Politics key to whether we sink or swim

DESPITE the strong rise in equities, against my usually optimistic inclinations I am feeling increasingly uneasy.

The root cause of this lies not in the level of world equity markets, but in that of bond markets.

Having long argued the merits of UK conventional government fixed income investments (Gilts) as insurance policies against deflation, this case is becoming more difficult to make as government bond yields fall.

UK 10-year Gilts tumbled last week to a record low of under 0.7 per cent, down from almost 1.4 per cent immediately prior to the Brexit vote. And in spite of the currency risks posed by our twin deficits in trade and government finances.

The result is all key areas of investment increasing at the same time – both those whose rise is consistent with a triumph for the demons of deflation (bonds) and those whose rise relies upon the slaying of that same demon (shares). Both continuing to surge is unsustainable.

Post Brexit, compounded by currency effects, the UK is an extreme example of this, but the same trends are visible throughout the developed world.

Which market is right? Fixed income or equities? Since the financial crisis, fixed income markets have always given a better steer than equity markets globally, but this may yet change.

Steadying commodity prices and easing monetary conditions are helping the economies of emerging markets, and if Brexit has done anything positive, it may have accelerated the deployment of fiscal stimulus as an antidote to the rise of populism in Europe.

The risk is that having enjoyed such a strong run, if fixed income markets do turn they will do so sharply and undermine confidence in equities. Central banks are standing in the way of such a sharp reset happening, but this leaves us with an investment outlook that is policy dependent.

In this context, with global politics highly charged, dramatic changes in personnel and policy direction are possible and almost certainly unwelcome to stabilityloving investors. John Wyn-Evans is head of investment strategy at Investec Wealth & Investment