What’s been happening?

After a prolonged spell of almost a year when markets reflected a lack of volatility on the sanguine view of a ‘soft landing, recent market moves have reminded investors that markets can be volatile. This has finally shaken the VIX to rise from its muted mid-teen slumber to touch a level of 50 on the 5th August that demonstrates an element of investor panic.

The reason for the market downturn can be attributed to investor sentiment that has swung more bearish following the US macro data last week. In recent months we have witnessed the early signs of growth moderating from the surprisingly good levels at the start of the year. This is a necessary precursor required to help the plateaued inflation number to fall more comfortably toward the FED target.

Source: Bloomberg 18.07.19 – 05.08.24.

As a result, equity markets took a tumble of approximately 3% on Friday the 2 August, after a somewhat soggy Thursday too. Meanwhile longer duration bonds (Gilts and Treasuries) have found favour as a haven as expectations grew that more rate cuts are inevitable. This has seen 20yr Gilts rally by 3% over the week to 5 August (Source: Bloomberg).

We have also seen Japan react quite poorly with a -12% return over the two days to 5 August (Source: FE Analytics) as it reacts along with world equities to the moves in the US. This has been coupled with digesting the surprise policy changes that have seen the Bank of Japan take a more deliberate stance toward policy normalisation by increasing interest rates and reducing their purchase of government bonds.

Our view

The recent employment numbers have evidenced a softening of this data, with job creations of 114k surprising to the downside (185k expected). This also coincides with the unemployment rate moving up from 4.1% to 4.3% (although still a relatively muted level), weekly jobless claims jumping from 235k to 249k and the FED comments following their ‘hold’ decision on US rates to focus on their dual mandate of price stability and maximum employment. This has raised concerns around the employment market, stirring considerations that the FED is getting ‘behind the curve’ with their rate cuts. This view was further bolstered by softening of manufacturing data last week, albeit from overly lofty levels.

While the data is consistent with a moderation, investors are fretting that the numbers foretell a harsher outcome than the ‘soft landing’ narrative that has endured for the last 9 months or so. This is despite the data remaining subject to revisions and external one-off events, such as the weather impacting the job creations figures.

We must not forget that as we are now in ‘holiday season’, market trading levels naturally reduce as liquidity becomes a bit thinner across markets. We suspect that this is exacerbating the moves we are seeing.

Regarding Japan, some of the market weakness is being countered by a rising value of the Yen. There is the potential for the Yen to strengthen more from here and although the equity markets have initially responded negatively, we think there are good reasons to remain optimistic. We do not think recent measures damage corporate Japan or the ongoing outlook for corporate earnings. The corporate governance reforms remain a fundamental tailwind to the market on improving equity returns and those to shareholders. The current weakness does not seem justified by fundamentals and feels more of a temporary response to the unexpected firmness of the policy change. We would suggest that as Japanese investors unwind the carry-trade of selling their currency for higher yielding assets elsewhere, the repatriation of the Yen could in due time act as a boon to the market as investors re-evaluate the opportunities of where to place their monies on the domestic stage. Such a development will provide more solidity and a stable platform for the market to advance than the fickle interest of the overseas investor.

Activity

We have been slowly increasing duration within mandates over the last year or so in the Premier Miton Liberation funds and the Premier Miton Mult-Asset Absolute Return Fund, although given recent moves, we of course would have appreciated having far greater exposure! The strong moves seen, particularly regarding US Treasuries, is not one we feel we need to chase. In fact, the market has now moved to price in four US rate cuts by the end of the year. This has been a panic-driven change and is one we think could soften from here.

While equity markets were weak at the end of last week, our allocations have not been immune but appear to have held up relatively well, particularly in defensive areas such as infrastructure and Insurance. We think our positioning to areas such as the UK, where valuations are not overly stretched, has helped insulate us from the falls seen elsewhere – particularly high growth US technology areas.

The one area of disappointment continues to be our property selections. These have not benefitted from the bond yield reductions we have seen and instead have been inappropriately caught up with fears of a slower growth outlook. As we have reiterated many times before, our focus on properties with a secular growth focus, that are largely indifferent to the prevailing growth backdrop, should see their resiliency be well rewarded amid an economic slowdown. We have not yet seen those attributes be rewarded.

Market moves of the last week have benefitted our relative performance across mandates. The diversified nature of our income funds, risk targeted funds and our growth mandate has so far proved resilient. Encouragingly our Premier Miton Multi-Asset Absolute Return fund appears untroubled by recent market events, where the gains from our Treasury bonds, portfolio insurance protection, and our alternative positions, have helped offset any weakness from elsewhere.

In the face of these market moves, we have looked to maintain our target allocations – predominantly taking a little of the duration gains off the table (where we have them). Across mandates we have had a somewhat cautious tone already, given the low levels of equity volatility that we had been experiencing, suggestive of the market being vulnerable to a change in sentiment. We do not feel it necessary to change any of our target allocations at this point, although we are being alert to liquidity across all our funds, and the positions they hold, in order to take advantage of any clear opportunities that may arise.

Opportunities

We have been saying for some time that we expect an uptick in volatility given the markets too sanguine view of risks. We now find the market has lurched from complacency regarding the slowing of economic activity, to one of panic. We continue to think that maintaining cooler heads and a disciplined approach will steer us through the turbulence and will provide opportunity for attractive gains on the other side. In that regard, we would highlight that corporate earnings growth is still healthy, consumer confidence has shown resilience, and there is a plentiful supply of valuations across regions that continue to provide encouragement for potential returns from here.