At our London Q4 Investment Outlook event, Willem Sels, our Global CIO, shared our key priorities for the remainder of the year:
1. Put cash to work in high-quality bonds. Bond yields are far more appealing now that inflation is easing, and quality bonds can further add to portfolio diversification. Quality is a style that runs deep through our portfolio as it helps protect against balance sheet risks.
2. Our focus on US markets continues as we forecast US economic growth will comfortably outpace Europe. We talked our clients through numerous ways to play the US markets, from re-industrialisation to world-leading innovation.
3. Broaden out Asia exposure. India is benefiting from investment flows, thanks to its huge growth potential and a destination for supply chain diversification and service sector growth. Policy reforms combined with a young demographic mean that India is getting deserved attention from investors.
4. In this uncertain climate, hedge funds can once again gain the upper hand. Higher rates and elevated volatility can open up the opportunities that dried up during the near-zero rates environment that dominated the decade before COVID. We see opportunities in hedge funds for alpha generation and diversification.
Guided by Andy Haldane, former Bank of England Chief Economist, we took a deep dive into the UK economy, answering our client’s questions along the way. Andy was interviewed by me, on reasons behind the UK productivity deficit, current economic backdrop, etc. The assessment was that policymakers had been slow off the blocks to act against inflation, but now that most of the heavy lifting has been done, the BoE has clawed itself back into a position of control.
With growth clearly slowing in the UK, Andy was more concerned that the UK might come grinding to a halt, and the eventual cuts to rates would have to be steeper than currently priced in by the market. Following this thought, we find support for our preference for gilts and expectation of a drift lower in GBP.
We concluded that the coming 9-12 months will likely be very challenging for the UK economy. This sits well with our neutral view on domestically focused UK equities. The FTSE 250, for example, stands out as a cheap equities market that is priced for stagnation.
There is no getting away from the uncertainty the UK faces amid the breakaway from the lower-for-longer regime, but the former BoE Chief Economist argued that the post-financial crisis lows in rates were the anomaly, as quantitative easing pushed real yields into deeply negative territory. Andy argued that other structural factors, such as demographics (where there has been a propensity to save for retirement) and sluggish investment spending were also waning headwinds to higher rates.
Undoubtedly, the UK has some mountains to climb in addressing the low productivity, and Andy pinpointed the underlying challenges to investment. However, Andy injected a note of optimism: the UK towers above much of Europe in world-leading research (it just has to work on the development), and it is well placed to capitalise on AI-led productivity growth. The longer-term outlook, therefore, looks much brighter than the near-term gloom.
On balance, we believe investing in the UK should be done through the gilt market for the near term. Further out, there are reasons to be more hopeful, and the good news is that the investors are being paid to take equity risk. This boils down to a more cautious tactical asset allocation stance for now, with the expectation of moving towards a more positive position once the UK digests the impact of high rates.