Anyone who has got to know our views over the last 12 months or so has probably heard us talking about trying to pick low hanging fruit. By this, we obviously mean that we wish to focus on the trades where we think there is an excellent chance of making money, and where the risks are relatively small and controllable.

When we cast our eye around the financial landscape, there is simply not much low hanging fruit available for long term investors who like to take a buy and hold approach. We continue to believe that developed equity markets will offer close to zero returns for the next 7 to 10 years with the likelihood of a vicious bear market in the next year or two. Government bonds are not attractive, with zero or negative yields on offer on huge swathes of the market, and negative real yields on virtually all sensibly rated paper.

With equity markets now mostly (and unexpectedly) higher for the month of May, it seems like policymakers are getting their way. With Brexit seemingly less likely at the moment, Greece being given more bailout funds and the market apparently comfortable with the prospect of another Fed rate hike, being bearish on equities has been a losing proposition in the short term. Perhaps there are simply too many investors who have been underweight and they now feel compelled to buy to reduce their relative risk. Perhaps corporate buy backs are still powerful enough to nudge prices higher, especially as executives are incentivised by higher share prices and so are completely price insensitive when they enter the market.

If the thesis of close to zero returns for a number of years from both bonds and equities is correct, then how can investors make money? First, they will have to do something different from the crowd, and that means taking well thought out risks to capitalise on trends that may last for weeks or months rather than years. It means investors will have to be happy having some form of tactical approach within their portfolios. In market parlance, investors will need to search for some alpha and reduce their beta, even though this may not have worked in recent quarters for a number of active managers.

We continue to believe that the hawkish shift from the Fed in recent weeks is the most important macro development in recent weeks. With the Yellen speech last week reinforcing market expectations for a rate hike in either June or July, the policy divergence between the Fed and the rest of the World is clear. Despite a decent bounce in the Dollar, we expect more to come, and not just against the Euro and the Yen, but against Asian currencies in general.

Chart 1 shows the performance of global trade which is now stagnating. This is clearly bad news for those Asian countries that are heavily dependent on global trade. Furthermore, we expect Japan to embark on another programme of policies soon, part of which will be a weaker Yen. We also expect China to manage the Yuan gently lower in the months ahead. It is highly likely that Asian currencies will allow their currencies to weaken if the Yen and Yuan are weak. In fact, they may have no choice if the market decides that higher US interest rates are sufficient to push these currencies lower.

Chart 1 – Global trade is simply not growing

Another trade that makes sense to us with the Fed now being more hawkish is for the US Yield curve to flatten. We discussed this last week (see report HERE), but the dynamics are that 2 year yields have to rise if the Fed is serious about raising rates two or three times this year with more to come in 2017. Not only will this tighten financial conditions which should then become a headwind to US growth, but 10 year bond yields near 1.85% look very attractive compared to German and Japanese bond yields at +0.12% and -0.12% respectively, or zero on average.

So rather than have a directional exposure to US bonds, we wish to have a relative value exposure via trades that benefit from a flatter yield curve.

Chart 2- The US yield curve 10 year less two year yields

We continue to believe that there will be periods of risk off, driven by the unwinding of macro imbalances. We have written about these many times in the past. We continue to believe that there are trades that will pay off very well in these risk off scenarios and where the risk can be very well controlled. But what we cannot say for sure is that these “blow up” trades will work well in the short term as investors ignore them and policymakers do everything they can to prevent them.

So although we continue to hold some “blow up” trades in our multi asset macro fund, we think the lower hanging fruit is available from trades that benefit from the renewed hawkishness from the Fed and these can be accessed through the RMG FX Strategy UCITS fund – see information HERE.

Stewart Richardson
Chief Investment Officer