Brewin Dolphin: How Will Different Sectors Cope With Constant Political Risk?

Gilts

As concerns over global growth deepened, investors fled risky assets helping government bonds to rally at the end of the year.

UK gilts even managed to eke out a small positive return over the last 12 months to the end to December 2018, outperforming higher-yielding corporate bonds.

Inflation-linked government bonds started to look better value on a break-even basis in the US and Germany but remained fair value to rich in the UK.

Lower nominal yields, however, mean the risks continue to be skewed to the downside.

Corporate bonds

Year-to-date corporate bonds posted strong total returns across the full risk spectrum, while government bond prices slightly fell. 

However, we still believe fundamentals warrant a continuation of a cautious approach to corporate bonds, in particular US both investment grade and high yield.

UK Equities

The economic performance of the UK economy appears to have held up reasonably well since the decision to leave the European Union.

We are awaiting more clarity on the likely future relationship of the UK with Europe to determine the longer-term economic impact.

The market offers broad global exposure, with access to US earnings a particular positive given the strength of the economic recovery.

The UK market also provides a good dividend yield, which is attractive in the current environment of extremely low interest rates.

US Equities

Though slowing, the US economy continues to lead the developed world which is, in no small part, a result of President Donald Trump's more expansive fiscal agenda.

The recent dip in economic momentum, however, has encouraged a more cautious response from the Federal Reserve in normalising interest rates; a policy setting which should help extend the economic cycle and boost equities.

We also continue to favour the quality of earnings offered by US companies, where profitability looks more secure.

Europe ex UK Equities

Europe's growth slowed in 2018; Italy went into recession and Germany had flat GDP growth in the final quarter, leading to disappointing revenues and profits at European companies.

While the oil price remains relatively low and the euro has weakened, we do not expect these as stimulants to drive a reacceleration in growth in the near-term. Longer-term, Europe presents a higher political risk profile.

We have reduced our underweight because Europe is highly out of favour with investors, PMIs indicate the economic slow-down may have bottomed, while the European Central Bank in March indicated a significantly more dovish stance.

Japan Equities

The profitability of Japanese companies has improved significantly over recent years.

While this appears largely driven by their reducing tax burden, brought about by the reduction in corporate tax rates, there is at least anecdotal evidence that the reform agenda set out by Prime Minister Shinzo Abe's government is bringing about an improving corporate attitude and increased efficiencies.

Asia ex Japan Equities

Asian equity markets came under severe stress last year as a combination of a stronger dollar, more restrictive domestic policy in China and the growing Sino-US trade tensions weighed on asset markets.

Coming into 2019, there is evidence the bull market in the dollar may be losing steam, policy has turned more stimulative in China and there are tentative signs of progress in trade negotiations.

Therefore, the backdrop for the asset class appears more supportive whilst equity market valuations look relatively attractive.

Emerging Markets

Emerging markets remain a volatile asset class with performance swinging as sentiment towards global growth, Chinese growth and trade ebb and flow.

In the short term, the path of least resistance for the dollar is higher as US growth outstrips the rest of the world.

Over the medium term, however, the dollar could endure secular decline under the weight of debt raised to fund President Trump's deficit-busting fiscal programme.

Absolute Return

A weighting to absolute return will provide some diversification benefits to portfolios if equities and bonds sell off together.

Furthermore, an allocation to absolute return provides some optionality to benefit from the increase in volatility that we have been anticipating.

UK Property

Return expectations from the property sector have fallen as the retail sector continues to face structural challenges, and rental growth in the industrial and logistics sectors are likely to moderate.

Following the Brexit vote, the increased redemptions caused the majority of open ended 'bricks and mortar' property funds to suspend trading in order to protect shareholder interests. This makes allocation to the asset class a challenge in the current environment.

Cash

The return on cash is negligible. A position is required to provide portfolio liquidity and for opportunistic allocation if there is a market correction.