Trevor Greetham, Head of Multi Asset, Royal London Asset Management
Stock markets fell sharply after US wage inflation hit its highest level since 2009, triggering fears that the US Federal Reserve (Fed) will need to raise interest rates more rapidly than expected. The sell-off was exacerbated by the frothy level of investor bullishness beforehand and the severity of the downward move suggests forced selling by risk parity funds and other leveraged investors, with the VIX index of US stock market volatility seeing its largest ever one day increase.
To keep things in context, the sell-off to date merely reverses part of the December/January rally in stocks. The world economy is growing strongly, corporate earnings are being upgraded, equity market valuations are less heady and we’re seeing a total clearing out of bullishness. Our composite sentiment indicator is heading for its most negative reading since the China devaluation panic of summer 2015.
The sell-off in stocks looks like an overreaction. We expect bouts of volatility to become more common now the Fed is in play but expect stocks to recover over the coming weeks and months as the economy continues to expand. Yes, rising interest rates are a challenge to the stock market but only a serious one once they are high enough to cause the economy to roll over. With the Fed Funds rate still below core inflation, that could take quite a while.
We are adding to our moderate overweight position in equities on market weakness, buying stocks in the emerging markets in particular, and deepening the underweight in government bonds. We have also taken this opportunity to move commodities further overweight.
The Investment Clock model that guides our asset allocation has moved into the Overheat phase of the global business cycle, characterised by strong growth and rising inflation. Commodities are usually the best performer at this time as higher than average demand depletes inventories and bids up prices. Bonds usually suffer on inflation worries.
Stocks can do reasonably well at this stage of the cycle but volatility often picks up as there is a two way pull - strong earnings growth is good news as we saw in January, but interest rate hikes can cause valuations to drop, as we have seen in February.
We went into the sell-off only moderately overweight equities, holding back from a larger position on valuation grounds. Investor sentiment has swung rapidly from excessively bullish to excessively bearish.
RL Global Multi Asset Portfolios (GMAPs)
The Royal London GMAPs are a range of six diversified multi asset funds, actively managed in line with a robust, systematic investment process. An important component of this is the Investment Clock. We regularly update on the positioning of the Investment Clock and the GMAP range through our reports, videos and blog posts. Visit http://www.investmentclock.co.uk/ for the latest updates from RLAM’s Multi asset team.
Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice. For funds that use derivatives, their use may be beneficial, however, they also involve specific risks. Derivatives may alter the economic exposure of a fund over time, causing it to deviate from the performance of the broader market. Sub-investment grade bonds have characteristics which may result in a higher probability of default than investment grade bonds and therefore a higher risk.
This article was provided by Royal London Asset Management and does not necessarily reflect the views of Citywire