Recession fears labelled most overhyped theme of 2019

Recession fears have been labelled the most overhyped theme of 2019 by City fund managers as Investment Association figures reveal billions of pounds rotated out of equities and into bonds throughout the year as markets rallied.

Over the year to September, investors pulled £5.5bn from equities, while the MSCI AC World rose 20.1% in sterling terms and the FTSE 100 rallied 14.3%. Fixed income funds took in £9bn over the same period, according to IA figures, which are currently only available for the period up to September.

The risk-off trade reflected the views of fund managers, quizzed by Portfolio Adviser, who thought investors took too much heed of the Q4 2018 sell-off and yield curve inversion.

The opportunity cost of sitting on the sidelines

“Investors climbed the wall of worry and stayed on the side-lines, remaining cautiously positioned,” says Suzanne Hutchins (pictured), co-lead manager of the BNY Mellon Real Return fund. “This meant they missed out on potential returns from financial assets compared to cash.”

Hutchins pointed to the Q4 2018 sell-off, during which the S&P 500 dropped 12%, as the source of investor anxiety.

Markets quickly rebounded but investors were slow to dip back in with the Bank of America Merrill Lynch survey from February noting cash overweights among fund managers were at their highest levels since September 2009 at net 44% despite equities rising 5% since the previous survey in mid January.

Investment Association net flows for 2019 (£m)

Caution remained a theme in most monthly surveys from BoAML throughout the year. In June, the average cash allocation rose one percentage point to 5.6%, the biggest jump since the US debt ceiling crisis in 2011.

In September, 38% of fund managers surveyed expected a recession in the next 12 months, and while this was lower than the 58% who did not share that forecast, the response represented the highest net recession risk since August 2009.

‘I probably got most of my 2019 macro calls wrong’

AJ Bell head of active portfolios Ryan Hughes and Fairview Consulting director Ben Yearsley both admit 2019 did not turn out as expected.

“If I went back and read my outlook piece from a year ago, I’d probably find I got most of it wrong,” said Hughes, who had anticipated US Federal Reserve rate rises, a tough time for bonds and leadership change within equities.

But in a year where “pretty much everything’s gone up”, his defensive fund picks that he published in a 2019 outlook at the start of the year have managed to deliver solid returns regardless of the strong market backdrop.

In ascending level of risk, Hughes suggested investors consider Janus Henderson Absolute Return, BNY Global Income, Polar Capital Global Insurance and Troy Trojan Income.

The US Federal Reserve is to blame for investors getting their judgement wrong at the start of 2019, says Yearsley, who adds he never anticipated a recession in 2019 and does not expect one next year either.

He says this time last year the central bank was indicating two further rate rises. “But they changed tack in January, meaning bonds had a tremendous year, risk assets had another tremendous year.”

Yield curve inversion was the cause of further nerves

Stonehage Fleming head of equity management Gerrit Smit thought too many investors moved to the sidelines in response to the inversion of the US yield curve, another event that triggered investors to turn risk off.

“With the global outlook starting to improve slowly following monetary easing those investors may be left behind with difficult decisions whether to buy back equities at higher share prices,” Smit says.

The BoAML survey showed equity allocations sliding to net 12% underweight in August, the month the yield curve inverted, while in the UK equity outflows reached their highest monthly outflows in 2019 up to that point.

Smit says there were not enough economic imbalances or material build-up of cost pressures to trigger a material slowdown in economic activity.

‘Bad news is good news’

Yearsley describes Jeremy Corbyn winning the UK general election or Elizabeth Warren becoming US president as “terrible news” that could jolt equity markets. But his base case is that markets continue to view “mild bad news” as a positive in anticipation of central bank stimulus.

Politics was the presiding theme fund managers expected to define markets in 2020 thanks to the US trade war with China and other markets plus the presidential election in November, while quantitative easing continues to stoke populism.

“Ultimately, the money printing machines of the central banks have pumped liquidity into financial asset prices while the real economy has not seen the benefit,” Hutchins says, adding: “Populism has arisen around the globe from countries such as Spain, France, Chile, Hong Kong, and closer to home with Brexit.”

Policymakers would keep investors on their toes, she says.

Late cycle fund picks

Yearsley names Artemis US Extended Alpha among his top fund picks going into 2020, stating he likes the 130/30 fund’s ability to go short at this stage of the cycle. Architas Diversified Real Assets is his suggestion for investors of a “nervous disposition” thanks to its real assets exposure and lack of correlation with bonds and equities.

In fixed income, GDIM investment manager Tom Sparke says the Allianz Strategic Bond fund as one of the key funds he brought into portfolios this year.

Substantial fixed income exposure mitigated downside risk as equity allocations remained between 55-60% in balanced portfolios, Sparke says. “I think that this fund will be an asset to our portfolios next year as bond markets are likely to be more volatile with unpredictable central bank policy and major geopolitical changes.”

Over at AJ Bell, Hughes lists two UK equity funds among his fund picks for 2020 – Man GLG UK Income and Jupiter UK Special Situations. For adventurous investors he highlights another fund with a value bias, Schroder Global Recovery, while for cautious investors he suggests Royal London Short Duration Global High Yield.