Challenges surrounding ongoing Brexit negotiations are likely to weigh on sterling and UK equities, according to Fidelity International’s Nick Peters and Kevin O’Nolan (pictured), who also warn risk assets across the board may struggle this year. 
This is despite robust economic data, which puts global growth and inflation indicators at multi-year highs.
While the duo is cautious on bonds, equities and some currencies, however, they are still finding opportunities through futures and long-term market themes that will remain intact irrespective of the macroeconomic backdrop.
“This kind of environment would typically see central banks start to tighten monetary policy, and therefore it’s quite interesting that they haven’t done so to any great degree so far this cycle,” O’Nolan noted.
“That might start to change, with the Fed starting to accelerate its tightening path. The ECB has also opened the door to raising its deposit rate at some point in the next year or so.
“That combination is clearly very negative for bonds and it remains my largest asset class underweight position.
“The outlook for equities is less clear. The strong growth picture is a positive but, during tightening cycles, multiples don’t tend to expand and that means equities are very reliant on earnings coming through.”
A squeeze in real earnings growth has been a particular concern for UK investors, given yesterday’s announcement that consumer price inflation came in at 2.3 per cent for February. In contrast, average wages in the three months to January only rose by 2.2 per cent, which would mean average wage growth declined last month unless wages surprised to the upside.
Peters says earnings growth should be a key theme for multi-asset investors this year and warns that, on a broader, global basis, this could be weaker than expected throughout 2017.
“I’m slightly concerned we won’t see the strength in earnings growth that the markets are anticipating, so I have reduced my equity exposure recently,” he explained.
“I think valuations – certainly in the US – look quite high and if the earnings growth doesn’t come through then I think we probably will see the markets at least treading water if we don’t see some weakness.
Performance of index over 10yrs
Source: FE Analytics
“In particular, I’m worried about the margins we are seeing, wage pressures coming through and, in a low-growth environment, I do wonder whether companies are going to be able to pass on those rises and therefore protect margins.
“With that in mind, I just think it’s sensible to take a bit of risk off the table.”
In the UK, the managers warn that there are numerous ‘known unknowns’ when it comes to Brexit.
O’Nolan remains cautious on the home market and says focus is already shifting to the ‘divorce’ negotiations and how much the UK will have to pay to leave the EU.
“My concern is that both sides are quite far apart; the EU is expecting a pretty significant payment whereas the UK is expecting almost nothing or in fact to gain something from it,” he explained.
“I think that is setting things up for quite a difficult negotiation. I think it is going to be quite problematic and the currency is likely to trade on political headlines.
“At the same time, we’ve had two new developments which are quite negative. Firstly, quite senior government members have been introducing the idea that it wouldn’t be so bad if we didn’t have a trade deal with the EU at all. I think that’s a bad development for the currency.
“In addition, we’ve had some softness finally coming through in the data. This combination means I remain negative and I am particularly playing that versus European currency, so the Swedish krona and the Swiss franc.”
Performance of currencies vs US dollar over 1yr
Source: FE Analytics
O’Nolan and Peters aren’t the only multi-asset managers reducing risk in their portfolios at the moment. In an article published earlier this month, Artemis’s William Littlewood warned that the global economy is in danger of “slipping back to the 1970s”, a period burdened with stagflation and recession.
“There will be a recession again in the developed world. Although Trump seems to have lifted animal spirits, possibly deferring the timing of the next recession, the last one was nine years ago and these events are cyclical and unavoidable,” he said.
However, Peters points out that multi-asset investors are at a greater advantage when it comes to navigating tricky market conditions, given there are different drivers for the returns of different asset classes.
“Generally, I have reduced risk particularly in equities, but there are still plenty of opportunities that should perform well and generate positive returns irrespective of market direction,” he said.
“We have exposure to social infrastructure and aircraft leasing, where really the behaviour of those vehicles is not dependent upon markets and economic growth.
“We can also use futures to play areas that we do like against areas that we don’t. For example, at the moment I have a position where I am long healthcare which looks relatively cheap compared to other areas, with a short in consumer staples, another defensive sector [that] I think is well-loved by the market and has a strong relationship to bond yields. If bond yields continue to move up, I think staples are going to struggle.
“As I say, there are different, uncorrelated opportunities out there and multi-asset funds can take advantage of those.”