Some action - upping stocks

Market report

1. Stagflation remained at the centre of the market debate, as commodity markets remained well supported
2. Bond yield curves (plots of various bond yields across maturities) flattened a little, with investors pulling forward interest rate lift-off in the US
3. Stock markets continued to bounce back, with the start of earnings season so far providing further salve to recently bruised sentiment

CIO view

Our Tactical Asset Allocation specialists decided to turn a little more positive on developed world stocks this week and, separately, soured slightly on emerging market local currency debt. With regards to the former, our in-house investor sentiment indicator has been at levels consistent with equities being treated a little too guilty until proven innocent.

There are certainly plenty of challenges in the path ahead for the world economy. Growth is slowing, the inflation spike is stickier, the pandemic is potentially far from over and a few of the major central banks have slightly itchier trigger fingers than was only recently argued. Nonetheless, the all-important US economy is still on course for the fastest calendar growth rate since 1983.[i] Indicators for prospective demand around the world, including that much discussed excess savings hoard accumulated by the developed world’s consumers (amounting to around 10% of advanced economies’ GDP), suggest the stagflation fears remain misplaced for now. Meanwhile, historically low interest rates have certainly been an important part of the attraction of equities for some time now. Future corporate cash flows are worth more to us today in such a context. However, there is some distance for interest rates to rise before they begin to really get in the way of that perspective, even if they already seem to be shuffling the deck of what looks attractive or not beneath the surface of the aggregate stock market indices.

The team’s position on emerging market local currency debt hinges more on the accompanying exposure to emerging market currencies. It is the foreign exchange that tends to dominate short-term returns from the asset class. The normalisation of spending patterns plays out around the world, with services consumption unevenly freed from the shackles of the pandemic, combined with diminishing developed world fiscal stimulus, is likely to see emerging market export volumes moderate. This is one of the short-term headwinds for the emerging market local currency debt world that have persuaded the team to express a little more related caution in our funds and portfolios. There are more scenarios now where this asset class is a hindrance rather than a help to performance on a three to six-month view at the moment. The reverse is the case with developed world equities as described above.

The important thing to remember here is that these are tilts at the edges of our multi-asset class funds and portfolios. The overall activity of tactical asset allocation, much like our manager selection efforts, is aimed at adding tens of basis points to the performance of the strategic asset allocation each year. The compounded returns to the skills of these in-house specialists is extremely valuable in our view. As we’ve pointed out before, that is particularly the case where the outlook for the returns to diversified access to the global markets is a little dimmer than it has been in the recent (stellar) past. High profit margins and valuations and record low interest rates are certainly an inauspicious starting point, even if there remain a variety of outcomes around those necessarily more modest, albeit inflation-beating, expectations. For this year, that strategic asset allocation (the tool we deploy to collect that return to diversified global markets) has been well positioned for this year as it goes, with the sizeable additions to the diversified commodities complex across risk profiles very helpful in year when the world has returned to worrying about scarcity and under-investment.??

[i] https://www.federalreserve.gov/newsevents/speech/clarida20211012a.htm

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