What a difference a printing press makes! This month has seen the European Central Bank (ECB) unveil a new round of monetary easing measures – its eleventh.
Credit easing is the ECB’s main target but our concern is that its success is dependent on the real economy’s desire to borrow. Before the announcement, the ECB’s bank lending survey was already at levels not far off those seen in the heady days of 2006/07.
Europe already has some of the loosest lending standards ever seen and there simply has not been demand for credit. While this may not do a huge amount to spur aggregate demand, it has improved the prospective cost of capital for European corporates.
Over in the US, the Federal Reserve is also leaning towards a more dovish bias, citing external factors. In the short term, while inflation is below the lower end of the desired target range and the labour market still appears strong, there is flexibility afforded to the Fed. The risk is that inflation accelerates and is driven further by rising employment costs. For now, the ‘dot plot’ in its latest release shows that the path of interest rate increases the Fed expects is shallower than in its own forecasts at the end of 2015. We are concerned about how much of a consensus position it is to be long US dollars, so would not be surprised to see some weakness ahead.
This is actually good news for a number of asset classes, notably those tied closely to the price of US dollar liquidity, such as emerging markets. However, we continue to be wary of the clear divide between commodity importers and exporters.
On this side of the Atlantic, the question of a ‘Brexit’ is front and centre, with uncertainty weighing on sterling. We expect to see considerable volatility in the currency in the four to six weeks leading up to the referendum. In terms of our portfolios, we have positioned these to protect investors from the potential risks of a vote to leave.
Mid February turning point
Following on from the market sell-off at the start of the year, the middle of February seems to have been a turning point. But we are not yet convinced the market has meaningfully returned to rewarding fundamental value.
We have spoken to almost every manager in our portfolios over the last three weeks and none have reported material weakness in their underlying companies. Indeed, a number of them are reporting solid growth, even from regions of apparent weakness.
Subsequently, we have maintained a small tilt of our asset allocation towards equities, favouring European stocks. Overall, we are comfortable with the procyclical stance of our fund managers.
In fixed income, we maintain a significant underweight position to government bonds and have added to our exposure to credit. Having been marginally underweight high yield, we chose to add to a manager focused on European issuers. Our expectation had been for a more difficult market in the US, given it is later through its credit cycle and facing headwinds from the energy sector.
In Europe, spreads had blown out in a similar fashion but with less risk from the energy sector. The decision to allocate to Europe received an extra boost since the ECB’s latest round of support is more than we anticipated.
In the current environment, a fund manager that has an acute sense of downside risk is crucial. Citywire AAA-rated Gary Greenberg, manager of the Hermes Investment Global Emerging Markets fund, ticks all the right boxes.
With more than 20 years’ experience in emerging markets, the investment process he follows is thorough, combining a detailed understanding of country risk together with the usual fundamental analysis of companies to identify potential investments.
If you would like to be on the next Investment Committee panel, email me on email@example.com