The ease with which investors have been able to make money over the past year-and-a-half may have made them complacent ahead of a more challenging outlook for markets, according to Tom Becket, chief investment officer at Psigma.
Since the start of 2016, equity and bond investors have had a relatively easy ride, with both asset classes offering high returns.
Indeed, as the below chart shows, the Barclays Global Aggregates index is up by 21.08 per cent over the period while the MSCI World has gained 35.83 per cent – both in sterling terms.
Performance of indices since January 2016
Source: FE Analytics
“It’s been pretty difficult once again not to make money in 2017 – and I’m pleased to say that we have made positive returns on behalf of our clients,” Becket said. “But I think lots of our clients are asking how that has been the case.”
He said that despite a number of unexpected events during the 18-month period, balanced portfolios have made a return of around 15 to 20 per cent.
“If you rewind 15 months in February 2016 we had a massive amount of issues that people around the world had been getting very worried about,” the CIO said.
The first was that there were fears Chinese growth could stall, with potential currency manipulation the year before also hanging over the country.
“[Additionally] if you remember, Standard Chartered’s commodity analyst came out and said the oil price which was then trading at $25 could go all the way down to $10 – of course that never happened it went straight back up to $50.
“And of course people were worried about the European banking system in particular Deutsche Bank collapsing.
“So, if you look back to what was happening in the first quarter of 2016 and then you fast forward it 15 months to where we are now, I think you would have been amazed to work out that portfolios and asset markets around the world have done as well as they have.”
He added that the UK’s decision to leave the EU following a referendum, president Trump winning the election in the US and a ‘no’ vote in the Italian election were also potential stumbling blocks.
“It was a non-sequitur that risk assets have done so well in the last 18 months. I think the general message from clients is one of pleasure, but one of confusion.” Becket said.
“I think to dice through that confusion and make things very simple – actually the world back then was quite an easy place to be invested.
“There was obviously lots of panic but global growth was okay, central banks around the world were doing everything they could do to help asset prices, corporate profits were okay.”
He said the key explanation as to why portfolios have performed so well over the last 18 months has been due to asset market valuations and sentiment.
“Back then market valuations were cheap and sentiment was poor,” Becket (pictured) said.
However, this is one of the important factors that has changed over the last 18 months and is among the reasons the CIO has become more cautious.
“As we fast forward 18 months, a lot of the inputs that we had back [at the start of 2016] have switched but, in particular, sentiment has gone from being very negative to actually everyone being quite complacent and embracing risk,” he said.
Becket said this is most significantly due to the actions of central bankers over the last 18 months which have included very aggressive measures of quantitative easing but stress that he has no concerns over the global economy.
“Our view going forward is that the global economy will be dull not disastrous,” the CIO said.
“Our concerns are not from an economic standpoint, we actually think that the global economy is going to be very similar to how it has been for the last five years.”
As mentioned, his main concern is the central bank policies that have dominated markets globally since the financial crisis in 2008.
He said ever-low interest rate policies have “forced some very bad capital allocation decisions on retail clients and institutional investors and frankly anyone trying to avoid zero interest rate policy which is still affecting cash positions”.
But recent comments from Federal Reserve chair Janet Yellen suggest that this period of support from central banks could be coming to an end.
“The comments that we’ve heard from Janet Yellen and the Federal Reserve over the last few months strike us as being somewhat of a non-sequitur,” he said.
“Really what you are seeing is despite no real change in the economic scenario or the inflation scenario, Yellen has started to take a much more significantly hawkish tone on what they might do with US interest rates.”
He said that this is despite economic data it is starting to disappoint against analysts’ expectations and the US market underwhelming in the first half of the year.
Ideally, the Fed want to raise rates over the next three years to reach its target of 3 per cent but markets are saying they will never get there.
Indeed, as the below shows, the Fed governors expectations are significantly higher than the market’s expectations.
Fed governors expected rate levels at end year (dots) vs. current market expectations (blue triangles)
Source: Psigma
“We take some sympathy with this and we are struggling to see US interest rates above 2 per cent at this point in the cycle,” Becket said.
But he added that if investors believe what the Fed is saying then we are heading into a very different macroeconomic environment.
“You’re still seeing aggressive bond buying from the Bank of Japan and European Central Bank and indeed the Fed, who might have stopped quantitative easing but through the mechanisms of their QE programs are still investing $33bn every month into the bond markets,” he noted.
“So you’re in the situation where lots of liquidity is being created by central bankers and pumped into the market.”
He added: “In 2018 you are about to see a significant foot being slammed on the brake for QE measures and actually that is going to go into reverse in 2019 and 2020.
“I’m not smart enough to know what impact that will have on asset markets but I am smart enough to know that whenever asset markets have done well in the past liquidity has been coming into the system.
“Now that it’s about to come out of the system our viewpoint is that by the end of this decade you’re going to see a significantly negative period for many asset markets and we’ve started to position our portfolios in expectations of it being a much more difficult market environment after it being frankly nine years of very good and easy returns.”
Indeed, Psigma head of investment strategy Rory McPherson, noted that its funds are now defensively positioned.
He said: “One of the key messages we are trying to get across to our clients is that buying those traditional investments is going to set you up for a fall because expected returns are very low and expected valuations are very high.
“Clients have to embrace the power of thinking differently and owning assets that perhaps aren’t so familiar to them.”
As such, in an upcoming article, we will look at the sectors Psigma is investing in for this cautious environment with fund specific examples.