April 2018 Market Report
During the quarter to March 29th, 2018, all major equity markets suffered marked declines leaving some indices down near 10% year to date, while the VIX rose significantly to 19.94. Globally, a “perfect storm” of rising interest rates, stock specifics e.g. Facebook, and the growing threat of a trade war were the clear market catalysts. The European Central Bank continued to move, as expected, towards further tapering mode, amidst some lack lustre economic data releases, German political relief but Italian political uncertainty. US market watchers negotiated the well anticipated March interest rate increase and healthy economic data in reasonable shape but were unsettled by growing trade tariff discussions and actions and several Trump’s personal issues. In the Far East, Chinese premier Xi Jinping consolidated his position, and the country responded to Donald Trump’s tariff imposition in robust fashion, while the “Koreas” edged very tentatively towards discussions. Aggregate world hard economic data continues to show steady expansion, excluding the UK, as confirmed by the IMF and the OECD with some forecasts of 2018 economic growth in the 3.5% to 4% area. Fluctuating currencies continue to play an important part in asset allocation decisions, the Japanese yen receiving some attention (unwelcome by some) as a haven, while sterling seemed to take heart from ongoing Brexit discussions. Bond watchers watched carefully as the US 10-year yield approached 3% before backing off towards the end of the period. Greater fluctuations in bond yields are likely to lead to higher equity volatility going forward.
Global Equities fell over the three-month period, the FTSE ALL World Index dropping by around 1.59% in dollar terms and falling 5.09% for a sterling-based investor. The UK broad and narrow market indices have underperformed other major markets over the quarter on a local and sterling adjusted basis. Emerging markets were one of the very few bright spots rising by about 1.5%, building on the 2017 outperformance, while the NASDAQ Index also eked out a small gain despite the well-publicised tech woes late in the quarter. In sterling adjusted terms there was much closer alignment of the year to date moves amongst the major overseas indices, Japan (-3.7%) and America (-5.2%) being the first quarter leaders and both UK broad and narrow indices falling about 8%,bringing up the rear. The VIX index advanced nearly 100% over the period, much in the early February period, and there is no doubt that the oscillations in the VIX and related products themselves, contributed to the nervous market environment at that time. At the time of writing, the absolute VIX level stands at 19.94, far from the 9-10 level that prevailed much of last year and reflecting a level of uncertainty but far from the extreme levels experienced during major market meltdowns of the past. Chartists would note that the quarter just ended was the first negative quarter for major indices since 2015!
Sector volatility remained high during the month, influenced by both global factors e.g. Mining, down 6.38% and pharmaceuticals, up 6.6%, due largely to corporate action (actual and rumoured). Amongst the financials, banking and insurance shares remain outperformers year to date although still down in absolute terms. It is worth pointing out the growing list of companies involved in some form of takeover/restructuring, Melrose/GKN being a high-profile example. Still relatively early in the year, but so far, UK small company funds are outperforming larger company peers, while active funds are outperforming passive. All the major UK equity sectors are, however showing negative year to date absolute returns, as are all “balanced” portfolios. Source: Trustnet
Gilt prices rose over the month but are down 0.66% year to date in capital terms, the 10-year yield standing at 1.39% currently. Other ten-year yield closed the quarter at US 2.75% Japan ,0.01% and Germany 0.43% respectively. UK corporate bonds also dropped in price terms over the three-month period. Amongst the more speculative grades, there were mixed trends, with emerging market bonds, in local currency terms, showing price gains in absolute terms and yet the US lower grade bonds were moving in the opposite direction. Convertible bonds continued to outperform gilts and the recommended floating rate bond fund showed a positive total return over the quarter, thus outperforming both equities and gilts. Preference shares had a very bumpy march, largely due to cancellation proposals, subsequently withdrawn, by Aviva plc See my recommendations in preference shares, convertibles, corporate bonds, floating rate bonds etc. A list of my top thirty income ideas (all yielding over 5%) from over 10 different asset classes is available.
Amongst the major currencies, a stronger pound was the major monthly feature rising 1.2% in trade weighted terms. On the other side of the coin, the Dollar fell. The Japanese Yen currently stands as the major currency “winner” over the quarter rising by 4.87% in trade weighted terms and over 5.5% against the US dollar. As mentioned above, the FX moves are becoming a growing factor in asset allocations discussions. For example, about half of the Japanese equity 4% outperformance of the UK market is due to currency gains, so far this year.
A very mixed month for commodities. Oil showed a large bounce, remaining above $60 while gold responded to the weaker dollar by rising about 0.5%. There were mixed trends amongst the other precious/PGM group metals. Most of the major global mining groups have just reported figures and rising commodity prices, capital discipline, balance sheet transformations and higher shareholder pay-outs have been a common theme. Soft commodities have also enjoyed reasonable price gains since the start of the year, wheat and corn for example both showing price gains of around 5%.
Just for completeness I note that bitcoins have lost about 50% of their value since the beginning of the year, not that that would interest many of my regular readers, I am sure!
Over the coming months, geo-political events and Central Bank actions/statements will likely be key market drivers while the first quarter reporting season and many ongoing corporate events will likely add a further level of volatility. With rising bond yields, equity valuations and fund flow dynamics, will also be increasingly important areas of interest/concern. US watchers will continue to speculate on the timing and number of interest rate hikes 2018/2019, as well as fleshing out the winners and losers from any tariff war. Furthermore, Facebook/tech issues and Donald Trumps’s personal affairs may dominate news for a while. In Japan market sentiment is likely to be influenced by economic policy, especially in the areas of low inflation/strong Yen, and any likely direct or indirect tariff impact. Global geo-politics will also feature Iranian sanctions and Korean discussions. Hard economic data (as opposed to sentiment surveys) will continue that UK economic growth will be slower in 2018 compared to 2017, and further down grades may appear. Brexit discussion have moved to a new level. Political tensions stay at elevated levels both within and across the major parties and considerable uncertainties still face individual companies and sectors.
On a valuation basis, most, but not all, conventional government fixed interest products continue to appear expensive against current economic forecasts and supply factors, and renewed bond price declines and further relative underperformance versus equities should be expected in the medium term, in my view. On the supply point there are increasing estimates of US bond issuance against a background of diminished QE and overseas buying (Chinese retaliation?). Equities appear more reasonably valued, apart from some PE metrics, (especially in the US), but there are wide variations, and opportunities, in both broad asset classes. Equity investors will be looking to see if superior earnings growth can compensate for higher interest rates in several areas. Corporate results from US, Europe and Japan were, on aggregate, up to expectations over 2017 although EY noted that the number of UK profits warning were about 10% higher than the previous year at the nine-month stage, mostly in the home improvement, motor, government supply,restaurant and other retail areas. Outside pure valuation measures, sentiment indicators and the VIX index are showing significant day to day variation, after the complacency of last year.
In terms of current recommendations,
Continue to overweight equities relative to core government bonds, especially within Continental Europe and Japan. However, the equity selection should be very focussed. Certain equity valuations are rather high, especially on a PE basis (see quarterly). A combination of sharper than expected interest rate increases with corporate earnings shocks would not be conducive to strong equity returns.
- UK equities still only warrant a neutral allocation now, in my view, despite the underperformance of last year and the first period of 2018, and some relatively modest ratings. It is tempting to rebuild some UK equity exposure on certain valuation considerations, though difficult to see a short-term catalyst. Within the UK equity space, I suggest moving the balance of small/large cap stocks now back to neutral following both the outperformance of the former and the volatility in the currency (part post-election, part BREXIT). Ongoing Brexit debate, political stalemate could cause more sterling wobbles, which in turn could affect sector/size choices. I would expect to see more profits warnings.
- Within UK sectors, some of the higher yielding defensive plays e.g. Pharma, telco’s and utilities have attractions relative to certain cyclicals and many financials are showing confidence by dividend hikes and buy-backs etc. Oil and gas majors may be worth topping up after recent weakness and balance sheet improvements and have lagged the recovery in the spot price. Concentrate on the major diversified although there are currently some very attractive equity and fixed interest ideas in the mid/small cap area. Mining stocks remain a strong hold, in my view (see my recent note for favoured large cap pooled play). Corporate activity, already apparent in the engineering (GKN), property (Hammerson), pharmaceutical (Glaxo, Shire?),packaging(Smurfit) is likely to increase in my view.
- Continental European equities continue to be preferred to those of USA, for reasons of valuation, and Central bank policy. Improving economic data adds to my enthusiasm for selected European names, although European investors may be advised to focus more on domestic, rather than export related themes. Look at underlying exposure of your funds carefully. Remember that certain European and Japanese companies provide US exposure, without paying US prices. I have recently written on Japan, and I would continue to overweight this market, especially in hedged form, despite the large 2017 outperformance. Smaller cap/ domestic focussed funds may out perform broader index averages e.g. JP Morgan Japanese Smaller Companies and Legg Mason.
- Alternative fixed interest vehicles, which continue to perform relatively well against conventional government bonds, have attractions e.g. floating rate funds, preference shares, convertibles, for balanced, cautious accounts and energy/ emerging/speculative grade for higher risk. These remain my favoured plays within the fixed interest space. See recent note
- UK bank preference shares still look particularly attractive and could be considered as alternatives to the ordinary shares in some cases. If anything, recent sector “news” has highlighted the attractions of the sector.
- Alternative income, private equity and renewable funds have exhibited their defensive characteristics during recent equity market wobbles and are still recommended as part of a balanced portfolio. Reference could be made to the renewable funds (see my recent solar and wind power recommendations). Results from Greencoat on February 26nd and Bluefield Solar the following day reinforce my optimism for the sector. Selected infrastructure funds are also recommended for purchase after the recent Corbyn/Carillion inspired weakness (see note).
- Any new commitments to the commercial property sector should be more focussed on direct equities and investment trusts than unit trusts (see my recent note comparing open ended and closed ended funds), thus exploiting the discount and double discount features respectively. However, in general I would not overweight the sector, as along with residential property, I expect further price stagnation especially in London offices and retail developments. The outlook for some specialist sub sectors and property outside London/South-East, however, is currently more favourable. Investors should also consider some continental European property plays. See my recent note on this sector. Corporate activity may unlock long term value.
- I suggest a selective approach to emerging equities and would currently avoid bonds. Although the overall valuation for emerging market equities is relatively modest, there are large differences between individual countries. A mixture of high growth/high valuation e.g. India, Vietnam and value e.g. Russia could yield rewards and there are signs of funds moving back to South Africa on political change. As highlighted in the quarterly, Chinese index weightings are expected to increase quite significantly over coming years and Saudi Arabia,is just being allowed into certain indices.
Full second quarter will be available in mid-April for clients/subscribers and suggested portfolio strategy/individual recommendations are available. Ideas for a ten stock FTSE portfolio, model pooled fund portfolios (cautious, balanced adventurous, income), 30 stock income lists, hedging ideas and a list of shorter term low risk/ high risk ideas can also be purchased, as well as bespoke portfolio construction/restructuring. I expect more clients, who may have been considering cashing in , to switch some final salary pots to SIPP, to act sooner rather than later, as the combination of rising gilt yields in the medium term and lower projected investment returns over the coming period will further erode CETV’s.
Good luck with performance! Ken Baksh 01/04/2018
Ken has over 35 years of investment management experience, working for two major City institutions between 1976 and 2002.
Since then he has been engaged as a self-employed investment consultant. He has worked with investment trusts, unit trusts, pension funds, charities, Life Fund,hedge fund and private clients. Individual asset managed have included direct equities and bonds pooled vehicles currencies, derivatives and commodities.
Projects undertaken in a number of areas including asset allocation, risk control, performance measurement, marketing, individual company research, legacy portfolios and portfolio construction. He has a BSc(Mathematics/Statistics) and is a Fellow Member of the UK Society of Investment Professionals.
Phone 07747 114 691
Good luck with performance! Ken Baksh 01/03/2018
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