Adding to equities
The ‘risk-on’ move in markets continued last week with global equities rising a further 1% or so in local currency terms, led by Emerging Markets and Asia. Government bond yields also increased with 10-year US Treasury yields now back up to 1.93%, close to 0.5% above their early September low.
The improvement in sentiment has been driven by signs that global manufacturing business confidence has bottomed out recently and even begun to recover. This in turn reflects increasing hopes that the US and China are moving closer, albeit slowly and erratically, towards a limited trade deal which will involve the roll-back of some tariffs.
We now have increased confidence in our forecast that global growth will recover somewhat over the coming year on the back of both the marked easing in monetary policy and reduced trade worries. This improvement in turn should feed through to renewed gains in corporate earnings and possibly a modest re-rating of equities.
The prospect of further gains in equity prices over coming months means we are closing our equity underweight position and moving back to neutral. We are adding both to our European and UK equity holdings and financing the trade by reducing our cash and short maturity bond holdings.
In mid-October, we delayed reinvesting the proceeds from a European fund sale so as to benefit from a rise in sterling if there were quick ratification of Boris Johnson’s Brexit Deal. However, uncertainty over the forthcoming election now looks set to put a cap on sterling and consequently it makes sense to rebuild our European equity exposure. Still, we remain cautious on the eurozone longer term and we have selected an equity fund which is focused on quality companies with good long-term growth prospects and significant revenues coming from outside the eurozone.
The main reason why we have turned less cautious on UK equities is that the risk of a No-Deal Brexit has fallen dramatically. In addition, while the election result is far from clear, the most negative outcome for the market - a Labour majority - seems pretty unlikely given the unpopularity of Jeremy Corbyn and Labour’s poor showing in the polls. As always however, we will await developments.
With the UK looking very cheap compared to other markets, this warrants moving back to a more neutral position. This will still leave our international holdings around 50% larger than our UK holdings. If the Conservatives look like winning a majority, we would very likely increase our UK holdings further – but this is far from assured and, as with Brexit all along, we do not believe it is appropriate to take a big bet on an event which is this uncertain.