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Shift in market forces affecting investors’ focus on risk

27 December 2018

Political policy makers not central bank policy makers are now dominating markets, with investors focussed on new risks, says Anthony Rayner, manager of Miton’s multi asset fund range

The three concerns dogging markets not so long ago were supposedly higher US rates, a plummeting oil price and the US-China trade war.

The US Federal Reserve clearly signposted they were moving from being date-dependent to data-dependent, which is probably a sensible move in terms of where we are in the cycle. Interest rate rises being date-dependent served a purpose in the initial QE exit phase, to help reduce uncertainty around US monetary policy more broadly; but time has moved on and this approach had to end at some point.

Markets have since priced in a much more dovish rate cycle, and this makes some sense too. The latest US economic activity surveys look strong but interest rate sensitive sectors, like housing, are slowing, domestic financial conditions are tightening and the global economy has been slowing for some time too. The US is relatively self-reliant but doesn’t operate in a complete vacuum.

Meanwhile, the oil price has stabilised after its sharp fall lower and two key actors, the Saudis and the US, have suggested they’re comfortable with these levels. Additionally, a 90-day truce in the trade war has been declared between the US and China.

Stepping back, this environment underscores the broader move we’ve been talking about for some time. Markets have moved away from being dominated by central bank policy makers, to being dominated by political policy makers.

And the reaction from markets to having these concerns put on ice? In short, they have continued selling-off. Markets have simply turned to focus on new risks, for example the aborted parliamentary vote on Brexit.

So, maybe it’s not these concerns per se, but rather that markets are just focusing on risk more. Maybe it’s the slow grind of quantitative tightening in the background, in crude terms, just acting in reverse to QE. This is leading to the “survival of the fittest”, but what has this meant for asset classes?

With the benefit of hindsight, despite a broadly positive macro environment since the beginning of February this year, it’s been a fairly textbook response to risk-off. Within equities, defensives have outperformed cyclicals and US Treasuries have outperformed US high yield corporate bonds; in commodities, gold has answered its safe-haven calling, and in currencies the traditional safe havens of the Japanese yen, Swiss franc and the US dollar have outperformed most other major currencies.

Effect on asset classes

Importantly, that’s not to say these risk-off assets all made positive gains, but they did generally outperform risk-on assets. Just because they were the better place to be, doesn’t mean they preserved capital.

This raises two questions, for how long will markets be driven by risk-off characteristics, and will the market continue to be driven by textbook responses? Risk-off sentiment feels fairly embedded but, without stating the obvious, at some point that will turn. Meanwhile, until markets signal otherwise, we’d expect a fairly textbook response to continue. We expect geopolitics to continue to dominate and QT to produce a more demanding environment generally. As such, we continue to be broadly defensive but with an eye to opportunities.