By Abhi Chatterjee, Chief Investment Strategist at Dynamic Planner
Since September 2024, there has been a marked increase in yields in the Fixed Income markets. Within the UK and its popular press, the move in UK Gilts has featured prominently with lengthy discussions on the whys and therefore, but when placed in the global perspective, the move is not singular. At Dynamic Planner, instead of concentrating on a single maturity point or issue, we consider a fixed income index and its redemption yield – the combined yield to maturity of the basket of issuances which is representative of the asset class – as the appropriate representative of investing in the particular fixed income asset class. Figure 1 and Figure 2 shows the changes in yields on the representative baskets of UK Gilts and Global Government Bonds, as well as the Sterling Investment Grade Corporate and Global Corporate Bonds.
An interesting case in point has been that both the UK and Government Bond yields have risen, with the Global Bonds rising slightly lower than their UK counterparts. Even if we did concentrate on the 10Y Benchmark rates in the UK and the US, Figure 3 shows that the yields on these have increased almost in lock step. This raises the question as to why the focus is on the UK Gilts in particular.
Let us consider the macro-economic back drop. Both the US and UK economies have been through a change of government. The Labour government in the UK has enacted a change in the business of government – a bold plan to invest in growth, combined with raising the taxes primarily on corporates outlined in the Autumn Budget. This is expected to inflationary by some quarters, with negative chatter around a “stagflationary” outlook impairing bond yield. The US has also seen its fair share of change, with an overwhelming majority for Republicans. The resultant Trumpian policies are also considered inflationary, with the possibility of tariffs being placed on countries deemed to be involved unfair business practices or running a high trade deficit. The only difference with the UK is the US exceptionalism, fuelled by sterling growth, tight labour markets and expected tax and government spending cuts proposed by the incoming US administration. In both cases, given that growth plans in the UK and the tax cuts in the US have to be funded, this raises questions about debt sustainability in all economies. Bond yields ebb and flow – as long as there is none of the disorderly rout one remembers from Liz Truss’s disastrous “mini” budget, one can expect as plans become reality, the market will incorporate all the information within to settle at the “new neutral”. In passing, it must be mentioned that UK Gilts now is quite near what they were when the last Labour Government under Tony Blair took power and what followed was a decade of UK exceptionalism with high growth and productivity, based on their “Tax and Spend” policies.
Let us now look to our current allocations and the impacts there of. Since 2017, we have been on the path of globalising our portfolio – increasing decreasing the “home bias” in the assets invested into a more globally oriented allocation. As mentioned during the previous “News from the IC”, while we do not endorse the between 5-7% allocation in either Fixed Income and Equities to the UK, which seems to be the norm. We felt that while there is optimism around UK Plc, given the supportive comments from the Labour Government, it was felt that the companies that would receive a boost from these would be the Mid and Small Cap companies which derive the primary revenues from UK. The proportion of these companies in the broad UK benchmark is small – thus allocating a higher proportion to UK equities was felt to be inefficient. In addition, with UK economy in a quagmire, the Investment Committee also felt that Global fixed income provided better risk-reward characteristics to UK fixed income.
Figure 5 shows the broad changes made during our last review of allocations in Q3 2024. The impact of the changes in Fixed Income Allocations can be seen in Figure 6.
As can be seen our shift in allocations has neutralised the impact of the drop in UK Gilts – the lowest negative is in Risk Profile 6 which stands at 0.16bps. The primary benefit to the allocations has been the drop in the Sterling, which fell from $1.31 in September 2024 to $1.22 in January 2025, a drop of around 6.8%. In a scenario such as this, foreign assets priced in Sterling, as our Global fixed income asset classes, become more expensive giving us a boost in returns, as can be seen in the change in prices of the foreign assets.
In conclusion, our allocation changes, made in line with the expectations about the macro environment, have proved resilient to the vagaries of the fixed income market. We will continue to monitor our allocations and updated our clients periodically.
Basis of Preparation and Use
You should not rely on this information in making an investment decision and it does not constitute a recommendation or advice in the selection of a specific investment or class of investments.
The information does not indicate a promise, forecast, or illustration of future volatility or returns. The outputs represent a range of possible indications of volatility and returns for various collections of asset classes. Dynamic Planner Ltd is not liable for the data in respect of direct or consequential loss attaching to the use of or reliance upon this information.
Dynamic Planner does not warrant or claim that the information in this document or any associated form is compliant with obligations governing the provision of advice or the promotion of products as defined by the Financial Services Act.
With 2024 the year of elections and approximately 25% of the global population exercising their right to vote, the potential outcomes and a combination of change and uncertainty are still evolving. As the dust settles, Abhi Chatterjee, Chief Investment Strategist at Dynamic Planner, the UK’s leading digital advice platform, has outlined what he expects to play out for markets as the world moves into 2025:
- Government change across 25% of the world means change in macroeconomic policy bringing uncertainty and volatility
- Shifting sands of trade policy between US and China could lead to higher prices as globalisation grinds to a halt hampering growth in export economies
- Two distinct themes: government issuance will see heightened risk; corporates will continue to be buoyant whether fixed income or equities
“Looking forward to 2025, a major source of influence on macroeconomic outcomes will be governments. Elections have taken place around the world, from the US to the UK, India and across Europe, many with shock outcomes. While there are numerous debates underway as to the whys and wherefores of such results, what they ultimately mean for macroeconomic policy in general – and more so for markets – is change. Change brings uncertainty, and along with uncertainty comes volatility.
“A primary concern for markets has been growth. Most of the developed market economies are in the doldrums. The manufacturing heart of the eurozone, Germany, has shown lacklustre growth on the back of sluggish exports, with energy shortages also playing a part. France and the UK remain in the same boat, with a moderate uptick expected in 2025.
“The growth engines in emerging markets, especially Asia, should see better prospects on the back of stronger domestic demand. The only clear bright spot globally remains the United States, where the economy has been humming along due to major fiscal policies enacted by the incumbent government. Should this remain the base case globally, we should expect modest growth, helped by easing inflation. However, changes in the political landscape raise significant risks to this scenario.
“Given the above, we expect the government sector to be the most affected. This includes issuances by government. The increasing budget deficits required for investments in infrastructure as well as social programmes mean government borrowing is expected to increase, raising concerns about the ability to service the increased debt burden. Thus 2025 is likely to bring greater volatility in government bond markets.
“The outlook on inflation also feeds into this. The combination of prospects for more protectionist US policy and China’s struggles could lead to possibly significant trade disruptions, which will invariably lead to higher prices as globalisation grinds to a halt. This could hamper growth in economies that export to the US – primarily Europe and China – as well as causing rates to stay higher for longer and producing tighter monetary conditions.
“The corporate sector seems to be in a healthier position. Earnings across regions have been strong, especially in the US, while Europe has strength in some sectors. As rates have started to come down, 2024 has become one of the busiest years for corporate bond issuance, and the trend is expected to continue in 2025. Should the Trump administration be supportive of corporates through tax cuts and reduced regulation, the US corporate sector will be in a favourable position. In Europe, there are likely to be sectoral winners and losers given the slowdown in China, a critical market for European companies. An unknown is the impact of future US policies, which could adversely impact both companies that trade with the US and the global economy as a whole.
“One sector expected to experience secular growth is infrastructure. Spending on capital projects has begun to rebound and is expected to accelerate significantly, with global spending forecast to increase to around USD 9 trillion for 2025. The World Economic Forum estimates that every dollar spent on a capital project (in utilities, energy, transport, waste management, flood defence and telecommunications) generates an economic return of between 5% and 25%. With government debt burdens increasing, private investors will be called on to do more, with the significant backing of governments.
“Looking forward, there seem to be two distinct themes – one each for the government and the corporate sector. Governments, through their policies and deficits, can significantly alter the macroeconomic landscape, but until the policies and their impact become clear, government issuance will see heightened risk. For now, safety may have to be sought elsewhere, rather than in this major “risk-off” asset. Corporate fixed income is likely to be a beneficiary, although strong corporate earnings are reflected in tighter spreads. Equity remains the asset of choice, on balance, given the policies expected to be enacted. But it would be unreasonable to expect the rising tide to lift all boats. More dispersion means this is an analysts’ market, in which research on sectors and names has the potential to provide better risk-adjusted outcomes.”
In the latest economic update, the Office for National Statistics (ONS) released its newest Consumer Price Index (CPI) data, painting a picture of what is happening in terms of inflationary trends and the broader economic landscape. Commenting, Abhi Chatterjee, Chief Investment Strategist at Dynamic Planner said:
“At last, some good news for the beleaguered consumer. Inflation, as measured by the Consumer Price Index, fell below the Bank of England target to 1.7% in 3 years. Better still, the print came in lower than was expected by practitioners. The downward move was from transport, fuelled by lower air fare and petrol prices. At the back of a cynic’s mind, is also the Middle East crisis, which has caused crude prices to rise as well as the rise in the Ofgem energy price cap rise for households – these have a potential to reverse the decline in inflation.
“Notwithstanding, this comes as a welcome boost to both consumers as well as the Government as it heads into its Budget, promising to do everything to “galvanise growth”. The Bank of England also gets a bit of a breathing room allowing it to take steps to begin the easing cycle in earnest. With the possibility of a rate cut by the Central Bank in November almost a certainty, it would not be too much of a leap of faith to expect another in December, should the trend in inflation continue.”
Abhimanyu Chatterjee is Chief Investment Strategist at Dynamic Planner. Abhi leads Dynamic Planner’s team of analysts, who are responsible for asset allocation and for the Dynamic Planner risk model. Read more about Abhi here
6min read
Abhimanyu Chatterjee, Dynamic Planner’s Chief Investment Strategist, discusses the hot topic of inflation amid increasing concerns it could soon rapidly rise. How has it been viewed over time? What are arguments both for and against?
Abhimanyu then analyses what could happen next before outlining four extreme inflation scenarios Dynamic Planner has run to robustly stress test its Asset Risk Model. Finally, he considers cash flow planning and inflation’s potentially acute impact here now for financial planners
Everyone worries about rising prices, especially savers. This general increase (or decrease) in prices of goods and services in an economy is referred to as inflation (or deflation). Margaret Thatcher referred to it as ‘the robber of those who have saved’, while the high priest of the ‘Free Market Economy’, Milton Freidman, called it ‘taxation without legislation’.
The general rise in the price level in an economy results in a sustained drop in the purchasing power of money, as each unit of currency buys fewer goods and services. It reflects a loss in the real value of the medium of exchange.
The opposite scenario, deflation, is characterized by a sustained decrease in prices in the economy.
Market participants are firmly of the opinion that low, positive and stable inflation is generally good for the economy as inflation causes reconfiguration of labour markets through increasing wages and lower unemployment. Excessive inflation or deflation is generally the cause for concern, often caused by step changes in monetary policy.
Inflation: Arguments for and against
It is said that if there are 10 economists in a room, there are 11 opinions. A debate on the causes of inflation results in 20 opinions in the same room.
One often cited reason for inflation is an increase in money supply – both steady or sudden as we have observed during the continuing Covid crisis or during the financial crisis of 2008.
Central banks in the developed world this year have expanded their balance sheets to previously unseen levels to stimulate their economies. Governments have moved beyond monetary policy to fiscal measures, given diminishing marginal returns of monetary policies. In addition, central banks are prepared to move away from their mandates of inflation stability for a period of time to jump-start economies.
As can be seen in Figure 1 above, while CPI inflation has dropped significantly due to the slowdown in demand, the expectations of inflation has picked up from previous levels. On the other hand, the case for disinflation is gaining traction.
At Dynamic Planner, we feel that, rather than being a financial crisis, as seen in the past, this is a social crisis – a crisis in which consumers are voluntarily choosing to socially distance themselves and postpone consumption, due to uncertainties surrounding health and employment. In addition, there is a sizeable output gap across the global economy, indicating spare capacity.
In China, the current output gap is around 7.5%, an historical high, as it is in the US (8%), which stands at the same levels of the Great Depression. In addition, there is a school of thought that the link between money supply and inflation has broken down – a case in point being the large stimulus measures implemented during the Financial Crisis 2008 did not result in runaway inflation as was expected then.
Further, given the nature of the current pandemic, it is obvious there will be sectors which will be worse off than others and hamstrung in their efforts to grow. Previous bouts of quantitative easing and other fiscal measures failed to increase inflation materially, with divergence being even more stark and asset prices rising and the bulk of the economy facing disinflationary forces.
Inflation scenarios: Stress testing the Dynamic Planner asset allocations
In stress testing our allocations, we consider four specific scenarios:
- Reflation: In this first scenario, monetary and fiscal policy proves to be successful and stimulus brings the economy closer to its pre-Covid long-term trend growth. Nominal rates remain relatively stable, inflation picks up to levels slightly above 2% and the US dollar strengthens. This is good news for equity markets in general. With real rates and risk premia decreasing further, they could gain around 16%.
- Deflation: A grimmer scenario where dis-inflationary trends get the upper hand despite central banks across developed markets keeping yields of all maturities close to zero. With economic growth impaired and increased uncertainty, this is bad news for equity markets, which could lose around 23% in this scenario, with growth stocks underperforming the market.
- Inflation overheating: In this scenario, inflation picks up slightly more than planned, which leads to disrupted economic growth and increases in nominal rates as the US Fed reacts to rising inflation. Equities benefit moderately from decreasing real rates with growth stocks benefiting more from declining real rates.
- Stagflation: This final test is a more extreme version of the previous one, with inflation going up even more. However, this scenario assumes developed market economies are impacted more severely than other regions, as a result of more aggressive fiscal and monetary stimulus. Although real rates decline, growth disruption and uncertainty take the upper hand, pushing equities into slightly negative territory and resulting in a positive bond-equity correlation.
In assessing these scenarios, we have set out the major risk factors to perform in Figure 2 below:
Based on the above scenarios above, we calculate the performance of the allocations for the different Dynamic Planner Risk Profiles.
As can be seen from the graphs in Figure 3 below, the deflationary scenario is the worst one for our allocations, which is understandable, as in this scenario all growth assets underperform immensely.
On the other hand, modest inflation increases or a re-emergence of the economy from the stress and uncertainty of the pandemic would be extremely beneficial for the allocations. In the stagflationary scenario, allocations for the more conservative risk profiles would be safe while the more aggressive allocations with higher equity allocations would suffer mild negative performances.
As fiscal and monetary policies expand to allow governments to deal with the fall out of the pandemic, market participants have started engaging in conversations regarding the possibilities of inflation. This analysis is meant to add structure around conversations for our clients, who use our allocations as a guide to making allocation decisions.
Cash flow planning with confidence
To navigate scenarios as mentioned, our clients, at the coalface of financial planning, need to create a long-term cash flow plan for their clients.
If the plan uses inflation and growth assumptions which are reasonable and based on objective data, a financial planner can engage more effectively with their client and create a quality and understandable plan.
Dynamic Planner forecasts real returns – i.e. net of inflation – across its system, in the risk-reward trade-off shown for risk profiling, in investment portfolio reviews and in cash flow planning.
The forecast is generated by a Monte Carlo scenario engine that generates thousands of possible real returns. As the returns are real to begin with, the various possibilities for inflation at different times are already factored in. It is therefore inappropriate to guess and factor in other numbers for inflation and apply them to the forecast.
With current events set to make inflation more confusing and volatile, clients will need your advice and explanation even more. It is therefore even more important that growth assumptions used are risk-based, real, reasonable and based on objective data. We conduct extreme stress testing like this, so that you can have confidence in ours and plan confidently with your client.
Read about new Dynamic Planner Cash flow planning
The Investment Committee reviewed the performance of the benchmark asset allocations and noted their great resilience in weathering the extreme market turmoil post the Covid outbreak, with all staying within, or very close to, their expected annual Value at Risk (VAR) limits.
The benefits of portfolio diversification provided by Dynamic Planner’s Asset Risk Model can be illustrated by the level of annual drawdown the benchmarks have experienced over these unprecedented times.
The one-year returns are compared to their respective expected VAR, within a 95% confidence limit, as represented by the horizontal line in the charts below. The benchmarks are calculated by MSCI [Morgan Stanley Capital International] and include quarterly rebalancing.
Navigating cross currents
- Uncertainty over the extent of lockdown measures and the nature of the eventual economic recovery prevails. In the absence of a vaccine, bolstering consumer confidence remains the priority for the post-lockdown world, but rising fears of the growing second wave of infections is beginning to see the re-imposition of stricter social distancing measures.With sentiment so fragile, any prolonged economic weakness could lead to increasing defaults from over-indebted corporates and the vicious cycle of increasing unemployment. However, there is an important distinction between the ‘run on the banks’ witnessed in 2008, to the ‘run to the banks’ to borrow this time round, as banks have significantly shored up their balance sheets.All eyes will be focused on how and when furlough measures will be adapted and tapered, as they must eventually have to be, given the eyewatering levels of debt / GDP that many economies are now having to grapple with.
- Interest rates are at rock bottom and if they remain ‘lower for longer’ or even ‘lower forever’ is an open question.Whether this macro demand-led shock leads to a long-term macro ‘regime change’, with the possibility of negative interest rates and deflation across developed economies, cannot be ruled out at this stage. However, low interest rates and excessive monetary stimulus must normalize at some point.In the case of the UK, the ballooning debt overhang, coupled with potential supply side inflation as a result of a no-deal Brexit and further weakening of the pound, could plausibly result in interest rate increases becoming necessary.
- From a valuation perspective, global bonds appear extremely overvalued after the extent of central bank intervention, with around 20% of issuance now in negative yield territory in nominal terms.Given the recent strong market bounce, global equity valuations also appear stretched and considerable uncertainty prevails around economic forecasts and corporate profitability. Existing business models are coming under increased scrutiny, with the market already signalling the potential winners (e.g. the tech and healthcare sectors) and the losers (such as retail, transport and energy).
- Given this unprecedented backdrop, ‘volatility of volatility’ will be an ongoing major concern for investors and can be expected to manifest itself in periods of heightened spikes.
Dynamic Planner Annual Asset Allocation Review – Key themes
During the annual review process, the Investment Committee agreed that the long-term strategic themes of building out further global diversification and a reduction from bonds into equities should gradually continue. The revised allocations – that went live in Dynamic Planner on 24 September 2020 – include:
- Further reduction in UK equities and an increase to US equities
- Reduced allocation into Sterling Corporate Bonds being exchanged for an increase in Global Investment Grade Bonds
- Recentralisation within expected risk boundaries being required. This involved marginal changes for the equity exposures being applied to the higher risk benchmark allocations
What’s the latest market and economic analysis? Read ‘Depression to euphoria’, by Abhi Chatterjee, Dynamic Planner Chief Investment Strategist
We are in the middle of a synchronized downturn. Analysis of the quarter or quarter change in GDP globally and in the US makes grim reading – worse than anything observed in the past.
Partially, this is due to the global reduction in activity through lockdown restrictions to mobility. Yet, if equities were to be considered as a barometer for future global activity, this would appear to be the shortest recession in history.
We can spotlight the performance of the S&P 500 Index. From being down approximately 30%, the market crossed its previous peak of 3389 on 18 August 2020. And with the backdrop of increasing infections globally, especially in the United States, and the upcoming presidential election in November. Analysis shows a real disconnect between the financial assets and the real-world economy. In addition, the stocks on NASDAQ, primarily small tech companies, have recovered an eye-watering 78%, after a drop of 28%.
In response to the Covid-19 crisis, central governments across the globe have unveiled massive fiscal and stimulus packages to help sustain their economies, especially from threats to the labour market.
The scale of stimulus has even dwarfed those created during the global financial crisis 2008. The stimulus packages in United States amount to approximately 13% of GDP, with the UK at 5% of GDP. The comparable figures in 2008 were 5.9% and 1.5% respectively.
A consistent concern expressed at this tidal flow of liquidity being provided is what happens in the wash. The bull run in equities and the compression of yields of corporate bonds is often attributed to the stimulus provided by central banks along with lower interest rates, which can be considered as a form of stimulus as well. Post the implementation of the emergency measures since March 2020, we see the same pattern re-occur, albeit on steroids.
The market participants have been especially selective. Consider [above] a chart of the 10 largest companies in the world and their market capitalisation as well as the change quarter on quarter. It is incredible to note that capitalisation of the top 10 companies is the highest that it has ever been and up almost 30% from the previous quarter. While it is understandable that after a severe shock to markets, there is generally a rebound in the valuations, in 2020 even compared to previous crises, the change in value appears egregious.
In addition, we can look at the composition of these 10 companies [above]. Since the time we have collected this data, which starts from Q2 2006, the companies have been composed of seven GICS sectors whereas as of Q2 2020, it composed of four sectors.
Out of the 10 companies, seven of them are technology enabled and include the likes of Facebook, Apple, Google, Microsoft and Amazon. The non-tech companies include Berkshire Hathaway, Visa and Johnson & Johnson.
Like any crisis, the Covid-19 pandemic has been a catalyst for change, being referred to even as the ‘Great Acceleration’. While it is immediate in some areas, as in the change in consumer behaviour and adoption of e-commerce, in others we may not see the impact in a few years.
What all economic participants realise and agree on is that there is no going back to pre-Covid in terms of business models, as well as consumer preferences and behaviours. What we do expect to see are the following:
- Shift to value and essentials. This, being a social crisis, affects the real economy more than previous crises. Uncertainty about prospects and health concerns, has shifted focus to being mindful of spending and researching brand and product choices before buying
- Increased and persistent utilisation of digital channels. Becoming a requirement due to restricted mobility, this is a trend which appears to have been adopted the most by consumers. The growth has been across the board for all kinds of products and across all age groups.
- Decreasing brand loyalty. Due to supply chain disruptions for certain products and brands, consumers could not find their preferred products at their preferred retailer. This has had an impact on brand loyalty through brand switches, with value, availability and quality being the main drivers.
- A home-based economy. Consumers have increased their consumption of in-home offerings across all sectors. This is not linked to easing of government restrictions, rather than waiting on guidance from medical authorities.
Given these changes, it is only logical and natural that companies which have already adopted such consumer preferences, within their business processes or have changed rapidly to do so, have benefited.
But, as we saw in the lead up to the dot-com bubble in the 1990s – a period of massive growth in the use and adoption of the internet – any company which purports to do business online or related to e-commerce, cloud computing or disruptive growth has seen huge uptake, resulting in near-egregious valuations.
So, when we look at headlines blaring about the peaks made by S&P 500, one tends to forget that it’s mainly the tech-driven companies which have been bought – even over bought maybe. As with any such exuberance with the advent of the new, there is always a dampener as business models get fixed into place. Winners and losers among the adopters will arise, leading to a shake-up in markets.
Looking forward, we expect to see some volatility coming through in markets, as investors rationalise and reassess. But this only serves to separate the wheat from the chaff – leading to the re-establishment of new order.
As investors, we need to be wary and congnizant of these changes and constantly re-assess the relative risks that arise. It is tempting and often simpler to go with the flow. But not jumping the FOMO bandwagon could possibly be the way forward.
Learn more about Dynamic Planner’s benchmark asset allocation.
Looking back over the first half of the year, January seems to be a completely different era. In between, an unprecedented health crisis has uprooted medical care, financial markets and the prospects for the global economy. In spite of the sharp rebound in markets, allocators are still reeling from the vehemence of the sell-off.
As economic numbers are now released, the severity of the downturn becomes slowly apparent, with further contractions expected for the rest of the year. Repeat lockdowns and voluntary social distancing, as well as uncertainty around re-opening, continues to negatively impact economic activity. Consumer confidence remains the priority for the post-lockdown world.
While unemployment has been kept in check with financial support from governments, as these policies stand to run off, as surely they will, uncertainty about jobs could delay consumption, leading to further decline in activity and a vicious cycle of defaults and further unemployment. These could possibly freeze up financial conditions, exposing vulnerabilities of already over-indebted households and corporates.
Though we have witnessed a sharp rebound in risk assets, we do wonder whether the market is pricing in a quicker recovery than what the ground reality is telling us. Analysis shows that the S&P 500 Index and Consumer Confidence has historically trended together, but recently there has been a decoupling, with a parting of ways for the two.
S&P 500 / Consumer confidence
As we look forward, what started feeling like a macro shock has slowly started to morph into a macro regime change. Government borrowing across the developed economies have reached eye watering levels, the proceeds being used to buying back government and for the first time, corporate debt, both investment grade and high yield.
Corporates themselves are going through an identity crisis, with business models and profitability coming under pressure from changing consumer preferences. Usage in public transport and workplaces have been way below baseline, with residential numbers higher than baseline in spite of re-opening. Thus, sectors like retail, energy and commercial property come under pressure.
Google UK mobility data
Even as business activity restarts, heightened health and safety concerns will continue to slow progress. It is likely that the recession we are in will be long and drawn out. Thus, with this context in mind, valuations of equities and fixed income, especially credit, appear to be stretched.
If markets were being irrational before the crisis, it looks to continue being irrational for some time to come. In fact, John Maynard Keynes’ pithy comment comes immediately to mind, ‘The markets can remain irrational longer than you can remain solvent’. In times like these, portfolio risk comes to the fore for our allocations and client solutions.
To achieve investment goals and meet the needs of clients, we need to stay invested, as the alternative would be inherently unproductive. Without risk, we would not have a return. Thus, we need to focus on putting together a portfolio of ‘desirable’ risks – risks which can be mitigated if the need arises, like the risk arising out of investments like equities and fixed income.
Risks like liquidity are the undesirable ones as there is nothing one can do if no one wants to buy illiquid holdings. Focusing on risk in this way helps us achieve our objectives, while keeping our powder dry to take opportunities as and when they arise, which they certainly will.
Clients in decumulation – What is the best defence against market volatility?
[vc_row type=”in_container” full_screen_row_position=”middle” column_margin=”default” column_direction=”default” column_direction_tablet=”default” column_direction_phone=”default” scene_position=”center” text_color=”dark” text_align=”left” row_border_radius=”none” row_border_radius_applies=”bg” overlay_strength=”0.3″ gradient_direction=”left_to_right” shape_divider_position=”bottom” bg_image_animation=”none”][vc_column column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/1″ tablet_width_inherit=”default” tablet_text_alignment=”default” phone_text_alignment=”default” column_border_width=”none” column_border_style=”solid” bg_image_animation=”none”][vc_column_text]As we try and shed our feelings of embattlement, with lockdown finally easing across most of the UK, the macro environment is radically different from the one which faced us when we entered lockdown in March, writes Abhi Chatterjee, Dynamic Planner Chief Investment Strategist.
Today, we are faced with an economy which is re-starting – with all its screeches and grinding gears – helped by the lubrication and deluge of ‘helicopter’ money, be it in terms of cheques to individuals or furlough schemes and loans to corporations. Here in the UK, this has been called the ‘Bounce Back Loan Scheme’ or BBLS.
The current situation has both similarities and dissimilarities with the last global financial crisis of 2008. Like then, governments and central banks across the planet reacted promptly in a coordinated manner to bolster the economy and put forward the balance sheets of central banks.
The difference now in 2020 is that 12 years ago it was just one sector – the financial sector – which had to be bailed out. This time it is all sectors across the board, apart from a few, that need bailing out.
Economics 101 says that with an increase in money supply to a system, ceteris paribus, all things being equal, inflation should increase.
Post-2008, when the money taps were opened by the central banks, threats of inflation came to the forefront. However, while we waited and waited, the inflation that was predicted never arrived. The debate regarding the why and wherefores rages on. Now, as was then, once the fiscal stimulus has been delivered, inflation has started to dominate discussions once again.
But is there only one possibility, just inflation, or does its alter-ego, deflation, get to dominate media headlines this time around?
Anyone can see the reasons for inflation, given the enormous largesse being doled out. However, inflation, which has recently been below the central bank targets, fell further during the lockdown. Even with the fiscal stimulus provided by central banks, the barriers posed by social distancing to shopping and increased precautionary saving has led to falling prices – evident from the falls in inflation in the developed economies.
Along with lower oil prices, lack of demand may quite possibly lead to companies discounting prices to reduce inventory and generate cash for their running costs. While this may not be the case for essential goods, the prospect of cheaper prices of non-essential purchases may prevent immediate expenditure by consumers.
Also, during this period, numerous companies have been looking into methods of increasing productivity and growth through the implementation of technology and digital transformation. If this continues apace, there is a possibility that growth in our economies takes on a different dimension and requires us to rethink our theories.
To quote from American-based Professor Yossi Sheffi’s Anna Karenina principle – every economic crisis comes with its own ‘roster of causes, cascade of effects and its own litany of misery’.[/vc_column_text][/vc_column][/vc_row][vc_row type=”full_width_background” full_screen_row_position=”middle” column_margin=”default” equal_height=”yes” content_placement=”middle” column_direction=”default” column_direction_tablet=”default” column_direction_phone=”default” bg_color=”#ffffff” scene_position=”center” top_padding=”80″ bottom_padding=”80″ text_color=”dark” text_align=”left” row_border_radius=”none” row_border_radius_applies=”bg” overlay_strength=”0.3″ gradient_direction=”left_to_right” shape_divider_position=”bottom” bg_image_animation=”none” shape_type=””][vc_column column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/2″ tablet_width_inherit=”default” tablet_text_alignment=”center” phone_text_alignment=”center” column_border_width=”none” column_border_style=”solid” bg_image_animation=”none”][vc_custom_heading text=”Want to see what Dynamic Planner can do for you?” font_container=”tag:h2|font_size:36|text_align:left|color:%23000000|line_height:44px” use_theme_fonts=”yes”][vc_column_text css=”.vc_custom_1534103308164{margin-top: 15px !important;}”]Schedule a free no-obligation demo with a business consultant and experience the full functionality of Dynamic Planner.[/vc_column_text][/vc_column][vc_column column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/2″ tablet_width_inherit=”default” tablet_text_alignment=”center” phone_text_alignment=”center” column_border_width=”none” column_border_style=”solid” bg_image_animation=”none”][vc_row_inner column_margin=”default” column_direction=”default” column_direction_tablet=”default” column_direction_phone=”default” text_align=”right”][vc_column_inner column_padding=”no-extra-padding” column_padding_tablet=”inherit” column_padding_phone=”inherit” column_padding_position=”all” background_color_opacity=”1″ background_hover_color_opacity=”1″ column_shadow=”none” column_border_radius=”none” column_link_target=”_self” gradient_direction=”left_to_right” overlay_strength=”0.3″ width=”1/1″ tablet_width_inherit=”default” column_border_width=”none” column_border_style=”solid” bg_image_animation=”none”][nectar_btn size=”large” button_style=”regular” button_color_2=”Accent-Color” icon_family=”default_arrow” url=”https://www.dynamicplanner.com/demo/” text=”Request Demo” margin_top=”20″][/vc_column_inner][/vc_row_inner][/vc_column][/vc_row]
By Abhi Chatterjee, Chief Investment Strategist
In the last six weeks, I have seen more from my home office desk than all the time I have previously spent in my career on trading desks. To recap, what have we witnessed?
- The single largest day increase in VIX since 1990
- Two of the largest daily falls in the S&P 500 since 1927
- Central banks committing larger amounts of money to targeted relief than during the crisis of 2008
- And people ready to pay others $38 to hold a barrel of oil
Given stringent social distancing policies have been largely in place, a sharp decline in economic activity has already occurred, as shown by PMI numbers plummeting to unforeseen lows.
It is expected that we will see a deep recession in the Western, as well as Emerging economies. The question now though still remains, ‘How long will the recession last and what will the long-term impacts of the coronavirus pandemic be?’
Answers are currently only speculation, as details of how and when lockdown measures precisely will be eased are only just emerging – and, of course, there is also the real threat and future concern that there will be a second, significant spike of infections.
Extrapolation of data from past recessions are unlikely to help. All we know is that pent-up domestic demand should come back online, once social distancing measures gradually begin to be rolled back, but economic growth may still be sluggish due to an equally gradual growth in international trade and investment.
Following the pandemic’s outbreak, central banks globally have unleashed a flood of fiscal policies to help the private sector and the cornerstone of all developed economies. In a concerted action across the board, central banks in developed countries have assured individuals as well as corporations that no measure is big enough for them to use in these times.
Central bank rates are at all-time lows; asset purchase programmes are worth billions and involve buying up of below investment grade debt and asset-backed securities; and governments effectively are providing loan guarantees to mortgages providers, banks and the like.
It appears Western governments have opened their balance sheets for households and the private sector, in order to stave off bankruptcies and large-scale lay-offs. Credit is the fuel which businesses run on and the availability of credit will determine which parts of the economic anatomy remain unaffected by all this.
However, credit perpetuates on the optimism of growth – the promise of an increase in activity resulting in repayment. Without growth, be it sustained or otherwise, we face a self-reinforcing cycle of diminished confidence, bankruptcies and lay-offs. Thus, the over-leveraged world, which gorged itself on debt in a low interest environment, looks on with mounting concern and interest – if you pardon the pun.
The policies enacted now by public institutions face the ultimate dilemma and balancing act: the creeping devastation of a stagnant economy or a terrible human cost.
Abhi Chatterjee is Chief Investment Strategist at Dynamic Planner and helps lead its expert, in-house team of analysts, who each quarter risk profile the 1,400+ investments currently available in Dynamic Planner – to research and recommend to clients of financial advice firms.
Speak with a consultant to find out how Dynamic Planner fund research can help your firm
By Abhi Chatterjee, Chief Investment Strategist
The ‘Corona Crash’
The Covid-19 outbreak triggered a geo-economic panic, resulting in an unprecedented spike in global equity market volatility, with severe declines exceeding 20% and extreme daily swings on a scale comparable to the financial crash of 2008.
Thus, we dramatically marked the end of a remarkably resilient equity bull market, that had begun back in March 2009. The moves largely occurred in late-February and March as numerous countries went into lockdown in response to the pandemic, bringing economic activity to a virtual standstill globally.
Meanwhile, government bond yields and prices were incredibly volatile. Yields first hit extreme lows on heightened fear, but then rose, as panicked investors sold off liquid assets indiscriminately, in order to raise cash. High yield credit was hardest hit given this dramatic spike in risk aversion, with the rout most evident in sectors perceived as most vulnerable, such as those related to travel and retail, as well as energy, given the price of Brent crude plummeted to its lowest level since 2003.
In emerging markets, the heaviest falls were suffered by local currency denominated bonds. There were double-digit declines, in some cases of around 20%, linked to issuance in currencies perceived as more sensitive to the economic growth shutdown, falling oil prices, and those with more market liquidity.
Maintaining essential checks and balances
The committee reviewed the performance of the current benchmark asset allocations, which have proven so resilient during this and other periods of extreme market volatility, with none breaching their defined, 95% value at risk limits over the quarter.
The above charts show the rolling, 12-month index returns for risk profiles 4, 5, 6 and 7 updated each month.
The horizontal lines are the respective, 95% value at risk limits for each.
The key role of the Investment Committee [IC] is to ensure that prudent checks and balances are in place, so the integrity of Dynamic Planner’s forward-looking asset and risk model is maintained. During the meeting, the IC carefully considered what could be learned from recent events and whether its current process in forecasting asset class growth and volatility remained appropriate if we are witnessing a significant macro-economic regime change in the making.
Given these extreme market swings and the current uncertainty, as to how long the global lockdown measures will remain in place, after much discussion, the IC agreed that now was not the time to make any changes to its long-term growth forecasts or strategic asset allocation benchmarks. There are just too many unknowns presently over the scale of the economic impact and recovery trajectory, the downstream implications of the huge fiscal and monetary stimulus measures on growth, inflation and interest rates and the likelihood of a viable vaccine becoming widely available.
The current process used for volatility forecasting involves detailed analysis and interpretation of data trends from both a long and short-term perspective. This requires striking a careful balance with the data inputs to the model. The danger of giving too much credence to short-term noise is the potential for overshooting of data in times of extreme market anxiety, potentially leading to significant misalignment in the forecasts generated.
Conversely, the process needs to be sufficiently sensitive to detect emerging changes in how asset classes are expected to behave and their impact on future volatility and correlations over the longer term. For this particular quarter, given the extent of recent extreme data outliers, the IC agreed that their use would be inappropriate on this occasion. Therefore, the longer term data trends for volatility and correlations were used for the Q2 2020 volatility and correlation assumption setting. The data derived from the shorter term modelling techniques were not included.
The IC also noted that post-Brexit negotiations between the UK and the EU were still ongoing, but no significant breakthroughs before the end of the December transition period that could have any bearing on the model assumptions have yet to be announced.
Summary of Investment Committee Q2 2020 decisions:
- No changes to strategic asset allocations
- Previous quarter’s growth forecasts remain unchanged for Q2 2020
- Forecasts for volatility and correlations were based solely on the long-term data modelling approach for this quarter
Disclaimers
You should not rely on this information in making an investment decision and it does not constitute a recommendation or advice in the selection of a specific investment or class of investments.