Kleinwort Hambros' CIO tells us to ignore the talk of Armageddon.
'The world has seemingly been on the brink for months, if not years. The all-too-familiar red bannered ‘breaking news’ headlines continue to hit the newswires on a near daily basis, making it impossible to avoid the unfolding geopolitical tensions.
So far in 2017, elections in the Netherlands and France, a referendum in Turkey and sabre-rattling across the Korean Peninsula have all threatened to derail markets at one time or another.
Looking back further over the last 10 years – from terror attacks to disputed annexations of gargantuan swathes of territory – geopolitical flashpoints have generated huge amounts of pain, suffering and anguish.
It is easy to draw the conclusion that one’s asset positioning should be defensive during times of heightened conflict or stress. However, financial history teaches a different lesson: geopolitics rarely impact equity markets over the medium to long term. The data simply does not support
the ‘geopolitical tensions are bad for markets’ hypothesis.
For example, the world was brought to within an inch of nuclear Armageddon during the Cuban missile crisis in October 1962 (markets were reasonably flat in the months leading up to the crisis). An investor in the S&P 500 – a US and global equity bellwether – would have been up 7% in the following month, up 16% over the next quarter and up 34% a year later. Khrushchev may have blinked, but investors were on a roll.
This supports our view that medium
and long-term performance is driven by fundamentals rather than geopolitical headlines.
Our investment framework provides structure to our investment decision making through objective analysis of the primary factors, which can be shown to drive future investment returns. These factors include: the prevailing economic climate, valuations and fundamentals, momentum and technicals, and investor sentiment.
The global macroeconomic environment remains supportive of risk assets. Indeed, a range of leading economic indicators suggest the global economy is in an ‘expansionary’ phase, with above average and accelerating expectations for economic growth. Analysis of similar periods in history suggests it is an environment that may lead to above average returns from equities.
We have increased our exposure to European equities because we believe they will continue their recent outperformance of the global average. Specifically, we note diminishing geopolitical risk resulting from the first round of the French election and following the election of Emmanuel Macron, a relatively moderate centrist.
Furthermore, the fundamentals of eurozone corporates are sound, and with economic expansion gaining traction, the European Central Bank remaining accommodative and the euro still weak, corporate profits should pick up in coming months: our estimates call for double-digit earnings-per-share growth this year. Eurozone valuations have yet to fully reflect these positives, warranting an overweight exposure.
Equities remain our most significant allocation across most multi-asset strategies. At the global level, the asset class is attractively valued versus others. Moreover, equities continue to be supported by strong momentum.
However, we recognise that markets can move lower with staggering speed and we continue to have significant allocations to government bonds in spite of low yields and increasing inflation expectations.
As another form of defence, we continue to hold cash across most portfolios. It gives us a flexible position to capitalise on attractive investment opportunities and reduces volatility from potential risks of all kinds, including the geopolitical risks.'