Monthly outlook June 2020
- 10 June 2020
- 5 mins reading time
Short-term positivity masks risks
Lockdowns are being eased, which may lead to a short-term improvement in economic data. However, looking six-to-12 months down the line, we remain concerned about the economic outlook. Without a medical breakthrough, subdued economic activity is the only way to contain the virus. The longer this drags on, the more likely we are to see a second round of detrimental effects on businesses and employment.
We continue to believe that on-going financial stimulus from governments and central banks is required. While such support remains likely, we will retain our positive outlook for lower-risk rated corporate bonds. At the same time, we remain cautious on the potential for other assets due to some driving factors that we see developing.
There are two new themes emerging from our analysis that explain how our overall thinking is developing.
Firstly, we expect to see various rates of economic growth across different regions driven by:
Diverse approaches to easing lockdowns and the potential for localised virus outbreaks
Varying levels of financial stimulus
A divergence between companies’ performance depending on how equipped each company is to weather the crisis.
Secondly, we are faced with a portfolio construction challenge.
We expect inflation to continue to fall further below preferred levels. In “normal” circumstances, central banks could reduce interest rates or even implement bond-buying programmes to help push inflation back towards the sweet spot of around 2%. But interest rates are near-zero, and bond-buying is already in full-flow. So inflation rates don’t appear likely to rise soon.
At the same time, yields on government bonds are extremely low. This is because the demand for and prices of them has been driven up as investors look for perceived havens in which to park money while, at the same time, the central banks implement their bond-buying programmes.
As the price of a bond goes up its yield goes down. One of consequences of this combination of low inflation and low yields is that we cannot rely on government bond yields to rise as much as they traditionally would when inflation falls. In other words, the compensation or “hedge” that government bond yields would traditionally provide within an investment portfolio is much lower than it normally would be.
One of the attractions of holding UK, US or German government bonds is the fact that they have low-risk ratings. Now that the yields have slumped, we have to consider other, higher-risk rated opportunities to get those yields. But we have to do so in such a way that we avoid taking more overall risk than might be appropriate for a given investment portfolio.
So, we are carefully and gradually moving some money into low-risk rated corporate bonds and into what we consider to be higher quality stocks.
In terms of other investment changes, we are also incorporating an allocation to gold which is made possible by cash generated from reducing our overall allocation to stocks. This provides an element of diversification across the relevant portfolios as well as an element of hedging against further stock price falls or temporary rises in inflation.
Our general view of assets over the coming months can be summarised as follows:
Any views expressed are our in-house views as at the time of publishing.
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Forecasts of future performance are not a reliable guide to actual results. Investment markets and conditions can change rapidly and the views expressed should not be taken as statements of fact nor relied upon when making investment decisions. The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor might not get back their initial investment.
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