From Brexit to the US election, it has been a noisy year in markets, and asset allocators have had to navigate some choppy waters. The key for Guy Stephens, managing director at Rowan Dartington, is to retain sufficient flexibility to take advantage of opportunities as they arise, while limiting clients’ exposure to the worst of the volatility.
As a result, the Rowan Dartington portfolios are overweight cash. Going into the US election, Stephens said this cash weighting allowed him optionality should markets sell off following a Trump victory.
“If Trump got in, we felt there would be an immediate sell-off, but had Clinton got in, there could have been problems with congress moving swiftly to impeach her over the email scandal. This would tick away and undermine the market. We wanted to be able to take advantage of any shocks,” he says.
Bad news for bonds
To some extent, these higher weightings in cash are also a response to an extremely underweight position in fixed income. The group has no sovereign exposure at all and Stephens believes yields have probably bottomed-out in the UK and elsewhere.
While there is some hysteria around the prospect of inflation and/or a resulting interest rate rise, he says higher inflation is likely. In the short term, he would rather have virtually no return from an overweight cash weighting than a definite negative return if inflation surprises.
He adds that government bond yields are more sensitive to inflation on the upside. “Within reason, deflation or, more accurately, disinflation is good for businesses and profitability. People may say the recent spike in inflation is technical, and only to do with oil prices, but we have to consider that central banks have printed a lot of money.
“No one is too worried about deflation any more. We would be quite worried about bond markets, were it not for the artificial stimulus still in place.”
Equally, fiscal stimulus is becoming more likely across the globe. Monetary policy seems to be reaching the end of its potential and global leaders, from Donald Trump and Theresa May to Chinese finance minister Xiao Jie, have made it clear they will loosen their countries’ purse strings. This also makes inflation more likely and spells bad news for the bond market.
That said, Stephens does not expect the bond market to plummet, not least because policymakers must tread a fine line. They can’t afford to upset bond markets and have them take fright as it will raise the cost of borrowing and destroy business confidence, possibly causing recession. There is a danger, for example, that if chancellor Philip Hammond goes too far on fiscal policy in the Autumn Statement, it will unsettle bond markets.
The equity market, in contrast, is polarised. Stephens says: “It is looking very expensive in some areas, while many UK domestic companies and mid-caps are looking over-sold. We can see why.
“The EU wants a hard Brexit to put anyone else off the idea and the other EU members are likely to make the UK squeal, potentially defaulting into the World Trade Organisation rules. We may hold the cards on starting the race, but that’s where it ends.”
On the other hand, he says, underneath those issues, earnings have been relatively robust. While there are some areas to worry about, shareholders are receiving reasonable dividends and getting some growth from their equity weightings with a benign economic outlook.
As a result, the group is fully weighted in equities across its portfolios. The overweight in cash is not earmarked for equity markets, more for value opportunities in other asset classes. If Hammond were to announce the creation of infrastructure bonds to pay for his fiscal expansion plans with an attractive yield, similar to a PPI type of arrangement, we would be interested.
“Valuations are questionable in some cases, but we are not in bubble territory. That said, we want to ensure we have a reasonable allocation to overseas earnings. We have had a big adjustment in sterling but as the Brexit debate intensifies, it will keep it depressed.”