Duncan Lawrie Online ▼

Posted on: 29 October 2015 by James Humphreys

Why we still believe well-diversified portfolios are the intelligent choice.

Financial markets suffered a sharp increase in volatility in the third quarter of 2015, to levels last seen during the euro crisis in 2011.

This coincided with a slowdown in global economic growth, mainly due to the slowing Chinese and emerging market economies, which the International Monetary Fund (IMF) has warned could cause a global recession. It's hard to predict whether the US might be badly affected, but the Federal Reserve (Fed) has decided not to raise interest rates until the economic outlook becomes clearer.

Trouble in China and the emerging markets

Over the summer, the enormous Chinese bubble that inflated earlier in the year suddenly popped, and the market fell sharply.

The Chinese authorities then tried to stop the fall in an apparently chaotic fashion. Surprisingly, they also devalued their currency, the renminbi, by 1.9% against the dollar, announcing that they wanted to make it more responsive to market forces.

Beijing is in a perilously difficult position, as it's attempting to achieve a number of conflicting objectives: liberalising the financial system and rebalancing the economy, but also trying to avoid a recession and deal with high levels of debt. This is a bit like spinning plates, and it would be surprising if they achieved it without an occasional wobble.

The emerging market world is also facing pressure. Emerging market equities and currencies saw significant falls in the third quarter, and economic reform is desperately needed to improve competitiveness; too many countries have been slow to address this.

Better news in the US and UK

The US and the UK both saw a slowdown in the quarter. However, this was mainly limited to industry and manufacturing. So far, other areas of the economy are holding up, and consumers are enjoying the boost to disposable incomes brought by the fall in oil prices. The financial systems in the west are far stronger than in the recent past, so there is every reason to expect this slowdown to remain just that, and not turn into a recession.

Another reason for optimism is that the Fed and the Bank of England will probably carry on postponing interest rate increases while the global economy is in such a precarious position. Thanks to this, bonds have had a strong quarter, particularly safe haven UK Gilts and US Treasuries. The 10 year Gilt saw its yield hit a high of 2.2% in June, but finished the quarter at 1.7%. 

We've been cautious about the prospects for equity markets since last year, as valuations have been very high in the context of market history. That's why we reduced our equity exposure 12 months ago and increased US exposure earlier in the year, as the dollar usually acts as a safe haven in difficult times. 

We still believe this cautious view is the right one, for the reasons given above. The market may manage to avoid big falls, but even sideways-moving markets can be uncomfortable, and we believe well-diversified portfolios are still the best choice for our investment clients.

All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.
The comments and figures in this document are generally applicable but you should always take specific advice  to suit your individual circumstances before taking any action. Errors and omissions excepted.
The value of investments and income generated may fall as well as rise, and investors may not get back the  amount invested. Past performance is not a reliable indicator of future results.