The risks have not gone unnoticed. The director of the Congressional Budget Office, the US government’s financial watchdog, recently warned that a repeat of the disastrous Liz Truss Budget fiasco is possible, even in the US.
Central banks are alert to this and will be quick to pause or slow bond sales if market volatility rises, but the disruption could still be substantial. We have reduced exposure to government bonds across portfolios.
Equity concentration risks are ebbing
Encouragingly, equity market leadership has finally started to broaden this year.
At the end of March all but one of the S&P 500 sectors delivered a positive return for the quarter, while returns from Asia actually outstripped the technology-rich S&P 500.
However, market concentration remains a concern. The first quarter saw both Meta and Nvidia add, in a single day, more in terms of capitalisation than has ever occurred in market history.
Managing concentration risk does not require investors to sell down positions in all AI-related companies.
Indeed, their robust growth dynamics provide good reasons to retain them.
But it does mean managing position sizes, being disciplined about valuation targets and putting portfolio insurance in place (or overwriting positions), where appropriate, ahead of any unwelcome increased volatility.
Rising real interest rates will squeeze leveraged assets
A further worry is the increase in real interest rates as inflation falls but nominal rates remain high.
This has the potential to expose strategically fragile assets and penalise high leverage.
Our principal worry here is commercial real estate, where investors are already facing multiple challenges, including remote working, sharply higher funding costs and the need to upgrade buildings to meet tougher emissions goals.
Indeed, many older buildings may have little equity value remaining.
Newmark, a US real estate advisory company, estimates that $2tn of US real estate loans will mature by 2026, of which $670bn may be troubled.
This argues for caution on more leveraged assets, and in particular toward commercial real estate developers and those who have lent to them.
Quality and focus will be key in 2024
With these caveats, the prospect of a soft landing across multiple economies provides powerful support for global thematic equities.
But to benefit we must reduce portfolio risk elsewhere; this will mean lowering bond allocations, managing concentration risks and reducing exposure to leveraged, climate-vulnerable assets.
So yes, we will stay the course, but quality and focus will be key to maximise our ability to ride out the shocks that will – almost inevitably – occur.
Guy Monson is chief market strategist at Sarasin & Partners
