It is rare that the macro environment gives a clear steer as to how asset classes will behave over the medium term. This is particularly the case at present and that’s before we even consider the tensions between the US and North Korea.
Broadly, global GDP growth looks to be supportive of a positive macro environment in 2017 and 2018, although the strength that the lead indicators were suggesting a while back is not really coming through and therefore inflationary pressures are pretty benign in most regions.
Daily economic data updates are not helping to clarify the picture but are influencing the thoughts and action, or lack of action, of central bankers. Interest rates across the world are typically not going up very far or very fast and additional tightening of monetary policy is slipping down the agenda.
So we have two key scenarios. Firstly that economic growth will improve as a result of loose monetary policy and secondly that growth will slow and monetary policy could be loosened further. Whatever happens, it seems likely that government and central bank policy will be supportive of the economy, as it has been since 2008, and that the fragile growth will not be put at risk.
Asset prices are likely to discount likely outcomes and at present the lack of clarity is being reflected between and within asset classes. After a bull run that started in the early 1980s, bond markets reacted to rising interest rates in the US at the end of last year, but have subsequently made back most of the losses.
The macro picture does not suggest that the bond bubble is about to burst just yet, but mainstream bond prices remain very much at risk to an inflation or interest rate surprise. We do not believe they offer sufficient value to justify much exposure given the risk. Although if safe haven assets are in demand, bonds will attract money along with similar assets and probably gold.
Equities overall do not look cheap and in some areas quite expensive. But within markets there is significant dispersion of valuation and growth prospects. Bond-like equities are typically expensive and offer little growth, while more cyclically orientated companies offer value and better prospects in the current macro environment. We can find more interesting opportunities and attractive valuations in equity markets and therefore equities remain our more favoured asset class on a medium term outlook.
Looking at other asset classes we can see attractions in commercial property, a case that is supported by the economic backdrop across Europe. Commodities have performed well, partly as a result of Chinese demand and supply side discipline. Both of these factors are hard to predict and unreliable, so we tend to steer clear of investments exposed to commodities unless valuations are compelling.
Currency markets have been volatile and have taken a lot of the strain of the big macro and political events that have occurred over the past two years and this trend is likely to continue.
Whatever happens it does seem likely that the generally very low volatility in assets classes will be unsustainable, but that has been a popular call for some time now. Therefore, alternative investments or assets that are lowly or negatively correlated with traditional asset classes such as bond and equities have many attractions.
Finally, given the uncertain outlook, we are firmly of the view that active management is a vital part of steering a path through high investment valuations and the disparity within asset classes.
Neil Birrell is manager of the Premier Diversified and Diversified Income funds