Reflections of the CIO…

A noisy and volatile summer was brought to a close in August on a broadly positive note, but only after another period of wild swings in sentiment and market performance. The month began badly as the knock on effects of a Japanese interest rate rise and weak(ish) US economic data continued to ripple though equity markets. Overconfident and over leveraged investors dramatically scaled back their positions as sentiment reversed on the perception of increasing risks to global growth.

The chill in the air as we exited summer and moved into autumn was palpable and marked a notable shift away from previous years’ worries, which almost exclusively focussed on the issue of bringing down inflation. That battle was and is now seen to be largely over, allowing attention to focus on the cost of victory. “Have central banks achieved their inflation goals without the need for a recession to bring down prices?”, was now the key unanswered issue on investors’ minds.

As this debate raged throughout August there were many sharp movements within and between asset classes. Commodities, apart from gold, were generally very weak, reflecting the general cooling in the economic climate and the specific worries over China, which is continuing to wrestle with the effects of a property market crash. Equity markets internally began to rotate their leadership groups. A cooling in the previous six months’ enthusiasm over artificial intelligence themes prompted some aggressive profit taking in the technology sector and a corresponding pick up in the relative performance of more stable, defensive type sectors. Previous months’ winners quickly became losers as profits were first booked, then rotated into sectors with lower expectations priced in.

Global bond investors rapidly began to raise their expectations surrounding the timing and extent of interest rate cuts, particularly in the USA. The Chair of the Federal Reserve confirmed later in the month they were right to do so, when he explicitly stated that the “time has come” for a change in policy. The small catch in this otherwise long hoped for signal was that the timing and pace of a reduction in rates would remain data dependent, i.e. a strong indication that markets would continue to be held in thrall to monthly data releases. The end of an extraordinary period of policy intervention was in sight over the next few months, but we aren’t quite there yet. Markets gave two cheers for this message and ended the month on a positive note, but also with a modest undercurrent of uncertainty.

Putting together the multiple events of the last month and of summer as a whole, we still end up thinking that the outlook is one where the glass is half full, rather than half empty. Very soon the developed world will be well into a synchronised interest rate cutting cycle, most likely against a backdrop of still positive economic growth. This scenario is strong medicine for risk assets and goes a long way towards offsetting the event risks in political and economic activity.

Interestingly, stock and bond markets now appear to be negatively correlated – with bond rallies helping to offset the effects of stock market falls. This feature, alongside the attraction of alternative assets where appropriate, helps us to keep taking investment risk in your portfolios, whilst simultaneously being able to diversify that risk. Of all the investment rules we have come to learn in our careers, the benefit of diversification is by far the most effective tool we have at our disposal, and we will lean hard on it as we navigate the final months of an eventful year.