01 Aug 2018
It is easy to waste time discussing politics. There is no doubt, however, that it is having a profound effect on markets at the moment. As fund managers, we sometimes think we would prefer the certainty of benevolent dictatorship to the unpredictability of democracy. In reality, we must live with political surprises. President Trump is merely the latest manifestation of this uncertainty. Clearly, a fully blown trade war would be very damaging to global growth. There is certainly a threat that tariffs will tip the world economy into recession. Our expectation, however, is that a face-saving settlement will be reached.
The US, meanwhile, is learning to live with some other of President Trump’s questionable policies. A vast increase in fiscal stimulus at a time when unemployment is at historic lows and growth is robust is forcing the Federal Reserve to tighten monetary policy more rapidly than it might do otherwise. To quell inflationary pressures, interest rates will continue to rise over the next couple of years. We believe government bond yields could rise further as a result.
This rise in US Treasury yields, the world’s benchmark risk-free asset, will have a knock-on effect on all other financial markets. Investment-grade markets tend to be closely correlated with government bonds. Yields on non-financial investment-grade bonds are rising (meaning their prices are falling) as issuers scramble to issue debt. Spreads (the extra margin you receive for owning corporate bonds rather than government debt) are widening. For now, we believe that spreads have reached more sensible levels. But with QE being withdrawn across Europe, this area of the market could remain under pressure. Meanwhile, bonds issued by banks and financial companies have struggled over the last few months, with the result that we are seeing new issues at more attractive yields. We believe opportunities are emerging.
The high-yield market is also offering better value. We are currently debating the relative merits of junior financials and high-yield bonds. Volatility will continue, but we believe the fundamentals are attractive for both groups of assets for as long as defaults remain low. The main risk, of course, is that a trade war prompts a global recession. That would increase defaults and we would have to rethink our strategy. We would, however, be surprised if President Trump’s threats turn out to be anything except showmanship in the run up to the mid-term elections. It is in nobody’s interests to see this escalate any further. Meanwhile higher oil prices seem to be becoming entrenched. This has benefited many of our high-yield positions and we feel that boost should continue.
In equities, we have taken some of the cyclical risk out of the portfolio. Since mid-2016, our broad thesis has been that the US economy would continue to grow, that inflation would start to come through and that 10-year US Treasury yields were more likely to hit 3% than fall to 1%. That thesis – and the positioning that followed from it – has largely been proven correct. Yet we are wary of complacency and it seems prudent to be less exposed to the most economically sensitive areas than we were at the start of the year. We have, for instance, reduced our exposure to financials, particularly in Europe, where the ECB seems increasingly dovish. We have recycled some of the capital into oil stocks.
Recent months have been tough across all asset classes. We have, however, avoided some of the most distressed areas, particularly in emerging markets. Rising interest rates in the US are increasing the pressure on them. We don’t expect that to change – so remain cautious towards emerging-market equities and bonds. Our goal is to produce a good income while paying due regard to capital risk. And we do feel we have weathered recent economic and market turbulence reasonably well, particularly as our equity exposure does not include some of the fastest-growing (but zero-yielding) technology companies.
Tensions around trade are likely to remain the main issue. Although this is clearly bad news for markets, it appears to be primarily a political move designed to shore up President Trump’s support ahead of November’s mid-term elections. We expect – at some point – a return to rationality and perhaps even a market driven more by fundamentals and less by the White House. In the meantime, we proceed with caution and in the expectation that things could remain bumpy over the summer. As ever, we must balance the risk of reaching for too high a yield (which would put your capital at risk) against the risk of it being too low (which wouldn’t satisfy your requirement for income).
Jacob de Tusch-Lec has managed the Artemis Global Income Fund since launch in July 2010, the Artemis Global Equity Income Fund since launch in June 2015 and the Artemis Funds (Lux) Global Equity Income fund since launch in May 2018.
James Foster joined Artemis in April 2005 and manages the Artemis Strategic Bond Fund and the Artemis Monthly Distribution Fund which were launched in June 2005 and May 2012 respectively.