A bear market is unlikely to emerge with the global economy in an expansion stage, according to Rathbones chief investment officer Julian Chillingworth (pictured), although he remains cautious on the outlook for the UK economy.
Chillingworth said the firm was fully-invested although it remained cautious, despite a broadly positive outlook for the global economy.
“We are not currently predicting a bear market nor are we likely to see one coming any time soon," he explained.
“It’s fair to say that we are not positioned at all for a bear market… it is not 1987 and the outcome is not likely to be one where we are seeing a recession anytime soon in the global economy and - particularly – [we’re] not forecasting a recession in either the USA or China in the next 12 months.
“Our overview from research we have done is that we are very much in expansion mode and that recovery phase has probably passed.
“We believe where we stand today in terms of the economy globally is one that is moving forward and we should be confident about the global economy in the near term.”
Chillingworth added: “We think that equities will continue to prosper through the next 12 to 18 months and – although we remain defensive in terms of overall sentiment – we think that risk assets will do reasonably well and it is not a time to be pulling back from these particular areas.”
However, asset allocation strategist Edward Smith said the firm was more cautious on UK-focused parts of the investment universe.
The snap general election held at the start of June meant the governing Conservative party lost its majority, raising concerns over the UK economy.
Smith said that there was “very little evidence” that general elections have an impact on the wider business cycle or economic uncertainty.
“Do general elections really matter to the economy?” he asked. “Historically, the answer is ‘categorically no’.”
He added: “An election, even one where there is a minority government, doesn’t tend to matter, but of course this time there was far more at risk and that was of course Brexit.”
While Rathbones’ own measure of economic uncertainty had fallen since the referendum, said Smith, the commencement of Brexit negotiations could create a more challenging environment.
Smith said market-implied equity risk premium for the FTSE 250 index – which has a stronger UK focus than the FTSE 100 – had a very close relationship with its own uncertainty index.
“Equity risk premium is the compensation you demand to accept risk to future companies’ earnings,” he said. “It’s the discount rate that investors assign to turn tomorrow’s earnings into today’s price.”
However, as the chart above shows there has been some divergence between the two measures more recently.
“FTSE 250 equity risk premium is still reasonably high, [although] it has been a lot higher,” he said. “There is a bit of a cushion for political uncertainty to increase… but we are cautious we’re still quite a long way below previous episodes of uncertainty. And that makes us slightly nervous.”
Smith said the firm favoured large-cap stocks over the small- and mid-cap sector in the UK, and noted that the equity risk premium has indeed diverged.
“Investors are applying a much more punitive rate to FTSE 100 earnings than they are FTSE 250 earnings a very unusual statement especially to the extent that gap has opened up,” he said. “We don’t think that is right given the global macro backdrop.”
Smith also highlighted the performance of sterling, which is also sensitive to political uncertainty, noting last year’s fall following the referendum result.
He said sterling was extremely undervalued against the US dollar and most currencies in the developed world. However, he said there was long-term fundamental support for the currency.
Following the snap election, Smith said the Conservative party could ease back on the austerity policies it has pursued in the past, which he said could prompt the firm to upgrade its outlook for the UK economy and could see sterling strengthen.
However, there are other challenges for the UK economy. Chillingworth said that inflation and the fall in sterling is likely to impact the household consumption-led economic growth.
“It’s not just where inflation sits in terms of maybe 3 per cent this year, but whether people think that inflation rate is accelerating or decelerating,” he said.
Chillingworth said wage growth was not enough to offset inflation levels, while the household savings ratio had dropped. Other components of the economy were not expected to help the economy and that, without some fiscal support, UK GDP is likely to fall short of expectations.
“I think we’re now entering period of uncertainty 12 months on from the first Brexit vote, and we’re seeing that shock is a drag on the economy was we go into the second half of the year,” he said.
“Our only suggestion is that the UK economy will slow a little in the second half not disastrously; we will have growth, but it will be at a slower rate.
“We therefore have to adjust forecasts accordingly and when making investments in the stock market in the UK, we have to look at companies that are growing and that is much more in the FTSE 100 than in the FTSE 250 and [those] much more with international bias than domestic bias.”