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RLAM’s Trevor Greetham: Why the economy is in the early stages of ‘overheating’

22 March 2017

The manager, who is head of multi-asset at Royal London Asset Management, uses the Investment Clock model to explain his current asset class positioning.

By Lauren Mason,

Senior reporter, FE Trustnet

Global growth is stronger and inflation is picking up, yet the US Federal Reserve looks set to be the “loan hiker” when it comes to rate rises this year, according to RLAM’s Trevor Greetham (pictured).

The manager, who is head of multi-asset at the firm, says we are therefore in the early ‘overheating’ phase of the Investment Clock model, which typically means equities and commodities will fare well while bonds will struggle.

However, given his belief that the US will raise rates several times this year, he says there could be intermittent spells of underperformance from commodities as the dollar strengthens.

“The multi-asset funds we manage remain overweight equities and, to a lesser extent, overweight commodities and underweight government bonds,” Greetham said.

“The three themes we have been monitoring in terms of tactical asset allocation remain solid: there’s a global growth recovery going on, only America looks likely to raise rates, but we have a lot of political risk to contend with. So far, equity markets have taken all of this positively.”

When making tactical allocation decisions, the manager uses the Investment Clock to decipher which areas of the market are set to thrive or buckle under cycle-related pressures, as shown below.

 

Source: Royal London Asset Management

Given that inflation is creeping up and growth forecasts continue to be revised upwards, he says we have moved from a ‘recovery’ phase to the start of an ‘overheat’ phase, which under normal circumstances would mean commodities are in a sweet spot and equities – while still strong – start to lose their shine.

However, he believes equities still look appealing and are currently his preferred asset class, while commodities remain at a modest overweight across the portfolios.

“Thinking about global growth, we’re seeing quite a big pick-up in business surveys all around the world. Since Trump won the US election last November business confidence has surged, perhaps on the back of expectations of corporate tax cuts, but we’ve also seen improvement in China, Europe and even in the UK,” Greetham noted.

“Global growth is getting stronger and inflation is picking up, which puts us at the ‘overheat’ phase of the investment clock model that guides our asset allocation, and typically that’s when commodities do well and bonds do badly.


“We think this is an early overheating, meaning that growth is strong and inflation is rising while the banks are keeping rates relatively low. As a result, we still favour equities.”

While he believes the US will raise rates a number of times this year, he says this is unlikely to happen elsewhere, given that the European Central Bank, the Bank of England and the Bank of Japan are all still printing money.

“That will cause bouts of dollar strength, so our ‘loan hiker’ scenario is where America is raising interest rates when nobody else is. When the dollar is strong, you tend to find that commodities don’t perhaps do as well as they might otherwise do, and Japanese equities do very well at perhaps the cost of emerging markets,” he explained.

Performance currency vs index over 10yrs

 

Source: FE Analytics

Another theme Greetham is focusing on this year is heightened political risk across the globe and, chiefly, in Europe. This has been a hot topic of debate recently, given last year’s shock ‘leave’ vote in the UK’s EU referendum and the election of controversial Republican candidate Donald Trump as US president.

Now, many industry professionals believe it is wise to expect the unexpected. In an article published last week, SYZ Asset Management’s Hartwig Kos told FE Trustnet that investors shouldn’t be too complacent about surprise election results in France, given the geopolitical shift seen towards populist parties in a bid for change.

“In terms of how we are approaching things now, we are quite cautious,” he said. “We fear that the market underestimates the potential of [French presidential candidate] Le Pen actually gaining power so we have been positioning ourselves reasonably defensively, with low allocation to duration and relatively little allocation to equities.”

Greetham agrees this needs to be closely monitored, in addition to the fact Brexit negotiations are ongoing, with Article 50 set to be triggered on 29 March.

“We’re thinking Brexit, but also thinking of a range of elections in Europe – the Dutch elections, the French elections, the German elections, possibly new Italian elections. We also have the political risk coming out of the Donald Trump administration in America,” he said.


“Really, the markets are climbing a wall of worry here. there’s all sorts of reasons not to buy equities but, because the funding is so strong, earnings have been upgraded and the markets keep rising.

Performance of indices in 2017

 

Source: FE Analytics

“We do think we will see some wobbles this year due to political risk but, at the moment, it looks like these will be buying opportunities rather than reasons to move out of equities.”

Over the longer term, the manager says there are a wide variety of different potential outcomes given we are so near the start of the ‘overheat’ phase within the Investment Clock model.

He says that, if growth continues to strengthen and inflation keeps rising, interest rates will inevitably begin rising elsewhere across the globe.

As such, he is most nervous on fixed income as an asset class. That said, he also says the impact of higher interest rates on equities should also be considered for those with very long-term time horizons.

“For the time being, I think we’d stick with our current strategy,” Greetham said. “On the other hand, growth could suddenly weaken.

“We have no signs of that at the moment but, if it were to happen, we would move back towards fixed income exposure.

“So summing up, global growth is recovering, the political risk is strong, but the multi-asset funds remain overweight in equities.”

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