Despite the unexpected result of a hung parliament in the UK’s snap election, markets displayed a remarkable stiff upper lip. Even sterling barely budged.
Much now depends on the path towards Brexit, which has clear power to affect returns through its impact on the pound, as witnessed in the aftermath of the referendum a year ago.
If the Government muddles through the negotiations, we would expect to see bouts of sterling weakness, followed by periods of recovery. In contrast, a deal equivalent to full single market membership would probably result in a strengthening of the currency. While this would be positive for commercial property, a strong pound would be a headwind for UK equities, given their high degree of overseas earnings.
A third and more remote possibility would be a no confidence vote, followed by a Labour-led government. Economic uncertainty would probably see sterling weaken in such a scenario. So it is up, down or sideways.
As the last year has amply demonstrated, it is impossible for investors to get every call on politics right. But it is important for investors to keep calm and carry on, and allocate to a wide range of asset classes whose different characteristics mean they are likely to perform well in a range of environments.
Playing the “investment clock”
Keeping calm also applies on a global scale. We have witnessed a long bull market in stocks and volatility has fallen to its lowest level in about 10 years. We expect the positive trend in stocks to continue as long as unemployment rates are dropping around the world, as this indicates a robust economic backdrop.
The question is: how low can they go? Once US unemployment levels fall too low, wages start to rise, the Federal Reserve increases interest rates and, more often than not, the business expansion and bull market come to an end.
At the moment, though, wage inflation remains muted and we do not see a danger of central banks risking recession in order to create slack in labour markets. Moreover, there are signs the pressure to raise interest rates is likely to wane.
We track a broad range of economic indicators in order to tell the time on the “investment clock” business cycle model that informs our asset allocation decisions. For the last year, the clock has been in “overheat” – an environment where stocks and commodities tend to perform well and central banks start to raise interest rates.
However, a weakening in growth and inflation indicators is moving it rapidly towards bond-friendly “reflation”. Business confidence is coming off the boil in the US and China, and commodity prices are weak.
Central banks have recently adopted more hawkish tones but it is not certain this will translate into monetary policy tightening, and we see the potential for fixed income to rally in the second half of the year.
Signs of slower global growth could spell trouble for stocks as the summer progresses but, given our sanguine longer-term view on inflation, we would view dips as a buying opportunity.
We have taken the sharp edges off our tactical positions in order to make room to buy stockmarket dips. We are overweight equities but only moderately so. While longer-term fundamentals look positive, we see reasons for concern over the next six months.
We have raised exposure to global high yield in recent months on the basis we expect volatility to remain relatively low and the business expansion to last at least another year or two.
We remain underweight government bonds but have lessened this position as growth lead indicators rolled over. It is not like us to be neutral for long but, when the future is unclear, sometimes that is the best policy.
Trevor Greetham is head of multi asset at Royal London Asset Management