Holding cash rather than government bonds, the unnecessary economic pain of trade wars and the defensive potential of US tech are some of the themes that asset manager Rathbones thinks investors should be paying attention to. 

As we move through the final quarter of the year, investors have plenty of headwinds to keep their eyes on – including but not limited to Brexit, the US-China trade war, slowing economic growth and geopolitical tensions in the Middle East.

With this in mind, asset allocators at Rathbones revealed the five key issues that are shaping the firm’s current investment strategy.

Theme 1: Rethinking tech

The first theme highlighted by the group’s strategists is US technology stocks, which they argue are not only attractively disruptive but also have some defensive characteristics.

The S&P 500 has outperformed its international peers by a significant margin over the past decade but, as the chart below shows, this has been led by its tech sector.

Stock market total returns (%, in local currency)

Source: Datastream, Rathbones

“Tech champions like Microsoft, Facebook and Alphabet meet the requirements for an ideal business set out by investor Warren Buffett – they need very little equity capital to grow and provide jam today and tomorrow,” Rathbones said.

Despite this, critics argue that US stocks look overvalued relative to other parts of the global stock market while some suggest tech companies are especially sensitive to any slowing in the economy.

Rathbones remains confident, though. “Earnings in the tech sector fell less than earnings for the overall S&P 500 index in 2009 following the global financial crisis,” it said.

“Other risks include overstretched valuations, obsolescence and anti-trust regulations. However, we think the US will remain the engine room of global capitalism and for that reason it merits strong representation in equity portfolios.”

Theme 2: Cash is king

Investors often use the phrase ‘cash is king’ when they consider the price of other assets to be stretched and they believe better opportunities will be abound when prices start to fall.

Rathbones’ strategists said: “This is very much a ‘cash is king’ moment – we would argue that government bond yields are unsustainably low. Some $15trn of global debt is now trading with negative yields.”

In the decade since the global financial crisis, central banks have lowered interest rates so drastically that there appears to be nowhere else for them to go but into negative territory.

There’s also the question of ‘the cost of carry’, which is the cost of holding an asset including financial costs like interest rates and storage costs such as storing commodities in a warehouse.

The strategists pointed out that assets with a negative yield often have a large cost of carry compared with those that make a positive return. In the case of government bonds – a traditional safe-haven holding – negative interest rates add to their cost of carry.

“Given the steep fall in yields, there is a risk that UK yields could rise sharply – or prices fall – for example, if Brexit goes more smoothly than expected,” they added.

“With the global economy slowing, and an outside chance of recession, there may be better opportunities for those who wait to invest their cash.”

Theme 3: Revenge of the bond nerds

Rathbones’ third theme focuses on how an inverted yield curve is capturing plenty of market attention. A typical yield curve – which is a chart looking at government bond yields offered by the time to maturity – is upward-sloping in normal circumstances but this year has inverted to slope downwards.

This is important as the last nine recessions have all been preceded by an ‘inverted’ yield curve in the US. What’s more, it has only inverted twice in the past 60 years without a recession following.

Yield curve inversion and recessions

Source: Datastream, Rathbones

“There is one thing that a yield curve inversion can’t help with though: timing,” the strategists said. “The yield curve can tell you what’s in front of it, but not how far away it is. And the time between a yield curve inversion and recession tends to be long (about 14 to 15 months, on average).”

They added that Europe “looks like the weakest link” amid the deteriorating environment facing the world’s major economies. But despite this, they do not see a significant risk of Europe’s weakness being severe enough to push it into a protracted Japan-style deflationary bust.

Theme 4: Sustainable investing

Another theme that Rathbones expects to become increasingly important is sustainable investing or addressing the challenge of “how to solve the world’s problems and turn a profit”.

“Responsible investing isn’t all about the risks,” the strategists said. “Increasingly, people are starting to cotton-on to the massive challenges that face our society and they are demanding change. Businesses have an enormous part to play in this.”

They gave the example of how the demand on the Earth’s fresh water supplies is expected to grow significantly as the population increases and developing nations become richer.

This is creating opportunities for investing in companies that are using technology to meet this challenge, such as by developing new water treatment processes or helping farmers grow food – a more efficient use of water.

But Rathbones’ strategists added: “It’s not about companies that ‘pivot’ to tech – that pretend to be something they’re not. You need to look for those companies that are taking good technology out into the world to solve real problems.”

Theme 5: Trade wars

The final theme highlighted in the outlook is the impact that the US’ trade war with China is having – and the suggestion that it could just be causing “economic pain without any gain”.

Research by the US Federal Reserve suggests that the level of global GDP growth was lowered by 0.8 percentage points in the first six months of 2019 because of trade policy uncertainty.

Meanwhile, the US National Bureau of Economic Research argued that US tariffs have largely been passed on through domestic prices, hitting consumers and importers.

Its figures suggest that after negotiations between the US and China broke down in May and tariffs on $200bn of Chinese imports increased from 10 per cent to 25 per cent, the typical US household was hit with an annual cost of $831 as a result.

World trade and industrial production

Source: Netherlands Bureau for Economic Policy Analysis, Haver Analytics

“Evidence is mounting that American protectionism is lowering global economic growth compared with what it would’ve been without all the trade uncertainty that comes with it. It may also be hurting the very people it’s purported to help,” the group’s strategists explained.

“The practice of shielding a country’s industry from foreign competition through tariffs and other barriers to free trade brings large, ostensible gains to relatively small industries or segments of the population. But at the same time it delivers a small, hard-to-quantify loss for every member of a large and silent majority.”