Whilst we try not to be short-term in our thinking, given the extreme market movements over the past few days we thought it would be helpful to provide a brief update to address investor concerns about the recent market falls and the effects these are having on portfolios.
Markets have had a horrible few days as a result of the widespread Tariff announcements by the US last Thursday. Tariffs had been anticipated but the scale, speed and breadth were worse than most expected. The UK escaped relatively lightly with a 10% rate but this is still small comfort for car makers and steel producers facing an extra 25% as well as the many multi-national firms listed on the FTSE 100 where tariff exposure is more complicated.
Tariffs are generally bad news for all involved. Inflationary in the medium term, with the risk of retaliation, escalation and supply chain shocks, as well as the uncertainty these may cause, likely to deter companies and individuals from making big capital expenditure decisions – this is then more damaging for longer term growth and innovation. If CEOs, consumers and politicians sit on their hands waiting to see what happens next, economies stagnate, increasing the chances of recession. We have been mindful of recession risk for some time, but the likelihood has just increased.
Over the past 18 months we have gradually been taking profits from more highly valued (expensive) parts of the equity market and using those to build the bond content within portfolios for their defensive characteristics by adding investment grade and government bonds. Where one would historically allocate to higher yield (but often lower quality) bonds, we have been investing in real assets, such as infrastructure and specialist property which have mainly proved to be relatively resilient recently. These asset classes, where returns are predominantly derived through reliable income streams rather than prospective future growth, are adding some stability at present and continue to offer reasonable income yields.
We have also been relatively underweight the US for a while, as we have been wary of excessive valuations from the Large Cap US Tech companies, preferring the more reasonable valuations in the UK and Europe. We have also had very little direct exposure to China which has been particularly hard hit and retaliated immediately which may lead to further tariff escalation. This positioning should help shield portfolios from the worst effects once markets settle, but in the short term the sell off in equity markets has been quite widespread.
We are firm advocates of diversification for precisely times such as these. In the immediate aftermath of a significant market shock the benefits are not always obvious, but a diversified portfolio of sensibly priced assets and companies that produce reliable profits should start to find their level after the initial knee-jerk reactions have played out.
We expect volatility to continue in the near term, as the world digests the news and adjusts accordingly, but where there is volatility and change there are often also new opportunities.
What are we doing about it?
Much of what we do in investment and portfolio management is predicated on trying to avoid acting on the most normal human emotions, to which we are all prone. The temptation is to extrapolate recent falls in value and assume they will continue downwards unchecked. This is almost always wrong. Markets turn quickly and it is better to remind oneself that the long pattern of history shows that markets trend upwards over time albeit with unsettling bumps along the way of which this is certainly one!
The big mistake is to overreact and sell in these scenarios; it is almost impossible to benefit from trying to sell once the market has started falling, the investment phrase often used is, ‘trying to catch a falling knife’ which is always a dangerous pastime. Markets often bounce back faster than one expects and the more damaging risk to long term growth and wealth is turning a paper loss into a real loss and missing out on the recovery.
Looking ahead, we do have some useful tools in the toolkit:
Active Management
One of the reasons we favour actively managed funds over index trackers is that they provide an added level of selection and scrutiny within your portfolio. Index trackers are generally cheaper but are indiscriminate buyers (and sellers) and, in recent years, most US and Global trackers have become disproportionately weighted to the most expensive shares i.e. those most vulnerable to a shock. As well as providing some defence in a downturn, good active managers will also be looking at these markets as an opportunity to buy good companies at distressed prices enhancing the upside when markets settle down.
Geographical Diversification
The tariff announcements have shaken existing trade relationships, but it is likely that other new alliances will form. It has often been said that the EU moves forward one crisis at a time, and with two in as many months (defence spending and tariffs) this may herald a time of increased cooperation and structural and economic reform – with that comes opportunity. A similar picture seems to be emerging in Asia. Even for the UK there is a glimmer of hope that there might be a new sense of urgency and willingness in striking trade deals that have been in long gestation since Brexit.
Bad news as good news
It is too early to predict, but worth noting that developed economies are in a position to simulate growth if it falters. The inflationary nature of tariffs makes this complicated, but Central Banks have scope to cut interest rates to stimulate growth if needed. The expectations for rate cuts had slowed over the past 9 months but these may be put back on the table which would be good for almost all asset classes and portfolios.
In summary
The key message in volatile markets is not to panic; this is a time to put on the tin hat and wait for the artillery barrage to pass. In the meantime, we will be working hard to understand the full implications of this new phase in markets. As always, we will be taking stock of current positions and re-examining the rationale for each fund and sector we invest in and trying to take a long-term view on whether/how the tariffs and new world order materially change our investment thesis. We will of course recommend changes if we think they are needed at that point, but we will also be looking for the new opportunities that will inevitably arise.
Please do ring or email us if you have any questions or if you would like to discuss your own circumstances and investments.
This note is intended as a general market update and should not be regarded as specific advice or treated as a recommendation to invest in any particular fund or asset class. Stock market investments can fall as well as rise. If you would like to discuss the implications for your own portfolio, please do get in touch.