Miton’s Anthony Rayner: Keeping up With the Joneses

• Record highs mask tug of war in markets
• Perceptions of slowing economic momentum are changing market dynamics
• We remain broadly constructive on markets, with a bias to economically sensitive businesses

Anthony Rayner, manager of Miton’s multi-asset fund range comments:

“Headlines were ablaze this week with the glory of the Dow Jones achieving record highs for 12 consecutive days. This is the first time in 30 years this has happened, but then 1987 did see some serious volatility in markets, with the Dow Jones falling 34% in October, despite managing to finish up over the calendar year.

“There has been some serious momentum to equity markets. No doubt a combination of the following should take some of the credit: decent corporate earnings growth, strong global economic growth and still low interest rates. The “Trump trade” is also in the mix with expectations of tax reform, a reduction in regulation and an increase in infrastructure spend all buoying markets, but this also comes with a lot of noise around policy formulation and implementation risk.

“Looking beyond the headlines, the story is more nuanced. The behaviour of equity markets had indeed been consistent with risk-on positioning for some months. For example, cyclical sectors had been outperforming defensive, and emerging markets had been outperforming developed. Meanwhile, high yield credit had been outperforming investment grade credit. However, this reversed in February this year and was accompanied by a rally in safe haven markets. Cyclicals have been outperforming defensives since the middle of 2016. The trend became less clear cut around year end and, in February this year reversed, although it’s too early to call it a new trend.

“The outperformance of cyclicals has been closely linked with bond yields moving higher. Going back further, this relationship holds pretty well, with bond markets and defensives (aka equity bond proxies) tending to move in tandem. Since the beginning of February, core government bonds have rallied, especially German bunds and UK gilts, reflecting regional differences such as heightened political risk in France (benefiting German bunds) and, in the UK, reduced expectations of a rate rise, with some signs of economic momentum slowing. US Treasuries have rallied less so, perhaps countered by stronger economic fundamentals and growing expectations of US interest rate hikes.

“So, asset classes are behaving in a broadly consistent way (with the exception of gold, which has rallied from the end of December, but gold does tend to do its own thing). The question is, why has there been a switch in market dynamics? It might simply be that markets are digesting the sharp rise in risk assets, with a healthy bit of mean reversion. Or that economic momentum is perceived to be slowing. Or that Trump needs to deliver more than a Twitter promise now and then.

“We can’t know the answers yet. So far, the economic data remains consistent with reflation, but that doesn’t mean that economically sensitive equities aren’t stretched short term. If bond yields move materially lower, or stay close to these levels, then it will likely mean that cyclicals will struggle to lead markets higher, as they have done for most of the period since the middle of 2016.

“For our part, we retain our reflation base case, and are broadly constructive on markets, with a bias to economically sensitive businesses and a preference for short duration, good quality corporate bonds. We also continue to add to our themes, such as technology healthcare, which helps to diversify our funds.”

• Record highs mask tug of war in markets
• Perceptions of slowing economic momentum are changing market dynamics
• We remain broadly constructive on markets, with a bias to economically sensitive businesses

Anthony Rayner, manager of Miton’s multi-asset fund range comments:

“Headlines were ablaze this week with the glory of the Dow Jones achieving record highs for 12 consecutive days. This is the first time in 30 years this has happened, but then 1987 did see some serious volatility in markets, with the Dow Jones falling 34% in October, despite managing to finish up over the calendar year.

“There has been some serious momentum to equity markets. No doubt a combination of the following should take some of the credit: decent corporate earnings growth, strong global economic growth and still low interest rates. The “Trump trade” is also in the mix with expectations of tax reform, a reduction in regulation and an increase in infrastructure spend all buoying markets, but this also comes with a lot of noise around policy formulation and implementation risk.

“Looking beyond the headlines, the story is more nuanced. The behaviour of equity markets had indeed been consistent with risk-on positioning for some months. For example, cyclical sectors had been outperforming defensive, and emerging markets had been outperforming developed. Meanwhile, high yield credit had been outperforming investment grade credit. However, this reversed in February this year and was accompanied by a rally in safe haven markets. Cyclicals have been outperforming defensives since the middle of 2016. The trend became less clear cut around year end and, in February this year reversed, although it’s too early to call it a new trend.

“The outperformance of cyclicals has been closely linked with bond yields moving higher. Going back further, this relationship holds pretty well, with bond markets and defensives (aka equity bond proxies) tending to move in tandem. Since the beginning of February, core government bonds have rallied, especially German bunds and UK gilts, reflecting regional differences such as heightened political risk in France (benefiting German bunds) and, in the UK, reduced expectations of a rate rise, with some signs of economic momentum slowing. US Treasuries have rallied less so, perhaps countered by stronger economic fundamentals and growing expectations of US interest rate hikes.

“So, asset classes are behaving in a broadly consistent way (with the exception of gold, which has rallied from the end of December, but gold does tend to do its own thing). The question is, why has there been a switch in market dynamics? It might simply be that markets are digesting the sharp rise in risk assets, with a healthy bit of mean reversion. Or that economic momentum is perceived to be slowing. Or that Trump needs to deliver more than a Twitter promise now and then.

“We can’t know the answers yet. So far, the economic data remains consistent with reflation, but that doesn’t mean that economically sensitive equities aren’t stretched short term. If bond yields move materially lower, or stay close to these levels, then it will likely mean that cyclicals will struggle to lead markets higher, as they have done for most of the period since the middle of 2016.

“For our part, we retain our reflation base case, and are broadly constructive on markets, with a bias to economically sensitive businesses and a preference for short duration, good quality corporate bonds. We also continue to add to our themes, such as technology healthcare, which helps to diversify our funds.”