Robert Lee, Co-Head of Multi-Asset Investment, discusses Asset Allocation in Investment Week
Investment Week reports:
As a fixed income investor, I tend to view equity markets through a distant and wide-angle lens - they often react differently to bond markets to economic data and are subject to a much greater degree of price volatility and investor myopia.
Monetary policy, however, is one market driver that binds both asset classes inextricably together; and February's equity market correction was a good example of this.
A significantly stronger than expected and potentially reflationary print of 2.9% for US average hourly earnings - the highest since June 2009 - meant expectations for the Federal Reserve's interest rate path were marked up further, causing equity and bond prices to decline as long-term discount rates applied to future cash flows increased.
The present value of future corporate earnings and investment income would therefore be worth less today than in a lower interest rate environment.
This 'normalisation' of economic indicators and interest rates is typically healthy for equity markets, but unfortunately the timing of this coincided with the end of a stable four-year term for US central bank chair Janet Yellen. Her Republican successor, Jerome Powell, represents a change of guard and party line at a critical phase for US monetary policy, where a policy error would be fatal for a bull market entering its tenth year.
We believe these concerns are overdone, and argue that core inflation is unlikely to overshoot its 'healthy' range of between 1.5% and 2.5% and the Federal Reserve is unlikely to stray too far from its slow and steady rate hiking path.
We expect the equity bull market to continue in 2018, albeit accompanied by higher volatility, as a combination of US tax cuts, fiscal expansion and deregulation supports the global economic expansion, while globalisation, demographics and technological innovation keep inflation in check.
Consequently, we remain overweight global equities, neutral on credit and underweight global sovereign bonds, with a preference for emerging market assets over developed market assets, and non-directional hedge funds over duration risk as a portfolio diversifier.
Robert Lee is co-head of multi-asset investment at Signia Wealth.
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