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March 2018 Market Report
During the period to February 28th, 2018, major equity markets registered little overall move on balance, but there was a large increase in volatility and day to day movement, leaving some markets, briefly, in “correction” territory earlier this month before recovering some of the fall. The European Central Bank continued to move, as expected, towards further tapering mode, amidst some very strong economic data releases while new additional political “noise” from Germany and Italy, affected shorter term market sentiment. US market watchers negotiated the Federal Reserve (both rate increase and change in Chairperson) as well as the last-minute passage of the Tax Reform Bill. However, at the time of writing, the expectation of greater than expected, monetary tightening in the short term, protectionism and growing longer term debt implications are unsettling factors. In the Far East, Chinese authorities stepped up regulatory action (specifically the financial sector) while still showing very satisfactory GDP growth, and Japan recorded yet another quarter of relatively strong GDP growth. The re-appointment of Japanese Central Bank Governor Haruhiko Kuroda signalled continued adoption of the easier monetary and fiscal stance for the time being. Aggregate world hard economic data still showed 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. Bond watchers are watching carefully the US 10 year as the yield hovers near 3.0%, (2.93% at close 28/02). Greater fluctuations in bond yields are likely to lead to higher equity volatility going forward.
Global Equities rose over the period, the FTSE ALL World Index climbing by around 2.02% in dollar terms. The UK broad and narrow market indices underperformed other major markets, both falling by near 6%. Emerging markets, Asia and the tech-heavy NASDAQ index had a relatively strong start to 2018, building on the 2017 outperformance. In sterling adjusted terms there was much closer alignment of the year to date moves amongst the major overseas indices, Japan and America a little ahead, both outperforming UK by about 6%. The VIX index advanced nearly 90% 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 19.26, far from the 9-10 level that prevailed much of last year.
Sector volatility during the period was high, mining outperforming telecoms by about 11% for example. Amongst the financials, banking and insurance shares have been stronger than average and the former sector has recently announced a series of buy-backs, dividend increases/reinstatements after the troubles of recent years. Still relatively early in the year, but so far, UK small company funds are outperforming larger company peers, and, along with mixed asset funds, are showing a negative year to date returns. The only IMA sectors still in positive territory are Tech,Asia and Emerging markets. Source: Trustnet
Gilt prices have fallen over the recent period, the ten-year yield currently 1.59%. Other ten-year yield movements were generally upwards, American, Japanese and German ten-year yields closing recently at 2.93%,0.04% and 0.62% respectively. UK corporate bonds also dropped in price terms over the period although slightly less than gilts. 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. 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, the Japanese Yen was the major feature rising by nearly 4% in trade weighted terms, partly on globalised dollar weakness and a certain amount of perceived “safe haven” buying during the volatile equity period. On the other side of the coin, the Dollar fell. The Euro did not show much net movement while sterling, a little stronger, seemed to be driven by slightly more hawkish MPC statements and difficult Brexit discussion. As mentioned above, the FX moves are becoming a growing factor in asset allocations discussions.The dollar yen,for instance has already moved over 5% in just two months.
A generally firm period for commodities. Oil(WTI) showed a small bounce, remaining above $60 while gold responded to the weaker dollar by rising about 2%. There were mixed trends amongst the other precious/PGM group metals, platinum and palladium rising while silver fell rose. 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.
Over the coming months, geo-political events and Central Bank actions/statements will likely be key market drivers. 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, as well as fleshing out the winners, losers and debt implications from the recent Infrastructure/ Tax Reform Bill initiatives and watching Donald Trumps’s personal issues. Protectionism also seems to be on the increase. In Japan, Shinzo Abe is likely to push for changes in the Constitution and reinforce the easier monetary and fiscal economic policy stance following his resounding election victory and re-appointment of Kuroda. Hard economic data (as opposed to sentiment surveys) will shows that the UK economic growth will be slower in 2018 compared to 2017, just released, and downgrades to have recently been made by many organizations. BREXIT discussions enter a new phase with discussions on the timing and nature of the new “Trade Deal”, as well as transitional arrangements being a major focus. Political tensions will arise both within and across the major parties.
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 my view. On the supply point there are increasing estimates of US bond issuance against a background of diminished QE and overseas buying. 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 (well flagged Maplins,ToysRus,Prexxo’s,this morning) were about 10% higher than the previous year at the nine-month stage, mostly in the home improvement, motor, government supply and other retail areas. Outside pure valuation measures, sentiment indicators and the VIX index are showing more day to day variation, after the complacency of the last quarter.
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. 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).
- Continental European equities continue to be preferred to those of USA, for reasons of valuation, and Central bank policy. This strategy, in sterling adjusted terms worked very well through 2017 and I expect to continue. 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. Prices have shown good capital growth since as well as offering annual yields more than 5%, but are still recommended for more cautious investors with a desire for regular annual income. Recent results and the November “stress test” results show that generally UK balance sheets are generally in good shape, and I see negligible risk of default on preference share dividends for the recommended stocks.
- 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 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.
- 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, especially after a rating upgrade earlier this week. As highlighted in the quarterly, Chinese index weightings are expected to increase quite significantly over coming years.
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 and lower projected investment returns over the coming period will further erode CETV’s.
by Ken Baksh
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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