Premier Miton Macro Thematic Multi Asset Team
The type of tensions dominating markets are amply illustrated by two dynamics. First, UK consumer confidence, which is now the lowest on record. Second, UK interest rates, which have not long started on their journey towards approximately 3%, according to market expectations, looking to peak around the middle of next year.
Meanwhile, newsflow around industrial disputes, in large part a barometer of the cost of living crisis, is increasingly spreading from the transport sector to other areas of the economy. The UK is not an exception, even if it is more exaggerated than many other developed countries. The message is clear though: inflation is being felt across geographies, assets, central banks and political spectrums.
How can multi asset investors position for such a seemingly indiscriminate force? Part of the answer depends on the persistency of inflation. It seems fanciful to believe inflation will simply return to pre-Covid levels, as dynamics such as globalisation, which were very disinflationary, are being replaced by deglobalisation. Just as important though, is the persistency of any recession resulting from central bank action to curtail inflation. In short, it’s about positioning around the degree of stagflation risk.
We are, and always have been, reluctant to forecast markets or economies. The chances of correctly forecasting within a helpful margin of error are slim. Even less likely is the probability of forecasting how asset classes will react to a pinpoint forecast, in part as the broader context is so important. Instead, we are more comfortable to accept that economic volatility will remain elevated, and to spend more time on understanding the levers we can pull, depending on the range of most probable scenarios.
If we assume, as our base case, that inflation remains ahead of market expectations, and that recession risk is rising, that provides some insight as to how portfolios should be structured across assets. That said, an inflationary environment and a recessionary environment often apply opposing forces on assets.
Equity exposure should be reduced, with a bias to less economically sensitive sectors such as utilities, telecoms, staples and healthcare, and some exposure to inflation beneficiaries, such as resources, though recession will be an opposing force to higher resource prices via lower end demand. So, gauging which is the most powerful force of the two at any point in time, will be important.
Turning to developed market government bonds, recession risk would imply longer duration, whereas inflation and higher rates would suggest shorter duration. This tension can be seen in how yields have been zigzagging in the last few months. So, having some duration might be sensible, especially if the Fed is being overly aggressive. Also, it’s probably best not to assume that government bonds will perform their safe haven role, if inflation risk is the primary risk in markets. Again, it comes down to inflation persistency.
Emerging market bonds, meanwhile, are fascinating, with increased performance divergence, as commodity producers fare much better than commodity consumers. Meanwhile, credit risk in corporate bonds is perhaps more clearcut, with recession and higher refinancing costs suggesting a bias to better quality credit, such as investment grade.
Commodities can provide some balance to portfolios, though here too the cross currents of inflation and recession are unhelpful in deciding an aggregate stance. So, we have elected to retain our material position in gold, and we have sold our more economically sensitive areas like industrial metals and agricultural commodities. The outlook for property is also mixed, with some inflation protection but some negative impact from any recession, added to the impact of the lingering Covid lockdown to certain sectors. A lack of clarity has led us to reduce our exposure here too.
Cash is more helpful than it has been for some time, in an environment where most assets have fallen. Though, with inflation higher, the real returns look poor, even if rates have risen somewhat. So we have elevated cash, in part reflecting our more cautious view and also for investment opportunities as and when they arrive.
Just as we avoid forecasting, we don’t assume it will be a straight line to our base case. This positioning won’t all be right, it never is. The point is not to focus solely on being right or wrong. Sometimes portfolios will need tweaking, for example to emphasis the bias to inflation or recession, sometimes they will need more radical action. Nevertheless, we believe that being vigilant, holding liquid assets and utilising the full range of levers available to global multi asset investors is a good place to start.