The appeal of some asset classes lies in the fact their performance is uncorrelated to global equities.
Among those that have historically outperformed during periods of equity underperformance or volatility are gold, the US dollar, the Japanese yen, and areas of the fixed income market, such as government bonds.
As Oliver Jones, asset allocation strategist at Rathbones, explains, safe haven assets are defined as those able to “provide some offset when equities are falling or, at least, not be strongly positively correlated”.
But the first six months of 2022 has proved to be the exception to that rule.
“We see conventional government bonds, in particular, not fulfil that function this year, with some really significant losses at the same time as global equities have been under a lot of pressure,” he says.
Bonds to rely on?
One explanation is the nature of the shock to the global economy, which has come from the supply side, resulting in soaring inflation.
“In a world where demand shocks dominate, conventional government bonds do a good job of offsetting equity risk. You get the demand shock, equities fall, generally there’s downward pressure on inflation, it creates space for central banks to cut interest rates, and government bonds do well,” Jones says.
“What’s particularly unusual about this situation is we’ve partly seen a supply shock and an inflationary shock. We’ve got that combination of global growth slowing and people becoming more worried about the global economy, but also significant upward pressure on inflation.”
In the UK, the consumer prices index rose 9% in the 12 months to April 2022, up from 7% in March. Across the pond, the US saw inflation reach a 40-year high, of 8.6% for the year to May.
This has prompted major central banks, such as the Federal Reserve and Bank of England, to raise interest rates, causing expectations for future interest rate hikes to increase. Against this backdrop, government bonds have not been able to provide a ‘haven’ for investors.
“We are in an environment where there’s no place to hide, at least in the next six months,” according to Capital Group fixed income investment director Flavio Carpenzano.
However, if investors look ahead 12 months and “envisage a potential higher risk of recession”, it is likely that the correlation between risky assets such as equities, and safe haven assets, like US government bonds, could once again become negative, Carpenzano adds.
Fundcalibre’s Darius McDermott agrees government bonds will “reassert” their defensive characteristics if there is a recession, and economic demand and inflationary pressures collapse.
“That said, the differential between yields and inflation remains very high, so we would be cautious,” McDermott adds.
Going for gold
The first six months of 2022 has been a mixed picture for gold – a renowned store of wealth and hedge against inflation.
“Conventional government bonds, generally, have done fairly badly, whereas gold is up slightly on the year, so it’s been a useful thing to be holding,” says Rathbones’ Jones.
“Gold and cash have preserved value much better than either equities or conventional government bonds.”
But McDermott remarks the yellow metal “hasn’t been the spectacular performer that some had hoped”.
“If you account for inflation, it is actually down in dollar terms which is a little disappointing. Gold has been hurt – like everything else – from quantitative tightening rather than quantitative easing, and money being withdrawn from the financial system,” he explains.
“In addition, higher government bond yields make gold, which yields nothing, look less attractive. We still like gold as a hedge though, and we think it could start to do really well if inflation expectations become entrenched and inflation proves more stubborn than people expect.”
Seeking safety in the dollar
There is one safe haven asset that has lived up to its title though – the US dollar. It has performed well versus a declining sterling and held up as equities have tumbled.
Jones attributes its strength to the “relative resilience of the US economy”.
Phil Smeaton, chief investment officer at Sanlam Private Wealth UK, acknowledges that the currency has remained buoyant, in part, because the Fed has been “leading the charge” when it comes to raising interest rates to dampen inflation.
However, he suggests that if the US central bank were to shift from “fighting inflation” to a role in “supporting the economy”, then it could weaken the dollar’s value.
Elsewhere, another major currency and historical safe haven – the Japanese yen – is treading a very different path.
“The Japanese central bank is trying to artificially suppress 10-year JGB yields at a time of rising inflation. The only way to do this is print infinite money to buy these bonds from investors who are selling,” says McDermott.
According to DWS, at over 136 yen to the dollar, the yen is “approaching levels of weakness last seen in the summer of 1998”.
