US equities and bonds - Investing in a shifting landscape

05/06/2018

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​Impressed by the resilience of the markets, portfolio manager Marc Pinto explains why he believes that investors should not be deterred by higher volatility, given the favorable backdrop for equities. Meanwhile, Darrell Watters, Head of US Fundamental Fixed Income, expects a difficult environment for credit markets.

Why did both fixed income and equity assets sell off in early 2018?

The primary factor was the unwinding of existing stimulus measures. The US Federal Reserve (Fed) reduced its balance sheet and raised interest rates, the European Central Bank signalled that it will move toward normalising monetary policy and the Bank of Japan subtly reduced its own asset purchase programme. During times of uncertainty, it is natural for stock valuations to adjust down as the pool of invested money shrinks. The Fed’s perception as overly hawkish also caused concerns that the central bank might inadvertently put the brakes on the economic expansion.

What could help push US equities higher this year?

Sustained economic growth, along with continued strength in company earnings, could continue to boost stock prices. Corporate tax reform should also aid cash flow, which could allow companies to enact aggressive capital return plans, such as higher dividends and share buybacks. It would also help if the US government minimised geopolitical threats and the Fed did not overstep its bounds. Market volatility has returned, but we continue to be impressed by the resilience of markets.

Is higher inflation likely to come through later in 2018?

There is room for inflation to go higher, but we do not expect to see any kind of significant inflation shock. Technological advances, especially, should help to keep inflation in check as they help companies to navigate labour market shortages (a lack of suitable skilled workers) and higher employee costs. Other factors that could support higher inflation, like strengthening crude oil or wages, are unlikely to have outsized impacts. Oil, for example, now makes up a smaller percentage of consumers’ spending than it did a decade ago, when prices were at the same level.

How are digitalisation and the subsequent disruption to business models creating investment opportunities in equities?

The disintermediation of traditional industries is creating many opportunities. For example, the shift from traditional retail to e-commerce may allow investors to capitalise on consumers’ changing habits. Similarly, in our view the continued adoption of cloud technology, which helps companies to run more efficiently, offers attractive potential.

Where are you finding fixed income opportunities amid rising rates?

When seeking new opportunities, our first question is if a security can deliver a reasonably positive return as interest rates go higher, so we are seeking to avoid duration risk. We remain focused on companies that we think have strong asset bases, management teams and balance sheets.

 

Glossary

Monetary policy: The actions of a central bank to control the cost of short-term borrowing or size/rate of growth of the money supply.

Duration risk: The sensitivity of a fixed income security (bond) to any change in interest rates.

Balance sheet: A financial statement that summarises the assets and liabilities of a company (or country) at a particular point in time.

Volatility: The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility. If the price moves more slowly and to a lesser extent, it has lower volatility.


 

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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Our investment managers outline the risks and opportunities for the rest of 2018.




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