At times such as these, says Guy Stephens, all investors and their advisers can do is spread assets far and wide - diversifying both to dilute the pain and participate in any gain
The investment markets are a real conundrum at the moment. The so-called ‘wall of worry' is exceptionally high and investors and their advisers must continually test outlook assumptions and decide whether to change tack.
There has been a marked pick-up in volatility since the Brexit vote back in June, with either significant losses or significant gains in all asset classes and very little remaining stable.
That said, the one asset class - perhaps the most important and widely held risk asset - that has remained solid, if not making gains, has been equities. We are forever hearing equities hate uncertainty and, on many fronts, there is currently more uncertainty than we have seen for some time - yet the asset class remains solid and seemingly well supported on any weakness. Why is this and is it about to change?
Bond markets are undergoing a rout with 10-year treasuries putting on almost 1% since the summer - much of this following the election of Donald Trump as US president and the higher inflation now expected as he goes on his reflationary spending spree next year. The trend in rates has turned and looks set to continue.
Commercial property for the UK investor looks vulnerable to a ‘hard' Brexit and a slowing in consumer spending as we begin the agony of triggering Article 50 and enduring whatever lies ahead. The economy is likely to slow and that usually crimps companies' expansion plans, which in turn reduces demand for property - both domestic and also from overseas while the future international trading environment is so opaque.
So that leaves equities as the only major conventional asset class that gives both yield and real earnings growth to protect against the pick-up in inflation. And that probably explains why the asset class has been so sanguine -equities are the least worst choice out of a poor hand where the negatives are hardest to define clearly.
There may be a three-month window before we hear anything substantive to upset the equity market but investors should not rely on the psychological comfort blanket of the recent Brexit and Trump obstacles being overcome.
If Trump is successful with his protectionist policies, most agree this will lower world growth and generally prove counterproductive. It would be the equivalent of the UK unilaterally putting tariffs on imported steel from China to protect jobs in Port Talbot and Ravenscroft. The end-products produced would have to rise in price and would ultimately fail to compete and the jobs would go anyway. The only solution is to invest to drive down costs and increase productivity.
Trump has promised the redundant workers of Cleveland and Detroit that he will get their jobs back from China. His government appointees so far are reputational nationalists and it is looking like he will be taking on China big time. That is bad news for world growth - and we all know how paranoid investors are about Chinese growth slowing.
Within equities, US dollar earners have continued to be strong as the currency has strengthened. This is no reflection of their underlying fundamentals, however - merely one-off translational benefits as sterling has remained weak.
‘Bond proxies' selling off
Income stocks and defensive ‘bond proxies' have sold off with the bond markets, and domestics remain Brexit caveated. Even gold, for the really bearish, has been weak as the dollar has strengthened with investors flocking to the Trump reflationary theme.
Emerging markets have been weakest on dollar strength and in anticipation of Trump's tariffs while Europe is about to begin its own populist revolution with the Italian referendum on 4 December and election fever throughout 2017.
For its part, cash looks appealing but gives zero return, if not negative in absolute terms or real terms - and increasingly so as inflation rises.
At times like this, there is only one strategy to follow. Spread your assets far and wide, diversify to dilute the pain and to participate in the gain - from wherever it may come.
Guy Stephens is technical investment director at Rowan Dartington
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