Heatwaves eventually end in thunderstorms. Some people think that the current investment cycle will end in a big storm. Indeed, I get the feeling from what I read and hear that some would actually welcome an abrupt end to what has been a frustrating period for many. Rates haven’t gone up much, inflation remains subdued, volatility is low and economic growth continues to rumble along at a decent pace. This has done for investors that positioned for a less benign outcome. It’s likely that the great “cleanse” is not going to come. So instead, a diversified beta approach to investing should continue to deliver slow and steady returns. In fixed income that means focus on carry, enhanced yield opportunities when they come, inflation protection and a big enough exposure to safe assets like government bonds to hedge when risk has one of its periodic wobbles.
- Will the final five months of the year bring anything different or will the combination of low volatility and low yields prevent fixed income returns even keeping pace with inflation? I suspect that the approach I have favoured so far in 2018 – having a barbell of long duration as a risk hedge and looking for yield enhancing opportunities – is likely to be a sensible way forward.
- There is a kind of death wish amongst some commentators in the market. Running a negative duration strategy is an example of forecasting something bad that only results in bad performance. Betting on a Chinese hard landing or a collapse in US high yield are others. My view is that the business cycle is not coming to an end this year and that market conditions are not going to change significantly. Populism will remain the dominant political narrative and that will keep people worried.
- A diversified investment approach remains the best way to be positioned. Market timing, as a strategy, is not likely to consistently work in such an environment. Most return will come from beta but that return itself might continue to be low, so better to diversify your sources of beta in a sensible way. Because there is uncertainty about how the cycle evolves from here (growth, inflation and interest rates), a portfolio that can benefit from a prolonged earnings cycle (US S&P reported earnings growth in the current season so far is 24%), some carry from a still benign credit cycle, a little inflation protection and some long-duration for those periods in which pessimism prevails is likely to do better than one that is tilted by a conviction about precisely where were are in the global business cycle.