the more important feed-through will come from the culmination of several months of strengthening global momentum. After all, in our view, inflation is a lagged a response to growth. Admittedly wage growth has been disappointing so far, but we expect that tighter labour market conditions will eventually produce higher wage pressures.
So it appears that we are entering a different stage of the cycle, likely to be characterised by more ‘normal’ conditions. Central banks are expected to stay on their journey of withdrawing emergency levels of monetary stimulus, as the regime shifts from quantitative easing to quantitative tightening. This expected reduction in excess liquidity growth is likely to present more challenges to markets further out, given its potential impact on earnings and sentiment. Moreover, despite the bond market’s recent revision towards a higher interest rate environment, we still believe that there remains a certain amount of complacency within financial markets. For example, financial conditions in the US have eased over the past year and there is still some way to go to normalise policy, especially if inflation rises as we anticipate.
We are therefore comfortable with maintaining our neutral exposure to risk assets. However, we also consider it to be appropriate to slightly reduce the cash position based on our short-term positive view. Rather than adding to equity risk, given the high valuations of some parts of the market, we are modestly increasing our commodity exposure to reflect our view of a reflationary environment. In our lower risk strategies, we are also modestly adding to short-term emerging market sovereign debt, which continues to benefit from benign economic conditions. Portfolios continue to hold a tilt towards the more value-orientated parts of the market, which we believe are positioned to withstand a higher interest rate environment. We are also sourcing diversified return streams from alternative assets, which should benefit from an environment of higher levels of market volatility.
Bonds: Inflation expectations are picking up and shorter- and intermediate-dated sovereign bond yields in developed markets are re-pricing to reflect a slightly faster US Federal Reserve interest rate tightening cycle. More focus is also being placed on the likely policy path of the European Central Bank, as its quantitative easing programme could end this September. The strong fundamental backdrop continues to support credit markets and, for this reason, we modestly added to emerging market sovereign debt. Overall, we continue to believe that developed sovereign bond valuations remain unattractive and maintain our short duration position. We are targeting ‘niche’ return drivers, such as asset-backed securities and infrastructure loans, until value returns to conventional credit.
Equities: 2017 ended on a strong note, with good news on the US tax bill adding support to developed markets. We continue to believe a modest overweight allocation to equities remains appropriate, mindful that the strong fundamental and liquidity backdrop are juxtaposed against the risks of high valuations and a lack of volatility. We are still not pushing for a shift back to UK equities at the expense of overseas, remaining underweight relative to other regions. We retain overweight positions in European and Japanese equities. We are neutral in US equities and remain comfortable taking a targeted approach to specific themes – healthcare, insurance and small cap. We continue to view our US exposure as a future source of funds on valuation grounds. Our emerging market equity exposure remains tilted towards Asia and we would view any pullback as an opportunity to add.
Property: The UK commercial real estate market ended 2017 strongly, having defied the Brexit gloom and continuing to attract the interest of overseas investors. We are comfortable maintaining our underweight position in UK commercial property, favouring a targeted approach towards long-term income strategies. Our preference remains for those sectors where there are supply/demand imbalances and are less exposed to broader macroeconomic events. While capital appreciation opportunities are diminishing given the maturity of the cycle, we continue to believe that UK commercial property offers attractive yields over UK gilts, which continue to be above historic averages in most sectors.
Commodities: We are increasing our exposure to commodities to reflect our more positive short-term view of a reflationary environment. While the oil price has seen a significant rally on a tightening supply/demand outlook, we believe that the fundamental backdrop remains supportive in the near term. OPEC discipline has been noteworthy and a higher oil price from current levels would be welcomed by Saudi Arabia given its growing fiscal deficit. Further out, we are mindful of the risks of US shale production resuming. Industrial metals are sensitive to rebalancing and deleveraging in China, but environmental controls introduce supply-side constraints which could be supportive to prices. Gold continues to play a protective role in portfolios in the event of any financial or geopolitical crisis.
Hedge funds: We made no change to our current allocation, although we expect more opportunities to arise owing to increasing monetary policy divergence and sector and stock dispersion. Our preference remains for macro/CTA strategies, as well as equity hedge strategies that have the potential to benefit from increased stock dispersion (i.e. between winners and losers).
Cash: We have slightly reduced our cash weighting, but continue to maintain reasonable levels of liquidity across our portfolios both in cash and short-dated bonds. Market volatility remains low – a situation that we believe is unlikely to persist as we move into the second half of the year
Not company earnings, not data but vaccines now steering investor sentiment
By Marc Jones and Dhara Ranasinghe
LONDON (Reuters) – Forget economic data releases and corporate trading statements — vaccine rollout progress is what fund managers and analysts are watching to gauge which markets may recover quickest from the COVID-19 devastation and to guide their investment decisions.
Consensus is for world economic growth to rebound this year above 5%, while Refinitiv I/B/E/S forecasts that 2021 earnings will expand 38% and 21% in Europe and the United States respectively.
Yet those projections and investment themes hinge almost entirely on how quickly inoculation campaigns progress; new COVID-19 strains and fresh lockdown extensions make official data releases and company profit-loss statements hopelessly out of date for anyone who uses them to guide investment decisions.
“The vaccine race remains the major wild card here. It will shape the outlook and perceptions of global growth leadership in 2021,” said Mark McCormick, head of currency strategy at TD Securities.
“While vaccines could reinforce a more synchronized recovery in the second half (2021), the early numbers reinforce the shifting fundamental between the United States, euro zone and others.”
The question is which country will be first to vaccinate 60%-70% of its population — the threshold generally seen as conferring herd immunity, where factories, bars and hotels can safely reopen. Delays could necessitate more stimulus from governments and central banks.
Patchy vaccine progress has forced some to push back initial estimates of when herd immunity could be reached. Deutsche Bank says late autumn is now more realistic than summer, though it expects the northern hemisphere spring to be a turning point, with 20%-25% of people vaccinated and restrictions slowly being lifted.
But race winners are already becoming evident, above all Israel, where a speedy immunisation campaign has brought a torrent of investment into its markets and pushed the shekel to quarter-century highs.
(Graphic: Vaccinations per 100 people by country, https://fingfx.thomsonreuters.com/gfx/mkt/azgvolalapd/Pasted%20image%201611247476583.png)
SHOT IN THE ARM
Others such as South Africa and Brazil, slower to get off the ground, have been punished by markets.
Britain’s pound meanwhile is at eight-month highs versus the euro which analysts attribute partly to better vaccination prospects; about 5 million people have had their first shot with numbers doubling in the past week.
Shamik Dhar, chief economist at BNY Mellon Investment Management expects double-digit GDP bouncebacks in Britain and the United States but noted sluggish euro zone progress.
“It is harder in the euro zone, the outlook is a bit more cloudy there as it looks like it will take longer to get herd immunity (due to slower vaccine programmes),” he added.
The euro bloc currently lags the likes of Britain and Israel in terms of per capita coverage, leading Germany to extend a hard lockdown until Feb. 14, while France and Netherlands are moving to impose night-time curfews.
Jack Allen-Reynolds, senior European economist at Capital Economics, said the slow vaccine progress and lockdowns had led him to revise down his euro zone 2021 GDP forecasts by a whole percentage point to 4%.
“We assume GDP gets back to pre-pandemic levels around 2022…the general story is that we think the euro zone will recover more slowly than US and UK.”
The United States, which started vaccinating its population last month, is also ahead of most other major economies with its vaccination rollout running at a rate of about 5 per 100.
Deutsche said at current rates 70 million Americans would have been immunised around April, the threshold for protecting the most vulnerable.
Some such as Eric Baurmeister, head of emerging markets fixed income at Morgan Stanley Investment Management, highlight risks to the vaccine trade, noting that markets appear to have more or less priced normality being restored, leaving room for disappointment.
Broadly though the view is that eventually consumers will channel pent-up savings into travel, shopping and entertainment, against a backdrop of abundant stimulus. In the meantime, investors are just trying to capture market moves when lockdowns are eased, said Hans Peterson global head of asset allocation at SEB Investment Management.
“All (market) moves depend now on the lower pace of infections,” Peterson said. “If that reverts, we have to go back to investing in the FAANGS (U.S. tech stocks) for good or for bad.”
(GRAPHIC: Renewed surge in COVID-19 across Europe – https://fingfx.thomsonreuters.com/gfx/mkt/xegvbejqwpq/COVID2101.PNG)
(Reporting by Dhara Ranasinghe and Marc Jones; Additional reporting by Karin Strohecker; Writing by Sujata Rao; Editing by Hugh Lawson)
BlackRock to add bitcoin as eligible investment to two funds
By David Randall
(Reuters) – BlackRock Inc, the world’s largest asset manager, is adding bitcoin futures as an eligible investment to two funds, a company filing showed.
The company said it could use bitcoin derivatives for its funds BlackRock Strategic Income Opportunities and BlackRock Global Allocation Fund Inc.
The funds will invest only in cash-settled bitcoin futures traded on commodity exchanges registered with the Commodity Futures Trading Commission, the company said in a filing to the Securities and Exchange Commission on Wednesday.
A BlackRock representative declined to comment beyond the filings when contacted by Reuters.
Earlier this month, Bitcoin, the world’s most popular cryptocurrency, hit a record high of $40,000, rallying more than 900% from a low in March and having only just breached $20,000 in mid-December.
Bitcoin tumbled 10.6% in midday U.S. trading Thursday.
Other U.S.-based asset managers will likely follow BlackRock’s lead and add exposure to bitcoin in some form to their go-anywhere or macro strategies as the cryptocurrency market becomes more liquid and developed, said Todd Rosenbluth, director of mutual fund research at CFRA.
“It’s easy to see how strong the performance has been of late and look at a historical asset allocation strategy that would have included a slice of crypto and how returns would have been enhanced as a result,” he said. “Large institutional investors are going to be able to tap into the futures market in a way that a retail investor could not do.”
There is currently no U.S.-based exchange-traded fund that owns bitcoin, limiting the ability of most fund managers to own the cryptocurrency in their portfolios.
BlackRock Chief Executive Officer Larry Fink had said at the Council of Foreign Relations in December that bitcoin is seeing giant moves every day and could possibly evolve into a global market. (https://bit.ly/2XXFHrB)
(Reporting by David Randall; Additional reporting by Radhika Anilkumar and Bhargav Acharya in Bengaluru; Editing by Arun Koyyur and Lisa Shumaker)
Bitcoin slumps 10% as pullback from record continues
LONDON (Reuters) – Bitcoin slumped 10% on Thursday to a 10-day low of $31,977 as the world’s most popular cryptocurrency continued to retreat from the $42,000 record high hit on Jan. 8.
The pullback came amid growing concerns that bitcoin is one of a number of financial bubbles threatening the overall stability of global markets.
Fears that U.S. President Joe Biden’s administration could attempt to regulate cryptocurrencies have also weighed, traders said.
(Reporting by Julien Ponthus; editing by Tom Wilson)
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