Don’t trust the consensus

A typical multi-asset portfolio today will very likely look something like this (with reasons in brackets): equity overweights in Europe (quantitative easing), Japan (QE) and Asia (valuations, decent growth); underweights in US (valuations, no QE, rate rises) and emerging markets (US dollar strength, decelerating growth); minimal duration (rates cannot go any lower), overweight high yield (the only place you can get yield in fixed income) and property (decent yield and solid outlook); no commodities (China slowdown, US dollar strength); long US dollar (US Federal Reserve to hike first); short Japanese Yen (QE) and euro (QE).

Even on a sector level the consensus is pretty strong: overweight technology (earnings growth) and consumer discretionary (oil ‘tax cut’), underweight energy (oil price) and materials (China slowdown).

You do not have to look at positioning surveys to know this; it is self-evident from price action and the financial media. Everyone is positioned the same way.

This of course is a concern because when sentiment eventually turns the outcome is usually much worse.

However, it is hard to argue against the logic of any or all of these trades. The key for some time now has been to act early and decisively, and to be active in asset allocation. Riding your winners has worked, but I think it is prudent to keep recycling your profits into the areas of the market where sentiment has got too bearish.

QE by the ECB has been the biggest market driver this year by far. Italian equities were up 22 per cent in the first quarter. You have to lend money to the German government for more than nine years to get a positive yield. It turns out that a 10-year bund with a yield of 54 basis points at the beginning of the year was good value.

The outperformance of European equities is no surprise, as QE has unfailingly lifted asset prices wherever it has been implemented on a major scale. The concurrent drop in the euro has been a material boost for any company with euro costs and US dollar revenues. Earnings in Europe are expected to be materially better in 2015 than in the US, partly driven by the currency moves. But what led some to go overweight Europe in Q4 of 2015 were signs of economic improvement, not just a hunch that QE would finally happen.

The Citi Surprise index for the eurozone bottomed early in 2014 when economists were at their most bearish and then actually turned positive in December. Meanwhile there was data showing credit creation was picking up momentum, just as eurozone banks got through the Asset Quality Review stress tests carried out by the ECB. Moreover, 2014 saw the last of any drags from austerity measures; the handbrake was finally released on the eurozone’s 15-year old, accident-prone party bus.

I would argue that QE and negative deposit rates are largely in the price of European equities, but the growth story is not. This is why some remain overweight the region.

Japan is about so much more than QE as well. The numbers involved are already staggeringly large relative to gross domestic product, but there is every reason to feel confident that if growth stalls or inflation undershoots they will increase the quantum or broaden out asset purchases. The government and central bank are fully committed to this course of action and have the mandate to follow through – for another three years at least in Japan’s prime minister Shinzo Abe’s case.

But the underlying story in Japanese equities is also very encouraging. It has the best earnings momentum of the major developed markets, and improved corporate governance looks set to boost returns on equity and margins. Meanwhile, the market is highly geared into a better growth environment in the West, which we expect to be led by the US. Moreover, this growth potential is not reflected in valuations which are on a par with peers but lower than their own history.

The obvious thing to note with emerging markets, especially now, is that they should not really be looked at as a homogeneous group. India has always had very different dynamics than Brazil, for example. But in today’s environment those differences look even more stark. Brazil became increasingly reliant on China’s seemingly unquenchable thirst for commodities and put nothing aside for a rainy day. Consider what happens when you combine that shock to growth with a tumbling oil price, a huge corporate and political scandal, runaway inflation caused by a freefalling currency, and twin deficits. India on the other hand benefits from lower oil prices and has seen resurgent confidence following the emphatic election victory of the pro-business, pro-reform Mahendra Modi as prime minister.

Meanwhile, falling inflation has allowed the central bank to cut interest rates and help boost growth. This does not mean managers are overweight India and underweight Brazil but some have recently allocated more money to relatively unconstrained emerging market managers who can pick up quality companies that are priced too bearishly.

Some managers continue to have a fairly neutral weighting in US equities, despite being more positive on the economy than consensus forecasts. Our expectation is that the economic data will pick up markedly as we move through Q2 after another surprisingly soft Q1. Whether it is mainly a function of repeated bad weather in recent years or not, there is a clear pattern emerging in US quarterly GDP numbers where the first three months of the year have serially been weak and growth subsequently bounces back strongly later in the year. Nonetheless, valuations are undoubtedly high relative to history and to other developed markets. Earnings expectations also seem unrealistic, even in a stronger growth environment.

The main event that everyone is waiting for is the first interest rate rise. While a 25bps rise in the Fed Funds rate is not a big deal in the real world, it is hugely symbolic. Markets will doubtless become a bit skittish as the moment grows ever closer and the Fed will have its work cut out reassuring bondholders in particular that there will not be a rout in fixed income.

James de Bunsen is multi-asset fund manager at Henderson Global Investors

Key Points

■ The consensus among market participants is the most consensual it has been for many years.

■ It has been right to be underweight the UK over the past six months.

■ Emerging markets are an area some are tactically much less negative about than others.