Posted on 20 June 2014
“What’s past is prologue” – William Shakespeare (The Tempest)
With the map of the Middle East starting to look in need of updating, the Russian army continuing to flex its muscles on Ukraine’s eastern border, and the rising probability of the crop-disruptive weather phenomenon El Nino re-emerging this year, the supply story for much of the commodity complex looks fragile. Nonetheless, we continue to see a small under performance in the asset class in light of the likely negative impact of impending monetary normalisation in the developed world, and China’s slowing appetite for base metals. However, the arguments for and against a more neutral tactical posture certainly look more finely balanced in light of the developments outlined above.
This week, it was the situation in Iraq that commanded the headlines as sparks from the war in Syria threaten to fan into a wider regional sectarian conflict. So far, with the action largely distant from Iraq’s export-focused oil fields in the south, oil prices have firmed. However, they remain some distance away from the level that would crimp global growth prospects. Equity and bond markets have remained largely insensitive to the human suffering (as they often can) with US equity markets repeatedly punching through to all-time highs.
From an equity market perspective, it is worth remembering that the mix of sectors in most of the world’s indices leans towards companies that benefit from, or are largely insensitive to, mildly higher oil prices.
We continue to urge clients to be mentally prepared for an increase in volatility across asset classes, but the more likely source of this volatility remains the approach of monetary normalisation in much of the developed world. The market’s reaction to the fairly benign Federal Open Market Committee statement and a multi year-low UK inflation print this week suggests that there is still some complacency surrounding the reality of more-normal monetary policy.
The recent developments in the Middle East illustrate again that, while we can not pretend that we can predict the future, we can meticulously prepare for it, diversifying risks where possible (which includes holding some exposure to commodities) and slanting client portfolios towards the most probable outcomes as we see them.
For now, the most probable outcomes continue to centre on a world economy that remains roadworthy and where plenty of economic opportunities are still unfulfilled. We don’t see the approach of interest rate rises or monetary normalisation as upsetting the economic apple cart just yet, and our advice remains that investors, risk appetite and investment personality permitting, should hold many more stocks than bonds – even though the ride is likely to get less comfortable from here on in.
William Hobbs, Head of Equity Strategy, Europe