Although timing the cycle is never an easy task, historically investors have been wise to gradually reallocate a proportion of a portfolio from equities to fixed income and cash as the cycle matured and the central bank raised rates. Even if investors moved too early with such a reallocation and equity prices pushed ever higher, they at least received a decent yield on their core government bonds, with the promise of capital returns when interest rates were eventually cut.
Global bond yields
% of BofA/Merrill Lynch Global Government Bonds Index
The fact that central banks have not managed to normalise interest rates in this cycle makes it much harder for investors to seek shelter and wait out any storm while at the same time maintaining any kind of decent return.
Moreover, derisking aggressively will prove costly if slowing economic data and a falling stock market prompt the US administration to reassess its trade agenda. The president walks a fine line between wanting to appear tough on trade to fulfil his “America First” electoral promises, and wanting a strong economy and an electorate feeling confident about job prospects ahead of the election in November 2020.
Valuations on a forward-price-to-earnings (P/E) basis are near their historical norms in most parts of the developed world, although our suspicion is that these are predicated on earnings forecasts that are a bit too high. Nevertheless, markets are not painting a screamingly optimistic picture, which provides comfort in terms of the scale of downside risk. The emerging market benchmarks and Japan are the key parts of the global market in which forward P/Es sit at a discount relative to their recent history.
Global forward price-to-earnings ratios