With the return of volatility, where now for equities and bonds?
Market volatility returned in February after a long lull since President Trump’s election. There was a double-digit stock market fall worldwide as inflation and rising interest rate fears came to the fore. The recovery process following such a fall can often be complicated and we may see more volatility before the coast is clear.
At the risk of sounding like other commentators, falls such as these – known as market corrections - are normal and healthy for markets. The average correction is 14% from top to bottom, even when markets end up with strong returns for the whole year, so the process we are experiencing should not be feared.
Furthermore, we believe the general direction of equities is still up and want to be fully invested against that backdrop.
A bleaker outlook for bonds
We are quite negative, however, on bonds (fixed income) and cannot find a specific pre-set level at which we would wish to add to our fixed income positions, although we will review this during the year.
Bond yields are likely to keep rising, fuelled by moderately higher inflation. 10-year US government bond yields will eventually exceed 3%, although at that level many buyers are likely to come in. If the Federal Reserve (Fed) hikes interest rates more than the predicted three times this year – and they end up around 3% late next year - we would expect the 10-year yield to be above that. This would be detrimental for certain higher-debt sectors, like utilities and telecoms, but could prove advantageous for others, such as financials, technology and energy.
If US bond yields are to rise, then the outlook for European bonds or gilts is even worse, as they start from a much lower interest rate: the 10-year German Bund could double in yield to 1.50% and 10-year UK gilts could easily exceed 2%.
Despite such rate rises, we cannot see a US recession (the country that normally causes others to follow) this year or next, and the prospect of one is unlikely to derail stock markets this year. We do, however, have to keep a sharp eye on such risks later this year.
Onwards and upwards for equities
Contrary to popular belief, equities tend to behave well against rising inflation, as long as it remains in the 2% or 3% area. Companies benefit from the additional pricing power if prices pick up moderately. We are therefore happy with our overweight position in equities (typically 62% in a balanced portfolio).
Within equities we prefer emerging markets first, then Europe and Japan, then the US and, least of all, the UK.
We recognise that stock selection could add a lot of value within the diverse UK market, although it is fraught with political risk. First is the risk of a very bumpy Brexit process – which could be uncertain until the eleventh hour - and second is the potential arrival of Labour at Number 10. This could have an impact on certain sectors and sterling which, so far, has recovered smartly from its post-referendum lows. As such, we still wish to have currency protection in our sterling portfolios (in the form of US dollars, euros and emerging market currencies).
Despite the widely publicised maturity of this economic cycle (we are experiencing one of the longest economic expansions on record since it started after the financial crisis of 2008), there is still sufficient room ahead for equities to perform. This is in an environment of US fiscal stimulus, strong European upswing and solid emerging market growth. Had the correction been deeper, we might have even considered adding more risk to our portfolios, but as it stands, our existing portfolio risk is in line with our expectations for the year. Volatility may continue but it’s no reason for investors to be unsettled.
Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.
The information provided is not to be treated as specific advice. It has no regard for the specific investment objectives, financial situation or needs of any specific person or entity.
The information contained herein is based on materials and sources that we believe to be reliable, however, Canaccord Genuity Wealth Management makes no representation or warranty, either expressed or implied, in relation to the accuracy, completeness or reliability of the information contained herein. All opinions and estimates included in this document are subject to change without notice and Canaccord Genuity Wealth Management is under no obligation to update the information contained herein.
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IMPORTANT: Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.