Columbia Threadneedle Investments is becoming “increasingly mindful” of the threats to risk assets, according to its chief investment officer, who warns that they could enter a “turbulent place” during the next six months. 
Mark Burgess, chief investment officer for EMEA and global head of equities at Columbia Threadneedle Investments, says factors such as the weak pound, signs that the credit cycle is approaching its end and large swathes of the government bond market trading at negative yields mean that greater caution is warranted from here.
Reviewing the recent period, Burgess points out that it was widely expected sterling would come under pressure if the UK voted to leave the European Union but the extent of its devaluation has surprised many analysts, who did not foresee investors fleeing the currency so much.
“The flipside is that both equities and fixed income markets have performed above expectations, largely as a result of ongoing quantitative easing and central bank intervention, both by the Bank of England and the European Central Bank,” he added.
Performance of indices and US dollar over 2016
Source: FE Analytics
However, the CIO believes that a material change to the status quo – and the implementation of fiscal easing in a bid to stimulate still-flagging economies appears to be one of the most likely – could lead to significant problems for risk assts.
“There is a rising fear that the theory of central bank intervention is not matching the reality in so much as ongoing monetary stimulus may be harming markets as much as it is helping them – certainly monetary stimulus is doing little to boost productivity growth,” he said.
“Against that backdrop, if inflation were to pick up and interest rates were to rise, there could be significant implications for risk assets, given how a yield-starved world has been forced to hunt for returns everywhere else.
“We have clearly had an extremely reassuring central bank 'comfort blanket' put around what, on the face of it, look to be very expensive risk assets; and this has underpinned valuations and helped us navigate through a challenging macro-economic and geo-political backdrop. As a result, people have become used to explaining away what in absolute and historic terms look to be expensive valuations, by referencing the bond market at all times.
“That to me feels relatively fragile and if you overlay that with an increasing recognition that monetary policy is doing bad things as well as good things, along with socio-economic tensions globally, then the cry for a fiscal response must be on the increase.”
Performance of indices since 1 Jan 2008
Source: FE Analytics
Looking to the US, Burgess notes that both the Democrats and Republicans appear to have a stronger appetite for fiscal stimulus than they might have in the past, although this looks unlikely in the short term owing to ongoing political polarisation.
Closer to home, the UK’s Autumn Statement – which will be held on 23 November – could see some fiscal easing being announced, given how critical the government has been of the Bank of England’s monetary measures recently. There are also strong arguments for fiscal stimulus in Japan and Europe.
Should fiscal easing be unleashed, then it is highly likely that curves in the bond market would steepen materially and this would impact other assets where relative valuations are referenced to bond yields – such as equities.
“While our central case is that the status quo is maintained and we continue to experience low inflation, low growth and low interest rates, we are mindful that if growth picks up on the back of increased fiscal stimulus, the interest rate environment is challenged for the same reason and the current valuation of risk assets is contested, we could see a dislocation in markets,” Burgess said.
“This ultimately depends on bond yields rising, how quickly they might do so and where we ultimately end up, but the worst-case scenario is that risk assets become a turbulent place to be in the next six months.
“A significant pick-up in inflation is one factor that could challenge the status quo, so our thoughts have turned to whether the world is being too complacent about inflation.”
The UK has already seen inflation tick up following the Brexit referendum result while the US has mild stagflationary pressures. This could prompt the Federal Reserve to lift rates in December, which would likely increase volatility across risk assets.
Columbia Threadneedle’s asset allocation grid
Source: Columbia Threadneedle Investments, as at 20 October 2016
Given this backdrop, Columbia Threadneedle remains neutral and cautious on equities from an asset allocation point of view. However, it is seeing “pockets of opportunity” in some areas, especially Asian emerging markets.