Phil Milburn

End of the beginning?

Phil Milburn

After periods of volatility such as we have witnessed in October, the classic question about economic growth gets rolled out: is this the end of the beginning or the beginning of the end?

The truth actually lies somewhere between these two poles. For the past few years, government yields have been low enough that any increase was interpreted as vindication of the strength in the economic recovery. It is now clear that US Treasuries have reached the stage where increases in yield do have a meaningful impact on the generic price of risk. Attention has switched to the monetary cycle and whether the Federal Reserve will overshoot on its tightening path. 

Economic growth is still strong – data released on Friday show that US GDP was up by 3.5 per cent in the third quarter – but worries about disruptions from trade wars are increasing. Some leaders in the Western world have not studied basic economics and do not realise that trade is not a zero sum game; it can have benefits for all, as any economics student could tell you. Trade frictions could knock 0.3 to 0.5 per cent off global growth but are unlikely to completely derail the cycle.

That said, economic data have been a little weaker than elevated expectations of late: this can be seen in the chart below, which shows how actual economic data have performed relative to market expectations.

Phil Milburn Citi Economic Surprises

Source: Citi, Bloomberg, Liontrust as at 29 October 2018

The negative turndown over the last two months is partly due to expectations having become too high and also to heightened uncertainties creating an impediment to investment. The last few weeks has been a growth scare and a repricing of risk, as opposed to an inflation scare, and this can be clearly seen by the fall in US breakeven inflation levels in the following chart (lower expectations are factored in to the market for future inflation).

File name	Size	Alternate text Phil Milburn Citi Economic Surprises.png	76 KB	 Phil Milburn Citi Economic Surprises Phil Milburn US Inflation Breakevens 

Source: Bloomberg, Liontrust as at 29 October 2018

However, labour markets are tightening and, as we have posited for a long time, it is wage inflation that creates the feedback for general inflation to accelerate. 

In this repricing of risk, we have moved our two Strategic Bond Funds from a net 10 per cent high yield weighting to 25 per cent. As rates have rallied, we have reduced duration (sensitivity to interest rates) from nearly four years to close to three. Finally, we have bought some inflation protection with 0.75 years of duration exposure (a quarter of overall duration) in TIPs (Treasury Inflation-Protected Securities) (Source: Liontrust and UBS Delta, as at 26.10.18).

We believe we are in a late cycle and these moves are tactical in nature for the next few months. Strategically, rates are still some way from peaking in the US and completely out of whack in Europe. The time to buy duration and credit aggressively has not come yet, but there are myriad ways of potentially exploiting this volatility to the benefit of investors.

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Key Risks 

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing. 

Tuesday, October 30, 2018, 12:04 PM