• Home
  • About
  • Subscribe
  • Conference
  • Events Calendar
  • Webcast151
  • MOTB
  • Log In
  • Register

Room 151

  • Treasury
  • Technical
  • Funding
  • Resources
  • LGPS
  • Development
  • 151 News
  • Blogs
    • David Green
    • Agent 151
    • Dan Bates
    • Richard Harbord
    • Stephen Sheen
    • James Bevan
    • Steve Bishop
    • Cllr John Clancy
    • David Crum
    • Graham Liddell
    • Ian O’Donnell
    • Jackie Shute
  • Interviews

2014 – a game of two halves?

0
  • by James Bevan
  • in James Bevan · LGPSi
  • — 1 Jul, 2014

 

The past six months have involved decent returns from global financial markets, and notably fixed income – following the negative returns of H2 13, the Barclays Global Fixed Income aggregate is up 4% since the start of the year and the MSCI World Equity Index is up just shy of 5%. On a risk-adjusted basis, long fixed income has delivered nearly twice the returns of equity thus far this year.
Whilst a combination of modest growth, well-behaved inflation, continued central bank easy policy and record low volatility across asset classes have proved constructive for markets, H2 2014 is likely to be more challenging especially for Fixed Interest but with the premise that it’s hard for H2 to be as helpful as H1, it looks prudent be more defensive in H2.
On the macro front, there have been scant signs of rising inflation pressures, and this has helped the Fixed Interest markets with the anchoring of yields supporting global risk assets. But now we can have far less confidence that the short-end of the US fixed income curve will remain well anchored in H2 – notwithstanding the relatively benign view presented by Fed Chair Yellen at the last FOMC meeting, US inflation pressures do appear to be picking up, and potentially significantly if recent trends are maintained. If the trend pick-up in inflation continues, we can expect core PCE to end the year at 1.9% compared with the Fed’s forecast of 1.55%. Perhaps more worryingly, fixed income investors have increasingly been looking through the US inflation data with the gap between the Fed’s forecast for the Fed Funds rate at the end of 2016 and market pricing running near 70bp – technically the largest gap between the Fed’s forecasts and the market since the Fed’s “dots” were introduced in 2012.
In terms of how we can position defensively, in the context of our mandates,

– We can increase our underweight of global fixed income, overweighting cash.
– With equities, a sustained period of rising yields should favour value stocks over growth ones, especially given the cheap valuations in value stocks, most notably in the UK and Europe.

That said, the global equity and general risk asset calls are hard for the coming months. While an increase in US inflation and the likelihood of a correction higher in short-end US yields may be disruptive for risk assets, this risk should be balanced to some degree by a scope for significant improvement in global growth in the second half of the year. Looking at the numbers, global GDP growth could accelerate markedly – from an average of c2.5% (qoq, sa) in H1 to c4.0% in H2, which would be the best six-month run in global GDP since 2010 – although 4% annual global GDP growth is far below levels seen before the financial crisis. But following nearly three years of sub-par global growth, the second half of 2014 should feel better. More importantly, as a context for the pricing of assets typically linked to the global economic cycle, equities look cheap relative to forecasts for global growth in H2.
As important as the acceleration in global growth is the composition and it looks as if leadership in growth is shifting away from the US towards Europe and China. To be fair, US growth is set to accelerate, but will still likely fall below consensus forecasts and only be incrementally more positive than in the past few years. Meanwhile, European growth, even with the recent disappointments, should provide the biggest lift to growth this year. Following a very weak two-year period, Euroland growth could average just over 1% in 2014, with UK growth even stronger. Meanwhile, China’s growth this year could come in close to the government’s 7.5% target, with perhaps 8.5% growth in H2. Importantly, any shift toward more growth leadership from Europe and China would happen at a time when asset prices linked to these regions’ growth are significantly cheaper than those linked to the US business cycle most notably US equities and to some degree US credit.
Overall, better global growth should be (just) enough to offset rising US yields as the market begins to more seriously contemplate the start of a Fed rate hike cycle. But even more so than before, we see a strong case for favouring better-valued assets outside the US. On the equity-front, from a top down perspective, it looks right to underweight US equity against EM, Asia (including Japan and Euroland. Stretched valuations make the US equity market the most vulnerable equity market to any hawkish shift in Fed policy expectations.
It also looks prudent to move to a tactical overweight in commodities, by increasing tactical (and strategic) weight to oil and copper/base metals. It looks that oil market participants and institutional investors have been lured into a false sense of security by the long period of stability in oil prices but investors could be in for a shock in the months ahead, with the sharply increased level of threat to oil output, especially in Iraq, combined with a lack of supply flexibility, leaving the global oil market more vulnerable to a supply shock than at any time since onset of the financial crisis in 2008.
Turning to credit, year-to-date returns have been surprisingly strong. The backdrop of rallying rates and low volatility has helped push spreads near historically tight levels across all major credit markets. Looking forward, it is hard to see a repeat of the H1 performance. The expectation of higher US and European yields means that total returns in credit are likely to be lackluster for the balance of the year – with likely negative total returns in IG, and small positive returns in HY and local currency EM debt. While we don’t expect rising inflation and the prospect of markets bringing forward Fed tightening expectations to be a major risk to credit, historical betas suggest that US HY and EM hard currency debt may experience some spread widening if US short end yields rise in line with our expectations.
Net-net, we hold our credit allocation broadly unchanged, but we view the next six months as a period of low total returns across the credit spectrum, while the negative asymmetries are non-negligible.

Share

You may also like...

  • Thoughts on the US fiscal cliff ‘deal’ Thoughts on the US fiscal cliff ‘deal’ 8 Jan, 2013
  • James Bevan: Quality growth and a decent dividend James Bevan: Quality growth and a decent dividend 1 Feb, 2016
  • Pension pools warned on governance structures Pension pools warned on governance structures 21 Apr, 2016
  • Managing inflation risk in LGPS funds Managing inflation risk in LGPS funds 21 Nov, 2013

Leave a Reply Cancel reply

You must be logged in to post a comment.

  • Register to become a Room151 user

  • Latest tweets

    Room151 1 day ago

    The vaccine may help settle cash flows but inflation remains a risk: Sponsored article: Lauren Sewell examines the prospects for long-term borrowing as Brexit settles and vaccines are deployed against Covid-19. On the 9th October 2019 Whitehall sent… dlvr.it/RqZXCr pic.twitter.com/PzgOZOGQ0k

    Room151 1 day ago

    ESG in liquidity: Sponsored article: Gavin Haywood looks at the integration of ESG in Federated Hermes’ money market funds. Federated Hermes has over 300 public sector clients invested in our AAA rated money[...] dlvr.it/RqZX5f pic.twitter.com/E87sBXsay8

    Room151 2 days ago

    New realities of investing cash and liquidity: “What to do now?”: Sponsored article: Brian Buck looks at the “unique challenge” for cash management strategies. As investors assess the ongoing impact of the pandemic on their business, levels of cash and… dlvr.it/RqVbk9 pic.twitter.com/ZElVASmEUV

    Room151 2 days ago

    Extra finance promised by the government receives a broad welcome: Sponsored article: The financial pressures facing local authorities this year continue to pose challenges for council treasurers. While the launch of the UK’s Covid-19 vaccination… dlvr.it/RqTzTF pic.twitter.com/HCjH0pyHR5

    Room151 2 days ago

    A savvy approach to managing your cash: Sponsored article: Caroline Hedges examines the need for active cash management to achieve a higher than average return. Last year saw the already mountainous pile of negative-yielding debt around the[...] dlvr.it/RqTzMK pic.twitter.com/uP0RQYTJLt

    Room151 3 days ago

    Putting alternatives at the heart of multi-asset portfolios: Sponsored article: Nick Edwardson looks at the assets that provide the “most attractive opportunities”. We believe that asset allocation is the primary driver of investment returns and that the… dlvr.it/RqQ2Qt pic.twitter.com/WLBzvRRRUQ

    Room151 3 days ago

    Thriving in the pandemic: Avoiding the stragglers: Sponsored article: George Crowdy looks at the sectors providing opportunities for sustainable investment. Throughout much of 2020, we talked about why sustainable investing has thrived in the pandemic,… dlvr.it/RqQ2NQ pic.twitter.com/dxiPWKFsPl

    Room151 3 days ago

    The development of CCLA’s mental health benchmark: Sponsored article: Amy Browne examines the importance of investing in mental health in the workplace. We are living through a public health emergency in more ways than one. Physical health[...] dlvr.it/RqQ2Jx pic.twitter.com/o6yRSCX3oF

    Room151 4 days ago

    Brexit: What the EU trade deal means for the UK economy: Sponsored article: Hetal Mehta looks at the impact of Brexit on economic prospects. Four and a half years after voting to leave the EU, on Christmas Eve the UK finally[...] dlvr.it/RqLBDt pic.twitter.com/No62srfE8h

    Room151 4 days ago

    Cash dethroned: The quest for liquid yield: Sponsored article: Peter Hunt and George Carne ask how treasury departments can balance the need for yield and liquidity. The massive stimulus and waves of liquidity provided by central banks[...] dlvr.it/RqLBDj pic.twitter.com/05g6Zhu1kU

    Room151 4 days ago

    Richard Harbord: Delayed “capital determinations” make section 25 opinions a new crunch point: The severe pressure on local government budgets now means section 151 officers confront a tricky call on  whether they can make a judgement on the robustness… dlvr.it/RqLBDV pic.twitter.com/vTAbDKFzkI

    Room151 1 month ago

    PWLB Consultation: Analysis straight from Dickens: Helen Radall and Paul McDermott present a legal examination of the new PWLB borrowing rules as Charles Dickens might have imagined it. Free and easy PWLB (“Marley” to his friends)[...] dlvr.it/RnmwLq pic.twitter.com/yFxcPrQqEG

    Room151 1 month ago

    Room151’s top stories from a momentous year: 2020 was the year in which local government grappled with Covid-19, funding strains, controversy over borrowing rules and the threat of financial collapse. It has been an exhausting and historic[...] dlvr.it/RnlpZg pic.twitter.com/g3myNyox6J

    Room151 1 month ago

    Tracy Bingham: 2020, a year best forgotten but also one of learning: Many will rush to erase 2020 from their memories but, writes Tracy Bingham, there were also many lessons about finance teams, strategic planning and leadership. 2020: A year we’d… dlvr.it/RnlpY2 pic.twitter.com/m7G1krrtCu

    Room151 1 month ago

    Settlement must address ‘precarious’ local government finances: Dan Bates crosses his fingers for “no nasty surprises” in this week’s funding settlement but argues the “bigger prize” is post-Covid financial certainty. Thursday (17 December) should be the… dlvr.it/Rnj9dG pic.twitter.com/KLKjjuBqJE

    Room151 1 month ago

    PWLB consultation: Big change on the way but there are ‘grey areas’ and opportunities: The consultation on PWLB borrowing has concluded creating a new landscape for funding property acquisition. Our experts look at the implications. Tracie Langley The… dlvr.it/RndRvJ pic.twitter.com/KEqXEBmEfq

    Room151 1 month ago

    2021: Better income outcomes?: Sponsored article: Investors should be mindful of structural challenges posed to income generation as a result of rapid thematic change. Jon Bell looks at the prospects for the coming year.[...] dlvr.it/RndRsw pic.twitter.com/TxVk8aXkMq

  • Categories

    • 151 News
    • Agent 151
    • Blogs
    • Chris Buss
    • Cllr John Clancy
    • Dan Bates
    • David Crum
    • David Green
    • Development
    • Forum
    • Funding
    • Graham Liddell
    • Ian O'Donnell
    • Interviews
    • Jackie Shute
    • James Bevan
    • Jobs
    • LGPSi
    • Mark Finnegan
    • Recent Posts
    • Resources
    • Richard Harbord
    • Stephen Fitzgerald
    • Stephen Sheen
    • Steve Bishop
    • Technical
    • Treasury
    • Uncategorized
  • Archives

    • 2021
    • 2020
    • 2019
    • 2018
    • 2017
    • 2016
    • 2015
    • 2014
    • 2013
    • 2012
    • 2011
  • Previous story Councils face increasing funding gap
  • Next story CIPFA poised to revise CFO role

© Copyright 2021 Room 151. Typegrid Theme by WPBandit.

We use cookies to ensure that we give you the best experience on our website. If you continue without changing your settings, we'll assume that you are happy to receive all cookies from this website.OK