Asset Allocator's Soapbox: Rathbones' David Coombs

David Coombs, head of multi-asset investments at Rathbone Unit Trust Management, on the best ways to play turbulent times.

A  recent business trip to the US has confirmed my belief in its ability to outperform this year. Some of the more bearish strategists have highlighted that while the presidential election cycle is usually positive for equities, the can has been kicked into the second half of the year, if one considers some key economic indicators.

Therefore, if the US delivers lower growth, coinciding with higher rates, it could lead to some serious sclerosis in the economy and market underperformance.

However, there is gathering support for the belief that policy action is now bearing fruit. The view is that GDP could reach 5% or above this year, and that Wall Street is underestimating the potential for corporate earnings to surprise on the upside.

Anecdotally, I heard that order books are strong, driving improvements in margins, and there could be some significant upgrades in the offing. As far as our portfolios go, I favour large cap exposure, based on valuation, and the element of defensiveness while the Dollar provides relief during the ‘risk-off’ trade. Technology is one sector that looks particularly attractive. This is on the premise of increased capex: a decade after 2000, I believe an IT reinvestment cycle is overdue.

Of course, at this juncture, any article on asset allocation must mention the emerging markets. The question for investors has been whether or not the events in Tunisia and Egypt represent tactical opportunities to increase weightings.

My view is twofold. First, the protests mark an important reminder of the significant volatility that can characterise these markets. There is still no way of knowing whether events in Egypt and Tunisia are a foretaste of things to come, but it puts a healthy dose of geopolitical risk back on the agenda. Second, it illustrates how a consolidated approach to emerging markets is no longer relevant.

My team and I are looking into ways of differentiating between emerging markets and delineating between risk profiles. Meanwhile, I’m sitting on the sidelines, and not using the immediate weakness as an opportunity to add because valuations still look excessive.

Inflation also remains a key risk in the mature emerging markets: similar to their western counterparts, headline inflation is lower than consumer inflation, disrupting discretionary spend. I need to keep an eye on this. However, in general, should emerging markets start to discount close to the 15% mark, and accounting for the risks, I would look to re-enter.

This raises a further question for investors: how big a risk is it to now be overweight in developed markets? Can they be a beacon of sobriety in and among the mess? In the UK, there is always the lingering fear of policy error of the Bank of England, particularly if it feels that its inflation-busting credibility is under threat, or if the US goes all out on QE and markets start to fight the Federal Reserve.

The point is that investors wishing to rotate out of developing markets into developed ones should also be aware of the risks proliferating those markets too: deficits, elevated inflation, higher interest rates and consumer stagnation, to name but a few. The remission of European sovereign debt issues remains a key issue this year, but there is no clear catalyst to jump in. Time-lines by policymakers, including further bank stress tests, suggest that the problem could play out in waves.

However, I believe that Germany will remain a beneficiary of current monetary conditions. A key concern for western markets remains the impact of a higher oil price. If this continues to rise, I will revise my view on equities.

Finally, I remain bearish on bonds, although I might look to increase gilt exposure if yields reach about 4%.