Q2-2019 QUARTERLY PERSPECTIVES

Tavistock Wealth - Investment Team OutlookChristopher Peel - John Leiper - Andrew Pottie - Sekar Indran - Alex Livingstone

India Turnbull - Jonah Levy - James Peel

As the first quarter ends, government bond markets are priced for recession. In the US, Treasury yields declined, prompting an inversion in the curve for the first time since 2007. Bond yields are already negative in Japan, whilst in Europe the 10-year Bund yield fell below zero for the first time since 2016. Meanwhile, global equities appear to be ignoring the warning signs flashing in the bond market and have risen more than 12% in 2019 – the best start to a year in two decades. Our preference for risk assets and pro-cyclical positioning benefited the portfolios which performed in-line with our high expectations. During the quarter we added new positions in commodity equities, emerging markets and increased exposure to long-dated government bonds.

Chart of the Quarter The US Federal Reserve has indicated a pause in

the tightening cycle and the market has gone

from pricing in 1-2 rate hikes to a rate cut. The

rally in the US Treasury market seems excessive

given that the Fed has stated that further policy

movements will be data dependant. Job growth

remains above trend, unemployment is low and

inflation remains benign, so it’s too early to

conclude that the next movement in interest rates

is down.

Q2-2019 - QUARTERLY PERSPECTIVES

Welcome to the Q2-2019 ‘Quarterly Perspectives’ publication

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Previous Quarter Review

Key ThemesThe record setting equity bull market in the US has further to run, but higher returns will likely come from markets in the UK, Europe and Asia, specifically China and India. A rotation away from the US will probably occur over the next 12-months, the speed of which will be heavily influenced by 2nd and 3rd quarter company earnings. Real yields are low or negative in many developed markets and represent a poor store of value rather than a source of positive return. The leveraged loan, high yield and BBB sector of the corporate bond markets are particularly vulnerable to any economic headwinds or rise in the default rate. Within the FX markets, sterling is significantly undervalued and should appreciate by year-end.

Less Attractive More Attractive

Current Previous

GBPCASH

EQUITY

UK

US

EUROPE

JAPAN

ASIA PACIFIC ex JAPAN

EMERGING MARKETS

SMART BETA EXPOSURE

UK GILTS

US TREASURIES

INVESTMENT GRADE

HIGH YIELD

EMERGING MKT DEBT (HARD)

EMERGING MKT DEBT (LOCAL)

DURATION RISK

FIXEDINCOME

US DOLLAR

EURO

JAPANESE YEN

SWISS FRANC

CANADIAN DOLLAR

AUSTRALIAN DOLLAR

COMMODITIES

PROPERTY EQUITIESALTERNATIVES

CURRENCY(vs. GBP)

0

20

40

60

80

100

Jun 18 Jul 18 Aug 18 Sep 18 Oct 18 Nov 18 Dec 18 Jan 19 Feb 19 Mar 19

All Change: Fed Funds Predictions for 2019

Probability of Cut Probability of Hike

Source: Thomson Reuters Datastream / Tavistock Wealth / CME GroupDate of Data: 29/05/2018 - 08/04/2019

EquitiesGlobal equities rebounded strongly to record their best first quarter in over two decades. It is likely that further price appreciation will be more measured going into the second quarter.

Although the economic fundamentals in Europe remain soft, we see the divergence in growth prospects between Europe and the US narrowing over the next 12-months. This could lead to investors rotating out of the US and into cheaper European equities.

Within equities, our preferred region is emerging markets, particularly China where sentiment surrounding the US-China trade talks remains positive. Stronger than expected PMI data, the inclusion of Chinese “A shares” in the MSCI EM index and accommodative policy out of Beijing should continue to support the asset class into Q2. We also like Indian equities, which should outperform in the run up to elections.

Within our core smart beta equity allocation, ‘quality’ remains our preferred factor. This is because corporations with strong balance sheets are better placed to withstand downward pressure on earnings growth during the late stages of the economic cycle.

Q2-2019 - QUARTERLY PERSPECTIVES

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Liquidity is the major risk facing corporate bond markets. Over the last decade, changing regulatory requirements has contributed to a dramatic decrease in dealer inventory even as the value of outstanding US corporate debt has increased.

US equities have delivered positive returns during previous periods where the Federal Reserve has paused or reversed interest rate hikes. This theme looks set to continue following the Fed’s decision to pause interest rate hikes in January.

Fixed IncomeThe dovish pivot in global central bank policy contributed to strong first quarter returns in fixed income assets. Although we remain underweight duration our decision to increase exposure to long-dated government bonds in Europe and the US contributed disproportionately to total performance. Ongoing concerns surrounding liquidity in corporate bond markets means we continue to favour short duration investment grade and high yield debt.

Within fixed income our preferred region is emerging markets. Our decision to switch from local to hard currency debt in the second half of last year has worked particularly well. Going forward, we believe the sell-off in certain emerging market currencies may provide an attractive opportunity for local currency debt later this year.

Date of Data: 01/01/2001 - 01/04/2019Source: Thomson Reuters Datastream / Tavistock Wealth / SIMFA

Outstanding US Corp Bonds ($tn, LHS) Corporate Dealer Inventory ($bn, RHS)

Corporate Bond Market Liquidity

0

2

3

1

4

5

6

7

2002 2004 2006 2008 2010 2012 2014 2016 2018 0

50

100

150

200

250

300

80

90

100

110

120

130

140

150

80

90

100

110

120

130

140

150

0-2M-4M-6M-8M-10M-12M 2M 4M 6M 8M 10M 12M

December 1987 September 1995 March 2016 January 2019 Average

Source: Thomson Reuters Datastream / Tavistock Wealth

Months since pause

S&P 500 Around Mid-Cycle Fed Pauses/Easing Price Returns Index

Foreign ExchangeDespite falling US Treasury yields the US

dollar has remained relatively strong given

its positive yield differential relative to the

rest of the world. The Japanese yen on the

other hand has not fared so well given the

resurgence in global risk appetite. The Euro

also performed poorly this quarter, weighed

down by deteriorating economic data in the

region and ongoing political instability.

Sterling’s recent past and indefinite future

continue to be defined by Brexit, as the

uncertainty surrounding the UK’s departure

from the EU remains as unclear as the day the UK made the decision to leave the union close to 3 years ago. Year-to-date

sterling has made considerable gains against a basket of developed market currencies, benefiting our currency overlay

strategy, which continues to protect the portfolios from excess levels of volatility.

120

Sterling Trade Weighted Index

Date of data 31/03/2004 – 31/03/2019Source: Thomson Reuters Datastream / Tavistock Wealth

Sterling Trade Weighted Index Average of Trade Weighted Index

-1 0 1 2 3 4 5

EUR

CHF

JPY

USD

AUD

CAD

Sterling Versus Developed Market Currencies YTD4.46%

3.54%3.33%

2.15%

1.50%-0.03%

110

100

90

80

702006 2008 2010 2012 2014 2016 2018

CommoditiesCommodities have led this year’s market rebound following Q4 2018’s heavy losses. Optimism surrounding the US-China trade talks has bolstered the asset class, particularly in the energy and base metals sectors. We are positioned for a trade deal, which would be bullish for the asset class. In the US, the Fed has gone into “patient” mode and announced that there will be no rate hikes in 2019. This dovish policy should lead to a marginally weaker dollar and higher commodity prices.

Oil prices have rallied for 4 straight months following OPEC+ cuts, US sanctions against Iran and Venezuela and growing (albeit slowing) global GDP. These drivers are expected to continue through Q2 2019. However, record crude production levels from the US may limit further price appreciation. This quarter we initiated a new position in an ETF which tracks companies in the global timber and forestry industries. These sectors are strongly correlated to housing and construction, emerging markets and a weaker US dollar – all of which stand to benefit from the Fed ‘pause’.

Q2-2019 - QUARTERLY PERSPECTIVES

The Global Timber and Forestry ETF has lagged broader equity market gains so far this year offering considerable upside potential. This position is sensitive to global growth and should outperform in an environment of low interest rates and a return to above trend growth later in the year.

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4600

5000

5600

4800

5200

5400

1600

1800

2100

1700

1900

2000

2200

2300

iShares MSCI World GBP Hedged (LHS) iShares Global Timber & Forestry ETF (RHS)

Source: Thomson Reuters Datastream / Tavistock WealthDate of Data: 10/04/2017 - 15/04/2019

Global Timber & Forestry ETF

Bought

2017 2018 2019

As Brexit uncertainty continues to fade we forecast further gains in sterling against the developed market currencies we actively hedge in the portfolio.

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This investment Blog is published and provided for informational purposes only. The information in the Blog constitutes the author’s own opinions. None of the information contained in the Blog constitutes a recommendation that any particular investment strategy is suitable for any specific person. Source of data: Tavistock Wealth Limited , Lipper for Investment Management and Thomson Reuters Datastream.

Date of data: 18th April 2019 unless otherwise stated.

Q2-2019 - QUARTERLY PERSPECTIVES

Final Thoughts

The global economy decelerated in the 2nd half of last year and the International Monetary Fund recently revised its growth forecast downward from 3.5% to 3.3% in 2019. This is far short of predicting a recession and the dovish policy changes by the Fed and the ECB push the cyclical time frame back even further. Equity and bond markets performed very well during the 1st quarter and further price appreciation will be more measured. We are positioned for a positive outcome to the US-China trade talks and that this will eventually lead to an increase in global trade. In this scenario, risk assets such as equities have further upside, however corporate bonds remain vulnerable given the size of the market and largescale refinancing requirements. Looking ahead, volatility is expected to rise and portfolio diversification between and within assets classes will be even more crucial in the coming months.

Over the next 5-years, equities are expected to offer greater risk-adjusted returns than fixed income. As a result we have increased our strategic risk allocation to this asset class. However, volatility is unlikely to stay at low-levels as we slowly return to historical norms, making tactical asset allocation decisions increasingly important.

Fixed Income Equities CashSource: Thomson Reuters Datastream / Blackrock / Tavistock Wealth

Date of Data: 31/12/18

Expe

cted

Ann

ualis

ed B

eta

Retu

rn

Expected Annualised Volatility

TreasuriesCash

Ex-gov US Bonds

0% 5% 10% 15% 20% 25%0%

2%

4%

6%

8%

10%EM EquityEx-US Large Caps

Small Caps

Large Caps

Long CreditLong US Treasuries

Local EM DebtUSD EM Debt

US High Yield

Bank LoansTIPS

Asset Class Return & Volatility Expectations (5 Year)