The yield curve, the difference between long and short-dated yields on government bonds is usually positive. With the US yield curve flattening, the prospect of an inversion – which in turn has been a reliable indicator of recession – has increased. A focus on some of the detail here, however, means we are not unduly concerned. The role of banks and their willingness/ability to lend is an important consideration. In a typical recessionary environment, margin compression results in banks cutting back lending. Currently, however, margins have been increasing which with banks being well capitalised, provides a significant positive going forward.
The investment environment also provides reassurance. Rather than being in a typical cycle characterised by overinvestment, squeezed margins and subsequent retrenchment in hiring and investment activity, we stand at a juncture in which investment levels remain relatively low. This supports our view that the cycle still has some way to run.
We entered 2018 with a cautious view on fixed income, wary on the prospects for bonds given valuations and the backdrop of rising interest rates and a reversal of quantitative easing. We maintain that stance, believing that whilst equity returns may be low in 2019, they look set to outperform bonds. Geographically, we are overweight the US, Japan and the emerging markets (ex-China), neutral on Europe and underweight China and the UK.