I am writing today to keep you up to date on how we are positioning portfolios in the run up to the potential Brexit deadline of 31st October (although keeping in mind this is not the first Brexit deadline we have seen, and may not be the last) and in light of some weakening economic data.
The slowdown in the global economy continues and the chances of a recession developing are increasing. Some countries such as Germany are probably already in recession, that is have a shrinking economy. However, even if recessionary conditions spread to other nations, we expect the extent of the economic contraction to be shallow and well short of what occurred in 2008/9. Nonetheless, the knock to companies’ profits would be felt by the stock market and equity prices would fall.
Against this backdrop, equity yields are generous when compared to virtually every other financial asset. We are by no means certain that a recession will develop in the US and if that pivotal economy can continue to grow, equity markets have the potential to make further modest gains over the next couple of years. Therefore, rather than reducing equity exposure, we are making changes to the portfolio to limit the damage that a recession might bring.
Yields on government bonds around the world are at tiny levels. UK gilt yields are now virtually non-existent and the government is able to borrow at long term interest rates of well below 1%.
On such yields, any capital gain potential if a recession does strike will be small. US bonds yields are more generous at a little below 2%. This means that if the US falls into recession, US Treasury bonds can potentially deliver a worthwhile capital gain. Thus, US government bonds appear to be a better option for the portfolio.
As we have no wish to take any currency risk on this position, we are buying the sterling hedged Vanguard US Government Bond Index fund. If global growth rebounds, the price of this fund is likely to fall, however, the equity positions held in the portfolio should gain to a far greater extent.
We will of course be watching events closely over the coming weeks and I shall write again if we feel that any further changes are required in the portfolios.
If you have any questions on the above, please do not hesitate to get in touch with us.
The Buckingham Gate Investment Committee