Investors should prepare for a continuation of the past 12 months’ “rollercoaster” ride in equity markets, according to Royal London’s Trevor Greetham, who has been reducing his allocation to risk assets as a result.
Equities, having delivered stellar gains over the previous five or so years, have been all over the place recently as macroeconomic headwinds have intensified.
FE data shows, for example, that the MSCI AC World index has lost 2.53 per cent over 12 months. While that isn’t too big a fall, those figures mask a huge amount of volatility and some severe drawdowns such as during August’s ‘Black Monday’ and the tumultuous start to 2016.
Performance of index over 1yr
Source: FE Analytics
There have been three major drivers behind the volatility over the past year – China’s growth slowdown and currency devaluation, falling energy prices and uncertainty over future US monetary policy – and they have all dissipated over the past month and half, coinciding in a strong relief rally for risk assets. 
However, Greetham – head of multi asset at Royal London – is more cautious than he has been for some time now, having made a number of very bullish arguments over the past few months.
Indeed, in his latest update, the former Fidelity manager says he has been “lightening up” his weighting to global equities – which have made 13 per cent since mid-February – as he fears the huge swings in markets may continue for a while yet.
“In total, we think there are two clear scenarios we need to be prepared for this year,” Greetham (pictured) said.
“One is the continuation of what you might call the rollercoaster of the last 12 months, with growth improving up until the point that the US feels comfortable enough to raise interest rates – and then China devaluing its currency and trying to steal some of that growth back from America, leading to the stock markets collapsing.”
“We’ve seen that twice: once last summer and once early this year. What makes us concerned that that might happen again is dollar strength and weakness out of China. That combination is going to raise risks that China devalues and we see another set-back.”
Relative performance of currencies over 1yr
Source: FE Analytics
“We were buying equities in January and February in the funds, but we have been lightening up our exposure over the last few weeks just in case we see that scenario.”
This is hardly in keeping with some of Greetham’s most recent outlooks. He argued in August, for example, that one of the strongest contrarian buying opportunities on record had opened up.
Nevertheless, Greetham is certainly not alone in his more cautious view on equities.
In their latest outlook, PIMCO’s Joachim Fels and Andrew Balls say that though investors are wrong to expect a recession in the global economy, risk-assets will struggle to make any real headway over the medium term and are highly sensitive to the downside.
“While we do not expect a recession in the US or the global economy over the cyclical horizon and think that financial markets have been over-anticipating recession risk, there are a number of key uncertainties and challenges that call for conservative portfolio positioning,” Fels and Balls said.
“Market valuations generally look fair to full, but there are still pockets of value following the recent bout of market volatility. Valuations should be underpinned by central banks, but at the same time there are valid questions about the declining effectiveness of their interventions.”
“We continue to expect bouts of volatility, reflecting reduced market liquidity, some crowded positions and in turn a tendency for markets to overreact to relatively minor changes in fundamentals.”
“Growing political risks across jurisdictions reinforce an outlook in which historical correlations and relations will be challenged.”
However, this is not to say Greetham has made his portfolios highly defensive.
His £41m Royal London Cautious Managed fund, for example, is still overweight equities relative to its benchmark.
Indeed, Greetham – who has comfortably outperformed his peer group composite over the past 10 years – says there is another scenario which could play out in financial markets in 2016 which is far more positive.
Performance of Greetham versus peer group composite
Source: FE Analytics
“We are starting to see signs, though, of something a bit more optimistic,” Greetham said.
“Manufacturing survey data, especially in America, is starting to improve. The dollar isn’t that strong. There is the possibility here that the world economy will be stronger in 2016 because of the low energy prices and the cheap money the world has seen.”
“That would be very positive for equities. Again, we are very much focused on Europe and Japan because that is where central banks are easing policy the most. There is a good chance here that we don’t see a continuation of the rollercoaster and we see some good returns for equity investors.”
In addition, Miton’s Anthony Rayner has become more bullish on equities over recent months having previously warned about the uncertain backdrop for risk assets.
“Markets are certainly in a much happier place than they were for the first six weeks of the year. Furthermore, underlying economies should benefit from easier financial market conditions (such as tighter US high yield spreads), with history showing that extended periods of tight financial market conditions have frequently been followed by recession,” Rayner said.
“So, short term pressures have eased. That said, we remain blighted with the same two questions that have been haunting markets since the Great Financial Recession: is growth sustainable and, if not, what can policy makers do? So long as the answer to the first question is in the negative, the confidence trick that is central banking gets ever more stretched and capital gets further misallocated.”
“However, we are pragmatists, not philosophers and while it’s impossible to know where markets will go from here, we’ll be paying close attention to the following areas, as they are likely to play an important role in broader asset class performance.”
