By David Absolon, Investment Director at Heartwood Investment Management
Despite the US presidential election outcome, we believe that the fundamentals of the global economy are improving modestly. In particular, we have been encouraged by better survey data across developed economies, as well as further tightening of labour markets. Meanwhile, the inflation picture is shifting. As disinflationary pressures ease with the recovery of commodity prices, this is challenging the ‘lower for longer’ environment, which is further reinforced by a more balanced tone from central banks.
Clearly, we have entered a new political paradigm and a President-elect Trump administration offers both opportunities and risks. Our portfolios were not positioned for a specific Trump or Clinton outcome, rather we saw the US election as a sequence of risk events. While we are likely to see volatility in markets with the ebb and flow of political noise over coming weeks, we have been reassured by the generally sanguine response of developed equity markets. We will wait to see how events unfold over the coming weeks as we learn more about the new administration, suffice to say that a shifting political and economic landscape implies a looser fiscal stance, culminating in the baton now seemingly being passed away from extraordinary monetary policy towards fiscal stimulus, tighter monetary conditions and rising price pressures.
Over recent months, we have been tilting our portfolios towards a value bias and this journey is likely to continue. Already we are seeing more performance dispersion between asset classes and sectors, with emerging market assets and currencies notably underperforming, as markets adjust to a reflationary backdrop and threats of protectionism. We expect a Trump presidency to have a meaningful impact on certain sectors such as infrastructure, industrials, defensives and energy. In consequence, we have addressed our US equity underweight exposure and rotated a modest allocation out of the S&P 500 into the industrials sector and smaller US companies, which are likely to benefit from the perception of more growth-friendly policies. With the economic environment seemingly less supportive for bond markets, we are maintaining our short duration position. We believe further financial market volatility is likely, but also that investors need to reassess the probability of a more positive economic backdrop, and whether that holds out the prospect of higher valuations for real assets. For now we remain slightly overweight equity, short duration in bonds, and underweight in commodities and property.
October was a tougher month, though sterling weakness flattered overseas equity returns. While economic data and results season were broadly positive, investors were more focused on geopolitical events and the pending US Presidential election. During the month, we modestly raised our US equity allocation into targeted exposures in industrials and smaller US companies, which are expected to benefit from a President-elect Trump’s pro-growth stance. Elsewhere, we are maintaining our overweight position in European equities. This market has not been favoured by investors, but it offers a relative value opportunity versus other regions. For similar reasons we are also maintaining our overweight position in Japanese equities, which should also benefit from a more shareholder-friendly approach among Japanese corporates. Within UK equities, we remain focused on large-cap value exporters, although domestically-focused smaller companies could provide opportunities over the medium-term as we see more visibility around Brexit and a more stable currency. We are modestly overweight in emerging market equities. While there are questions around US protectionism, we continue to believe this asset class will benefit from improving growth prospects, policy easing and ongoing liquidity flows.
The trend of steeper yield curves (longer-dated bonds rising more than shorter-dated bonds) has been in place over the past month, but it has been particularly reinforced by the US election outcome. Markets are re-pricing to reflect potentially higher levels of growth, debt, inflation and interest rates. We are maintaining our long-standing short duration position to reflect gradual reflation and the shifting bias of some central banks towards a neutral policy stance. If yields rise to a meaningful degree, we may take the opportunity to extend duration as our shorter-dated bonds mature. We have also trimmed our US High Yield energy position following strong performance. We are maintaining our modest allocation to emerging market sovereign debt (hard currency), given our expectations that the asset class should benefit from cyclical and structural economic improvements.
UK commercial property continued to fall in October as investors continue to assess the impact of Brexit. There are, however, a few signs that confidence is recovering. Investment picked up in September, including demand for Central London and regional offices, with sterling weakness attracting overseas investors back into the market. We maintain our underweight allocation to this asset class, having reduced exposure earlier in the year. We maintain exposure to regional offices and industrials, which are expected to benefit from rising rental income growth due to supply constraints and low vacancy rates. We have also broadened our exposure outside of London to other key UK cities.
Oil prices have seen more price fluctuations of late, responding to speculation around the OPEC meeting at the end of November and whether production cuts will be agreed. Evidence suggests a tightening in supply while demand remains strong, providing modest support to the oil price in the near term. Industrial metals fundamentals have also improved over recent months on supply constraints. Overall demand remains sluggish, but sentiment towards the sector could improve on Chinese data improvements and if we were to see meaningful fiscal stimulus. Our view remains constructive on precious metals, which we continue to view as a portfolio diversifier, although short-term performance closely follows the perceived course of global monetary policy. Agricultural commodities have bounced recently, but are still at multi-year lows; our long-term view remains positive.
We have a limited allocation to hedge funds, with select exposures to macro/CTA strategies with a proven track record. We have also been allocating a small amount of capital to the Heartwood Alternatives Fund, a dedicated managed portfolio of alternative investments. This vehicle provides access to a wider opportunity-set that would otherwise be unavailable due to regulatory and operational constraints.
We have built up sizeable liquidity across our portfolios both in cash and short-dated bonds, which we are ready to invest if we see opportunities.