Please see below an article from Tatton Investment Management regarding their recent portfolio adjustment – received 08/07/2020.
Portfolio strategy
As we head into the second half of 2020, we are making some changes to portfolios.
Since April, we have held a small overweight to equities within the portfolios, focused on emerging markets, mainly as a consequence of a positive view on the economic outlook for China. Its weighting within the MSCI EM equity index, and its economic influence, made the position attractive. Within the equity component, we also moved our UK exposure to underweight.
The equity overweight was balanced by an underweight allocation to bonds. Within bonds, we maintained the overweight to non-UK inflation-linked government debt, a position we have held since October 2019.
Our overweight to equities has benefited all portfolios, meaning that the proportional exposure to equities has increased overall.
We remain positive on the medium-term outlook, wishing to retain the overall appetite for risk, but we are now shifting our focus from emerging markets towards Europe. Throughout the coronavirus crisis, the European Union (EU) has proffered surprisingly strong and supportive economic policies, which contrast heavily with China’s reluctance to fuel liquidity. Europe has also led the way in reopening its respective economies while managing to avoid a rebound in infection rates. Additionally, political risks are falling in Europe and rising in emerging markets and especially China. We remain underweight in the UK and have a neutral weighting in the US, Japan, and developed Asia.
Our bond weightings remain as before: weighted towards higher-grade bond issuers and bonds with inflation protection
How have recent events shaped our thinking?
From February to June, the global economy went through the fastest and deepest recession in history. In the midst of this, a disagreement over strategy between oil-producing countries caused energy supply to be increased just as demand was plummeting. Risk assets, including equities and corporate and emerging market debt, came under heavy selling pressure, with equity markets bottoming on 23 March. The US oil spot price remained under pressure, leading to an extraordinary ‘oil price shock’ on 20 April, when some oil futures traders were stuck with contracts and no storage space available – meaning they had to pay counterparties to take the oil off their hands.
It was clear early on that the spread of the COVID-19 virus would create huge disruption, with very little near-term visibility and with countries experiencing different challenges in getting their economies back ‘open’. However, governments and central banks across the world pledged their support at each point it was needed.
In April, we felt China had dealt with the virus well enough to be in a recovery path ahead of other regions. Its domestic situation was likely to be positive, with strong fiscal and some monetary support. While exports would likely be curtailed by lockdowns elsewhere and continuing political pressure from the US especially, we felt it would provide reasonable demand for other Asian countries and for the wider commodity producers. In terms of the virus impact on emerging nations, we felt that it be difficult for their domestic situations but would probably not greatly affect output.
For Europe, the virus had meant significant lockdowns but also strong monetary support. However, the barriers to effective mutual fiscal support remained high, while it was not clear how long it would take to bring the disease under control.
The same seemed the case for the US, where Federal Reserve Chair Jerome Powell had put in place extraordinary asset purchases, buying unprecedented amounts of US Treasuries well in excess of near-term requirements, and extending this ‘quantitative easing’ into corporate bonds. Meanwhile, Congress gave bipartisan support to large unemployment payments, employment support and, in conjunction with the Fed, providing loan support to businesses.
The UK enacted similar support measures, although economic weakness over the past two years left it marginally less able to sustain long-term support, especially given the process of leaving the EU was still incomplete. We felt this would limit the ability of UK markets to outperform and that sterling would be likely to decline should risks worsen.
Risk markets rebounded in the second quarter, with portfolios recouping much of the losses sustained during the February and March falls. Emerging markets performed well, with China’s economic rebound providing the economic stability we expected.
Government bond markets, having been strong in the first quarter, remained stable. The high level of fiscal deficits created new issuance. Both government and corporate bonds benefitted generally from central bank purchases.
What is the near-term outlook?
As well as claiming the lives of thousands, the coronavirus has altered our day-to-day existence. Without a vaccine, it still poses a threat. Where the disease remains active, life cannot return to normal. China has shown that localised lockdowns can reduce infection rates substantially which, in turn, can allow most people to return to some form of work. However, social distancing rules remain in place, and personal choices about levels of contact mean that life is fundamentally different.
Economic activity is rebounding, helped by relief payments to companies and individuals. In the US, private sector incomes have risen sharply. The effective savings will support activity in the coming months. However, the fall in expenditure still places businesses in a precarious position. Filings for bankruptcy have risen to levels exceeding those of the financial crisis a decade ago.
Monetary policy initiatives have kept liquidity more than adequate and risk asset prices have regained much ground. In the case of the US Nasdaq composite index, prices have even hit new highs. Financial markets have functioned, but the fuel of available economic activity is thinly spread – meaning that current yields – and expected returns – are historically low.
Fiscal support has been more than adequate for this half-year, but more may well be needed through the course of the rest of this year and next. Europe has received a boost in the form of a joint French-German initiative to allow some mutualised debt issuance. Germany has also led the country-specific push for government spending, reversing frugality of previous years.
China’s domestic policies remain fiscally easy, although with less monetary infusion than other developed nations, with the People’s Bank of China still worried about excessive real estate valuations. However, the growing discord between China and the US, and the imposition of draconian new laws in Hong Kong, presents a significant impediment to markets making progress.
Although many aspects remain positive for emerging markets, China’s rising political risks will remain a concern throughout the region, while benefits from its earlier virus actions start to dissipate.
The US outlook remains positive, although risks are still elevated. The Federal Reserve policy framework can continue with significant liquidity injections, but its pace of increase has slowed. As the presidential election approaches, Donald Trump’s appeal to voters has fallen. Joe Biden, the likely Democratic nominee, may well be viewed as less business-friendly, but this is offset by the greater sense of global stability that a Democratic victory offers. Current electoral dynamics are not visibly impacting markets, which are more focused on Congress providing renewed household payments after July, and ahead of businesses being able to resume hiring.
The UK has had the most difficult economic environment of any of the developed nations and a return to normality is proving slow. London has been particularly hard hit, although the financial centre has appeared to function remarkably well given how few people are physically in the City. The Johnson government has announced ambitions for longer-term investment. Much will be needed especially if European trade negotiations are bumpy. The UK remains a concern, with sterling weakness the most likely outcome should risks become reality.
Globally, the most positive improvement has been in Europe’s policy backdrop. In addition to the fiscal stimulus mentioned earlier, the European Central Bank has made substantial injections using a number of tools. The German Constitutional Court’s ruling (that the ECB’s 2015 bond purchases were possibly improper) may yet present problems. However, a sense of discord among EU nations has been quelled – by Chancellor Merkel and other EU leaders – for the time being at least. After experiencing an awful February and March, resilient healthcare systems (particularly in Germany and France) have helped Europe to begin opening up with less personal risk-aversion than in the US, the UK and, to some extent, Asia. All of these factors make us more positive on Eurozone equities and the euro itself.
Portfolio positioning and changes
- Given our change in focus, most portfolio activity centres on moving from emerging market equities into European equities.
- A small reduction in cash has been deployed in various regions to balance portfolio exposures.
- Ethical portfolios reflect this change in positioning through a reduction in emerging markets managers, redeployed in global equity funds.
- Income portfolios have been rebalanced, with increased equity weights allocated to existing global equity managers.
- We have not made any fund manager changes to the portfolios in this rebalance.
As you can see from the above, Tatton look to remain positive and wish to retain the overall appetite for risk but are now shifting their focus. As Tatton move their focus from emerging markets equities towards European equities it will be interesting to see what effect this has on their portfolio’s.
Please keep checking back for regular up to date blog posts.
Charlotte Ennis
09/07/2020
