From Seneca Investment Managers' public marketing material. Seneca is now part of Momentum Global Investment Management.
Last year we laid out a road map for a gradual reduction in our funds’ equity exposure, firstly from overweight – in relation to strategic asset allocation (SAA) – towards neutral, then from neutral to underweight.
"That is not the way markets work"
In our latest reduction at the beginning of October, we reduced equity targets for our three public funds – LF Seneca Diversified Income Fund, LF Seneca Diversified Growth Fund, and Seneca Global Income and Growth Trust – to 32.5%, 47.5%, and 52.5% respectively. These positions represent underweights in relation to SAA of 7.5%, 12.5% and 7.5% respectively – the reason the growth fund’s underweight is greater than those of the other two is that it has no requirement to distribute income so can be higher conviction with respect to its tactical asset allocation.
It would be nice to think that we could know precisely when the next global equity bear market will start and move portfolios from being very overweight to very underweight the day before. Unfortunately, that is not the way markets work. Instead, one has to estimate, based on analysis, when it might start, then shift portfolio positioning gradually ahead of time. This allows for the virtual certainty that one’s estimate will be wrong – one will either be too late or too early. Too late and one will already have reduced. Too early and one can continue to reduce. But bear markets are like death and taxes – they are certain to happen. Thus, with asset allocation it is about the ‘what’ not the ‘when’.
In recent weeks and months, we have started to see comments from respected economists that appear to fall into the ‘this time it’s different’ bucket. Former US Fed Governor Ben Bernanke has warned against reading the wrong thing into the yield curve – in the past it has been a reliable predictor of recessions. Former US Treasury Secretary Larry Summers has argued that the relationship between employment and inflation – known as the Phillips Curve – appears to have broken down. More recently, Jerome Powell, current Fed Governor, has suggested that the expansion now underway in the United States can continue “effectively indefinitely”.
Given that business cycles – in which business and consumer confidence gradually improve from depressed levels following a downturn, then peak at a level from which the only way is down – are very real phenomena; it is always very dangerous to suggest that ‘this time is different’.
However, the temptation is to seek reasons why the party can last longer. That is, after all, human nature.
In the pessimists’ corner – the ‘this time is the same as last time, which is the same as the time before that, etc…’ camp – sits renowned economist Nouriel Roubini who is suggesting that a ‘perfect storm’ will hit the US economy in 2020, exacerbated by the first late cycle fiscal stimulus in history during peace time.
We share Roubini’s view that the US, and the world, economy will hit trouble in or around 2020, and are positioning our portfolios accordingly ahead of time.
Our approach is based on business cycle analysis that relates employment levels to wages to inflation to monetary policy to the performance of financial assets. There are logical links between each of these.
The three charts in this letter indicate that unemployment rates across the developed world have fallen to levels which are now causing wages to accelerate which in turn, in combination with the rising oil price, is putting upward pressure on inflation. It seems clear that inflation will continue to rise which, via tighter monetary policy and a higher price of money, will put further pressure on financial asset prices. It is also possible that the rise in inflation could turn out to be much more rapid than even the most pessimistic currently expect.
The great Sir John Templeton once said that the four most dangerous words in the English language are, ‘this time is different’. These are certainly words worth remembering in the current climate.
Published in Investment Letter, October 2018
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.