The broader economic environment appears to be healthy, with GDP growth rates in most regions well above where they were a number of years back. Unemployment across most of the Developed Market (DM) countries has been falling and inflation, for now, remains well anchored. Monetary policy, whilst being tightened, is coming off a very low base, and in some areas, fiscal policy remains in stimulus mode.
Despite this global backdrop, markets have been consistently volatile through the course of the last few months, with the MSCI All Countries Index, for example, down 1.53% year-to-date despite being up over 7% in January. In the fixed income space, the FTSE World Government Bond Index is down almost 1%, after being up almost 3% by end March. Clearly, something else is bothering the collective market consensus.
The catalyst for the most recent fear has been the simmering economic war between the USA and its trade partners, which appears during June to have tipped over into the early stages of a full-blown trade war. Despite most economic analysis pointing to a fairly limited impact on overall GDP growth of about 0.5% in this scenario, it is in overall risk appetite and sentiment that the fears have been realised. Emerging Markets (EM), as a somewhat leveraged play on global growth and being the most helpless in a trade war scenario, bore the brunt of this dramatic shift in appetite, with JPM EMBI spreads having risen to 389 points from a low of 289 in early 2018. EM currencies did not escape, with the MSCI EM Currency Index falling over 6% in the second quarter of 2018.
Despite a general view that US Treasuries will be in a gently rising mode, especially given the backdrop of a Federal Reserve (Fed) that is happy to keep shifting the Fed Funds rate incrementally higher through the year, the shift in sentiment has meant a flow of funds seeking safe-haven status has kept the US 10 year bond yield well contained, with only a brief foray above 3%. In the Eurozone, the European Central Bank (ECB) pointed to an end in the Quantitative Easing (QE) program by end 2018 and rather dovishly pointed to a shift in interest rates only in the latter part of 2019. That key difference in monetary policy between the US and Eurozone has also shifted relative sentiment as far as the euro vs dollar is concerned.
While already being neutral against benchmarks in our equity weightings by the time trade war rhetoric hit markets, we were also conscious of the lack of positive catalysts for the market in the near term. We accordingly opted to shift to a small underweight equity position on a tactical basis. This goes with our underweight fixed income position, in which we have also slowly been increasing duration closer towards benchmark levels. Within fixed income we also shifted our bias slightly away from EM to favour both a more diversified positioning as well as higher exposure to sovereign DM.
We retain our positive bias towards the US dollar and the Japanese yen as the two predominant safe haven currencies, and we have not made any recent significant shifts in Foreign Exchange (FX) positioning. We do not at this stage expect a full blown bear market, and await a suitable entry point for increased risk exposures.
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