Time to hold back on risk assets in Tactical Asset Allocator

Hang on to your hat! This month monetary policy is causing ructions across the developed world.

While the Bank of England (BoE) and the US Federal Reserve are likely to raise interest rates, the European Central Bank (ECB) has just lowered rates to 0.05% and introduced new stimulus measures, and the Bank of Japan is also expected to increase stimulus with an acceleration in its QQE (qualitative and quantitative easing) programme until October. It is a confusing picture for investors to digest.

The biggest risk in Europe is deflation, given that growth and inflation appears to be faltering, while a worsening of the "Russian Ukraine" conflict could drive up the cost of energy and muzzle the world's growth.

Much-needed reforms

In the UK, the consensus is factoring in a rate hike in February, believing that softening inflation has reduced the urgency for action, but that politicians will prefer to get it done well ahead of the general election in May.

The rate rise could of course happen sooner - August's services Purchasing Managers' Index rose unexpectedly to 60.5 from 59.1, suggesting stronger than expected growth in the second half of the year.

That's a key indicator for Monetary Policy Committee (MPC) policymakers, although the BoE deputy governor Ben Broadbent's recent Jackson Hole speech was intended to signal a shift away from its focus on GDP growth and instead towards labour market developments.

UK and US fund managers are therefore positioning their portfolios for a rate rise - higher interest rates are historically bad for both bonds (because lenders can find better rates elsewhere) and shares (because future earnings are discounted at higher rates).

Different for bond yields?

For bonds, this time is likely to be different, and yields could easily reverse as they bounce off their record lows. For shares, despite the market's broad deleveraging some companies still have high borrowing costs, and bull runs eventually run out of steam.

The predicted slowing of economic growth across the world in 2015 reflects the unusual cyclical juncture in markets, which has a lot to do with the unfavourable demographics of an ageing planet and rebalancing pressures.

Some of the best opportunities are in emerging markets, where global enterprises with geographically diversified exposures have been unfairly punished. Large cap stocks also typically do better from rising interest rates.

You might believe, as Goldman Sachs argued in a recent report, that earnings growth, dividends and high-risk premia will all support returns, but adding to risk assets of any sort does not seem to make sense at this juncture.

Our portfolio valuation was conducted on 8 September, when markets were battered by concerns over Scotland's independence referendum, as the polls tightened. Shares in Scottish-based financial stocks were at the time among the worst performers in Europe.

This month we are selling the iShares FTSE BRIC 50, as its Russian component has recovered, crystallising a profit of 9%. It had seemed increasingly awkward to hold fragmented emerging market countries in a single bucket. The proceeds will sit in cash until the dust settles.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.