Whilst we don’t discount the short-term uncertainty around our membership of the European Union. We believe that markets are vulnerable to several major economic risks – the scale of the Chinese credit bubble, negative interest rates and anaemic growth to name but three.
Over the next eighteen months, the political landscape will also alter with a new US president and the Eurozone’s four largest countries heading to the polls for a number of key ballots.
These factors have led us to position our portfolios more defensively and will exert a greater influence over the UK economy than whether the country votes in or out on 23 June. We have raised cash levels, lightened our exposure to developed market equities while maintaining our absolute return strategies and a light allocation to fixed income.
We have taken a defensive stance to equities tactically, as we feel that markets are vulnerable. Developed market equities are fully valued on most measures and we have grown cautious on the potential for a strong pick up in corporate earnings.
Emerging markets are very cheap in absolute terms and relative to their historical valuations. For the time being, the earnings outlook remains uncertain and so sentiment towards Asian markets is particularly sensitive to news about Chinese economic activity and movements in the US dollar.
As a simple but effective method for risk control, we have increased portfolio cash holdings.
We are comfortable holding cash on a short term tactical basis to reduce exposure to the market in light of the various risks we identify. As greater clarity is found, we will redeploy this cash into asset classes that we deem to be attractive.
Yields on sovereign debt remain too low to invest rationally and are being suppressed by central banks across the globe. In the UK the Bank of England is unlikely to change interest rates until Q4 2016 at the earliest. The European Central Bank is firmly in monetary easing mode, as is The Bank of Japan. The Peoples’ Bank of China is dealing with a slowing economy and so biased towards easing as well. The exception of course has been the US Federal Reserve which has started raising rates.
Although we recognise the defensive benefits of government bonds, we see little value in owning them. We do see riskier ‘high yield’ bonds in Europe as attractive on a relative basis.
Our overweight position in alternatives partly reflects our lack of enthusiasm for fixed interest. We have increased our allocation as it provides an opportunity to protect portfolios in the event of a significant downturn.
We have reduced our overweight position to property. While property has enjoyed a significant positive return over the past six years. Looking forward we see limited potential upside in prime properties except in the form of rental growth.