BlackRock trio Pierre Sarrau (pictured), deputy chief investment officer, multi-asset strategies, Adam Ryan, head of diversified strategies, and Sara Morgan, managing director, diversified strategies, offer their views on current trends in multi-asset investing
First came the global financial crisis. Then the European debt crisis. Now it is trouble in China that has spooked markets and hurt global growth prospects. The impact of the slowdown in the Chinese economy on the rest of the world is unclear.
There is a reasonable chance the current gloom around China is overdone – as was the exuberance of a few months ago. However, confusion around the actions and intents of Chinese policymakers is creating anxiety. The task of transitioning China to a service-led economy is a mammoth one – there is plenty that could go wrong. What we do know is that there will be implications for those economies who are net exporters to China and for commodity prices that are already under pressure.
|"These days, portfolios can be bolstered with alpha strategies, property and infrastructure – to name but three extra asset classes" |
Central bank infatuation
Disappointing prospects for global growth are nothing new in the post-crisis world. Since 2011, there have been serial downgrades of the global growth outlook. Inflation, and expectations of inflation, remain low, despite the unprecedented intervention of central banks following the global financial crisis.
Such intervention has created markets that are, in our view, overly obsessed by what central bankers may or may not do. Every policymaker speech is scrutinised for semantic nuances; every data point provokes a reaction.
When monetary policy is the focal point of positioning across asset classes, extreme consensus build-up provides fertile ground for short, sharp shocks of volatility – particularly when the data policymakers focus on continues to be mixed.
US non-farm payrolls is a great case in point – the August headline reading came in under expectations, but overall the report suggested an ongoing improvement in the US labour market in the run-up to the September Federal Open Market Committee (FOMC) meeting.
After that, the September headline figure surprised on the downside, the August number was revised down, and wages and unemployment were flat. Inevitably, expectations around a Federal Reserve rate rise have been pushed out beyond the end of the year. Markets sold off following the release; US domestic growth fears have been added to this summer’s worries about the global economy.
It was only a matter of time before the rising volatility in credit, rates and foreign exchange markets this year spilled over into equities. In August, the third longest bull run for stocks in history came to an abrupt end as equity volatility, as measured by the VIX ‘fear index’ spiked to levels not seen since November 2011. ‘Volatility of volatility’ – which can be simply interpreted as where investors expect volatility to be in the future – reached all-time highs, according to Bloomberg data.
With the prospect of a US rate rise pushed out, global monetary policy will continue to be the key driver of markets. That means more consensus build up, more ‘data dependency’ and therefore more volatility. Investor confidence is fragile and easily shaken, but it is difficult to point to a specific reason as to why global growth is disappointing.
Perhaps this is why markets are so obsessed by near-term economic indicators – it is all they have to hold on to. Such obsessive behaviour creates something of a self-fulfilling spiral. Asset prices are falling because of a deteriorating outlook. And how do we know that the outlook is deteriorating? Because asset prices are falling …
Good news among the bad
Amid the volatility and global growth fears, there are still reasons to be positive. For instance, though China faces a monumental challenge, we should remember it is transitioning to a service-led economy; policymaker – and therefore market – focus on weakening industrial and manufacturing data may be misplaced. The People’s Bank of China also appears to have more policy tools left in its toolkit than possibly any other major central bank.
Up until the latest non-farm payroll report, macroeconomic and labour market data in the US pointed towards a broad-based and sustained economic recovery. We were somewhat surprised, therefore, by the Fed’s focus on the international picture and near-term volatility at the September FOMC meeting – not least because of the insulated nature of the US economy: around 80% of US GDP is generated domestically.
However, suggestions the US needs another dose of QE, though at the extreme end of the range of views on the US economy, demonstrate just how difficult all major central banks are finding it to tighten policy. Andy Haldane, chief economist at the Bank of England, said in September there could be “a need to loosen rather than tighten the monetary reins as a next step to support UK growth and return inflation to target”.
In Europe, a domestic recovery, albeit fragile, is underway. However, Europe is more exposed to the global economy – particularly emerging markets – than the US, so European Central Bank (ECB) president Mario Draghi’s emphasis on the open-ended, flexible nature of its already sizeable QE programme in response to global events is perhaps more understandable.
Currency dynamics – particularly worries about a strengthening euro in the wake of the Fed’s decision – may see Draghi ramping up the rhetoric around more QE over the next few ECB meetings, particularly given the –0.1% inflation reading in September. At a global level, monetary policy remains easy and central bankers the major players in markets.
What could investors do?
As volatility rises, so too does the need for truly diversified portfolios. Investors also need agility, because heightened volatility typically leads to more dispersion between asset classes, regions, countries and sectors. Dispersion is not something to fear – it throws up idiosyncratic opportunities for those flexible enough with their asset allocation and shrewd enough to look beyond traditional investments.
Uncertainty hits home the need to:
* Invest more broadly across asset classes and geographies.
* Go deeper into capital structures.
* Have sophisticated risk controls to monitor – and mitigate – complex portfolio threats.