We expected 2016 to be another challenging year for investors, with higher market volatility and lower returns, and we have certainly seen that in these first few months. Markets have been rocked by global growth fears and dramatic swings in oil prices, plus an outbreak of concern about the waning potency of central banks.
However, the net result of all this drama for investors that simply held on to a standard 50/50 portfolio of bonds and equities has not been dramatic at all. Such a portfolio would be showing a total return of just over 2 per cent year to date. It is quite possible the rest of the year will deliver more of the same, with much ado in markets leading to not very much in either direction for a broadly balanced portfolio. But the world has changed since January – even if portfolios have not – and so has the focus of investors’ attention.
While it was previously manufacturing weakness causing concern, now it is the recent softening in services and consumer spending that worries investors.
Central banks came to the rescue yet again in the first quarter, with European Central Bank action helping to push down interest rates right across the curve and reassuring markets they had not run out of firepower.
But there is no getting around the fact forecasters in the developed world are yet again revising down their growth predictions for the year, despite more than six years of extraordinary monetary stimulus.
To be clear, we do not think a recession is imminent on either side of the Atlantic. However, clearly the risk is higher than it was a year or so ago and we will be monitoring the consumer side of the economy closely for signs the recent weakening in activity does not turn into anything worse.
Both policymakers and investors may have to accept there are deeper issues holding back global growth and investment at the moment, which central banks alone cannot fix.
The other big change for investors since the gloomy days of January is we have seen three of the key market trends of the past 18 months – a strong dollar, falling commodity prices and serial poor performance by emerging markets – all go into reverse.
It is too soon to say whether this will last. Emerging markets still have work to do improving their economic fundamentals and the dollar could strengthen again later in the year if investors revise up their expectations for rate increases in the US. But for active investors, it is probably a risky time to be underweight emerging markets.
With growth worries still lingering on both sides of the Atlantic and the corporate earnings picture still subdued, we also believe the trade-off between risk and reward is much less attractive now than in earlier stages of the cycle – at least for equities.
The case for riskier parts of the fixed income market looks stronger, given many of these bonds are now priced for a recession we do not think is imminent. Overall, however, it probably makes sense for investors to have a more balanced portfolio than in earlier stages of the bull market and to lower their expectations for overall returns.
What is keeping us up at night? Well, the risks we worry most about on a three-to six-month timeframe are as follows: further weakening in service sector activity in the US and Europe, bond market turbulence around changing US inflation and interest rate expectations, and political risks around Brexit.
On balance, we would still hope to see a majority vote in favour of remaining in the European Union on 23 June but the odds of a “no” vote have shortened in the first part of the campaign and investors need to take the possibility very seriously.
The pound has felt the brunt of Brexit fears so far. We would expect further downward pressure on sterling and slower growth in the medium term if the UK did vote to leave. But for long-term investors, it is the microeconomic impact on companies and sectors that will need most watching.
Stephanie Flanders is chief market strategist for Europe at JP Morgan Asset Management