Wealth managers are more confident on corporate profit growth than at any time in the last three years, but growing scepticism on valuations and low levels of political visibility have driven developed equity exposure to its lowest level since 2011.
Around half of the respondents to the Wealth Manager Quarterly Survey said they had pivoted equity exposure away from global growth blue chips, which have ruled the last six years, to capture increased momentum in riskier value, even if many expressed little long-term confidence.
But the apparent disparity between the direction of future earnings and the willingness to pay for them suggested an unusual anxiety about equity as an asset class, in addition to a broader reluctance to take on risk.
While managers mainly listed technical, market-led concerns, such as currency and yield curve disparities, as the issues keeping them awake at night, politics was a consistent undercurrent and Brexit and Trump were near-universally described as the primary sources of client anxiety.
Some of the potential downsides of the Trump Trade were visible last week as the president threatened a 20% import tax on Mexican products, upending decades of assumptions about trade and probably contravening WTO rules. ‘[We have adopted a] neutral allocation,’ said Darren Ruane, head of fixed interest at Investec Wealth & Investment. ‘Waiting to see if Trump dislodges markets.’
Almost half of managers (47%), currently expect profits to rise. The last time confidence approached that level, during late 2013 and 2014, the number of managers overweight developed equity was at the upper end of its historical range, at between 50% and 60%. The figure currently stands around half of that, at 27%; well below the six-year average of 38%.
‘The scope for optimism in an improving outlook for the global economy will be held in check by the vulnerability of most economies to higher interest rates,’ said Richard Scott, senior manager at Hawksmoor, and lead on its Vanbrugh and Distribution funds.
‘If bond yields and the rate of inflation rise much further it will quickly dampen growth, given the very high levels of debt in most economies.
‘The strong performance of most assets since 2009 has caused complacency among many investors about downside risks. The critical call is to constantly ensure portfolios are appropriately diversified and the level of risk being taken is not allowed to creep up with valuations of most assets having risen considerably.’
Consensus on inflation
Respondents showed greater consensus on inflation than at any previous time since Wealth Manager began polling in mid-2011, with 88.2% expecting pricing pressure to rise, and 11.5% expecting it to rise ‘significantly’.
The rapid increase in inflation expectations from just under 52% forecasting a rise in the previous quarter has sharply outpaced expectations on global growth. The number of managers expecting the pace of global output gains to increase climbed from 40% to 58.8%, while the number forecasting a fall slid from 30% to 5.9%, with the balance expecting little change.
‘There are dark clouds on the horizon, but it may not rain for a good year or 18 months,’ said Andrew Moore, partner and investment director at Alexander Beard. ‘[The biggest challenge for the next year will be] positioning portfolios for an inflationary environment, the timing may prove critical.’
Japanese equity was the only developed equity region to see risk added over the quarter, with the number of managers actively overweight rising from 26.3% in late 2016 to 47.1% in January 2017, the highest level of conviction in two years.
Elsewhere, risk was consistently downgraded, with an absolute majority of managers currently benchmark-neutral on both European and US equities, and more than 40% on domestic equity.
This pattern was true across the major asset classes, with only emerging market equities seeing moderate additional risk-taking, as the number of managers reporting positive conviction rose from 25% to 29.4%. That remained well below the 12 month high of 40% in June, however.
‘The inescapable crux facing professional fund investors is whether a bull case scenario for US fund managers is a bear case for everyone else,’ said Jon ‘JB’ Beckett, senior manager in Lloyds funds assessment team.
‘Trump may mean that global GDP remains quite flat, but with growing regional differences. This could drive some unexpected inflation scenarios. When speaking to active fund managers, we are keen to understand how they are positioning and likewise it casts a challenge to passive investors given their typical high exposure to the US, e.g. [via the] MSCI World index.’
‘The big “risk” call is clearly a Trump-driven infrastructure and protectionist policy; bank equities, real estate, energy… how much to get in by; how much have markets already priced in. Whether to hedge the dollar or go long.
‘The logical investment is EM, but the bear case on China will clearly dampen sentiment, with Europe as some political yo-yo in between; if centre politics prevails, then European equity looks attractive.'
He added that a US transition out of almost a decade in which it was reliant on monetary policy to keep the economy afloat was likely to lead to an unpredictable environment for most widely-owned asset classes.
‘Alternatives have broadly underperformed giving rise to the lauded “60:40” bull.
‘If you believe in reversion to mean and valuation, then now may be a better time to again reinvest into alternatives. The outlook for bond managers looks very challenging in the near term with the optimism of normalising rates (in the US at least) in 3+ years.’
While polling readers on their allocations to the amorphous and necessarily hazily defined category of funds labelled Alternatives provides low levels of confidence in the usefulness of the results, the survey did not offer any evidence managers had upped their investment.
The number of managers reporting overweight positions in the category dropped from 35% to 23.5% in the quarter; to within a percentage point, the joint lowest figure since 2014.
Similarly, with the dollar strengthening, the number of managers overweight gold fell from 35% to 23.5%, while the number underweight near-doubled from 15% to 29.4%.