True Potential Portfolios Key Themes – June 2021
Our central investment thesis of a cyclical recovery is maturing. Within the True Potential Portfolio proposition, reductions have taken place from early-stage cyclical equity sectors such as energy and financials after their recent strong performance. The more quality focussed areas of the equity market, sectors such as pharmaceuticals, utilities, and consumer discretionary are being added to as the style tilt of the proposition broadens. Opportunities continue to present themselves but many of the True Potential managers are analysing the next stage of the cycle before significantly adjusting positioning. In this environment, we believe the best returns will come from equity markets and we are overweight compared to a naïve equally weighted portfolio.
Ten-year US Treasury yields are now at 1.48% having fallen as low as 1.44% over the past month, as investors respond to the prospect of interest rate increases coming through in the US earlier than initially expected. The True Potential manager cohort holds differing views as to potential yield levels at the end of the year with a range of 1.5% up to 1.75%, lower than when polled earlier in the year. Our view is that yields will rise from here but slowly. We do not foresee a “taper tantrum” reaction with the Federal Reserve careful with their communication and investors understanding that tapering will come through at some point. We do not foresee yield levels in US Treasuries falling significantly lower from here unless there is a shock to economic growth or activity data.
Investment-grade credit is generally deemed unattractive with spread levels, the amount of extra yield an investor receives above government bonds, very tight relative to history but we are willing to hold and take the higher yield. Alternative assets to traditional bonds and equities have been added to and are being further investigated as we move to the next stage of the cycle. Examples include analysing the role of FX and opportunities for return enhancement and those products that can benefit from movements in volatility.
The global economic recovery continues onwards driven by vaccination rollout and stimulus. Economic data points continue to be strong. A question we are asking ourselves, when will we reach or even have we reached peak global growth? We believe we are seeing signs of PMI data peaking led by the US. This does not mean we will see a contraction, global PMIs are anticipated to remain above 50 through the remainder of 2021, demonstrating expansion, although momentum will slow. There will be regional nuances. Hence the key tenet of the True Potential proposition of diversification.
Inflation continues to be a key discussion topic. We believe the pick up in the inflation rate will be transitory. Looking at the components that have seen the most pressure, second-hand cars, travel, this backs up our thesis, although we are determined not to be complacent, this something we are monitoring. Within the US, there are some examples of higher wage inflation coming through particularly within leisure and hospitality. We recognise many factors are presenting a barrier to individuals re-entering the labour market, namely challenges around childcare and fiscal support replacing (enhancing) incomes. As we move through the year, we see these factors moderating as individual fiscal support rolls off (Q3) and more people going to back to work which should help dampen wage increases.
Emerging market assets were discussed with the conclusion that increasing emerging market equities was not attractive. Pandemic-related concerns will persist over the short term. From an index perspective, China is a significant component of indices and an area deemed not attractive right now. Other ways to play this theme are being used within the proposition such as EMFX, commodity holdings, and developed market shares with a strong link to commodity prices.