• Bond yields collapsed as worries from an escalation of the trade war contributed to a view of impending US slowdown. 10 year US yields dropped from 2.5% to 2.15%.
• The uncertainty also reverberated in the equity market, with the MSCI All Countries Index dropping over 6%, the first negative performance month in 2019.
• Markets now pricing a ~90% chance of a rate cut before the end of 2019 as pessimism about the trade war increases.
• In the UK, Prime Minister May was forced to announce her resignation as Brexit consensus eluded parliament. Sterling weakened by over 3% against the US dollar.

Market update

After 4 months of positive performance, equity markets finally blinked as the escalation of the US-China trade war showed no signs of abating. The result was a distinctly risk-off climate, with both developed and emerging components of global equity markets delivering negative performance. Overall, the MSCI All Countries Index was down 6.3% for May.

At the same time, with increasing worries about a supply glut in oil markets, oil prices also fell and this, combined with slowing trade and GDP outlook, led to the inflation outlook improving substantially. Bond yields in most developed markets fell precipitously in the aftermath, with German bund yields falling to record negative lows as 10 year yields fell to -0.2% by month end. In the US, 10 year yields dropped to 2.15% – the lowest level since Q3 2017.

US employment remains low, inflation and wage costs steady and GDP only just starting to fall off from higher levels. The pressure is on the Fed to deliver a rate cut and certainly, given what is priced into the Fed funds futures (a full 50 bps rate cut by December 2019). The only question is, what will be the catalyst for the Fed to initiate a change in direction?

The global uncertainty also stemmed from the political turmoil in the UK, where Prime Minister May was forced by internal Tory party machinations to announce her resignation. This threw the whole Brexit debate wide open again as there is now even less consensus looking forward. Sterling then lost over 3% against the US dollar as a result.

Given the risk-off environment that unfolded, the US dollar continues to be strong, although if the Fed does deliver a shift in rate outlook it is likely that the strength will dissipate. In Japan, the risk-off environment almost always produces a stronger yen, and indeed this was the case as the Yen strengthened by almost 3% against the dollar.

Portfolio strategy

Global equity markets declined substantially during May – the MSCI All Countries Index declined by 6.2%. Given that equity markets are certainly cheaper than before, but not necessarily substantially cheap, we made the decision to cut our equity position to below benchmark and continue to consider whether, given the trade war issues, to increase that underweight. Despite this decision, equity market weakness resulted in a negative impact on performance within our multi asset fund range.

This was the first negative performance month of 2019, which is significant given the extreme pessimism that ended 2018. Whilst we were underweight equities against benchmarks, these positions were not sufficient to outweigh the overall risk-off environment.  As such, the Global Growth Fund returned -2.9% for the month, whilst the Sterling Asset Management Fund, being more defensive, returned -1.4%. In particular, positions that worked for us included being underweight overall equity and long Japanese yen, whilst performance detractors were our short position in the US dollar, and overweight position in Japanese equities.

We added a position in inflation linked bonds which, given the fall off in bond yields, will help performance. This also has the effect of increasing our overall bond duration as well. In the US, where our predominant equity exposure lies, we are short on the technology sector but have a thematic exposure to financials.

We remain overweight in the yen, as it is still fundamentally cheap with strong risk diversification properties, whilst being relatively neutral on sterling.