Government bonds remain the best protection from an economic or market downturn, according to Guy Miller, strategist and head of macroeconomics at Zurich.
Government bonds traditionally do well when economies are in trouble because investors, unsure of the returns available from other assets, buy the bonds in the near certainty they will be paid.
Mr Miller acknowledged that the price of US and UK government bonds has fallen sharply in 2019, as investors revised downwards their expectations for growth and inflation.
But while investors in the bond market have behaved as if they expect a downturn in growth and inflation, equity investors have, since the start of 2019, pushed markets higher, something that typically happens when investors expect higher inflation and better economic growth.
Because government bonds tend to go up in price when inflation is expected to fall, and equities go up in price when inflation is expected to rise, the prices of those assets tend to move in the opposite direction.
This means that government bonds have historically been cheap when economic growth is strong, and equities have been cheap when economic growth is slowing.
But Mr Miller noted that bonds and equities have both risen in the past three months, meaning that the traditional asset allocation approach of switching between government bonds and equities depending on the economic outlook doesn’t look as obviously effective, because whatever the adviser's view of the world economy, the asset they would buy would be expensive.
He believes the sell-off in equities at the end of 2018 was overdone.
Mr Miller said: "The US Federal Reserve put up interest rates nine times in recent years, that affects the rest of the world as well as the US, because many emerging market economies have to put interest rates up as well, to protect their currencies.
"That made economic conditions around the world more challenging and revised growth expectations downwards.
"The equity markets were probably not reflecting those changed circumstances, but the sell-off probably was a little overdone, the markets have rallied in 2019, and probably are back up with events again."
He also believes the market is wrong to expect that inflation won’t rise in the US, and this will necessitate further interest rate rises. He continues to expect a recession in the US in 2020.
Mr Miller said: "Advisers looking for protection, I think equities will continue to do ok until the inflation comes in, and the market starts to think US interest rates will have to rise.
"At that point, government bond prices will fall, and that is when investors should buy them for clients, because then they will be cheap, and so will play the traditional role in portfolios of being cheap in time for a recession."
Mike Bell, a market strategist at JP Morgan Asset Management said that global absolute return funds and traditional defensive equities performed strongly during the global financial crisis and he would expect this to happen again.
david.thorpe@ft.com
