These are the questions top mind for many investors at the moment. says Anthony Rayner, Fund Manager, Premier Miton Macro Thematic Multi Asset Team.
This question comes up at some point in pretty much every client meeting at the moment and, understandably so, with many financial assets at, or close to, record highs. Indeed, it’s not just equity markets, precious metals too. Oil is the notable exception.
Somewhat unusually, all this at a time when there is less visibility for investors in very important areas like the US economic environment and the Fed outlook. News flow on US economic data has been thin on the ground because of the Government shut down. Meanwhile, the outlook for US central bank policy is muddied by concerns over a weaker jobs markets, arguing for lower rates, while elevated inflation is pushing for higher rates. This general lack of visibility is further compounded by the recent politicisation of the Fed.
So why are asset prices so lofty? This brings us to AI, where there is a high level of newsflow, although not necessarily high levels of visibility. We would argue that if it looks like a bubble and smells like a bubble, then it probably is. There are three basic factors to look for when trying to identify a bubble. Firstly, the shape of the price movement is looking increasingly bubble/exponential like in nature. Secondly, there has been a genuine innovation, namely AI, and thirdly, liquidity is plentiful, and it has to go somewhere.
However, despite their reputation, bubbles are not all bad and, from an investment point of view, bubbles tend to go on for much longer than most investors think. Therefore, it doesn’t pay to be too pre-emptive, even if it has all the hallmarks of a bubble.
However, it’s not just AI and AI-related investments that have risen sharply. With the exception of oil, it looks a bit like another “everything rally” and, if there are few assets looking like diversifiers, this makes it even harder to position portfolios. For example, government and corporate bonds have also had a decent year.
Some investors look for so called alternatives. This always feels like a marketing phrase to us. All assets are made up, to varying degrees, of equity beta, credit risk or interest rate risk, ironically there is no alternative to these elements. Other investors look for complex derivatives to provide the silver bullet, though visibility is often poor and historically they haven’t covered themselves in glory.
Our philosophy is to participate in the upside but have high levels of liquidity across positions so that when the market does correct, we can adjust quickly. More specifically, from a bottom up perspective we limit stock specific risk and from a top down perspective we try to balance macro and thematic risks. In aggregate, sometimes we won’t be taking enough risk and other times, probably like now, we have to be cautious of taking too much.
We can’t know when we will get a correction, what the cause of it will be or how it will play out. However, we probably can assume that those stocks that have gone up the most, will likely fall the most, at least in the first instance. Therefore, in these types of situations, we look to minimise mean reversion risk. In practice, valuations and position contribution to portfolio risk can be a good starting point to understand mean reversion risk across portfolio positions.
Using these techniques, we are guided to reducing longer term momentum and adding to shorter term momentum. As such, we have been trimming our tech exposure and our precious metals exposure. We still have a decent exposure to equity, as our bias is to participate, but it is reduced in aggregate and the mix has started to change. For example in addition to reducing new economy stocks, we have been adding to old economy stocks, such as oils and miners, which have shorter term momentum.
As discussed, our commodities exposure includes a reduced exposure to gold, due to its run up and recent volatility (up as well as down), but we continue to hold industrial metals and agricultural commodities ETCs, as diversifiers. In bonds, we remain short duration on average, with a bias to good quality credit and, whilst this might not act as diversifiers per se, there will be some dilution of equity market volatility. In addition, more recently we have initiated small positions in a long maturity US Treasury and Gilt, which should help across a range of market conditions.
This information should not be relied upon by retail clients or investment professionals. The views provided are those of the author at the time of writing and do not constitute advice. These views are subject to change and do not necessarily reflect the views of Premier Miton Investors. Capital at Risk. The value of investments may fluctuate which will cause fund prices to fall as well as rise and investors may not get back the original amount invested. Past performance is not a reliable indicator of future returns.
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