A “regime change” in the markets
Sterling’s fortunes continue to wane off the back of Brexit uncertainty.
Positive sentiment on the US economy buoys its equity market.
Markets’ “regime change” raises need to review asset allocations.
US tech companies continue to lead global equites.
Featuring this month’s experts:
As the second half of the year gets underway, it is clear that markets have undergone a regime change. Investors are also pondering geopolitical developments, particularly in the UK, and trade tensions.
Here, leading wealth managers from our panel give their views on recent events and explain the key risks – and opportunities – investors should be thinking about.
Our thoughts on sterling
Christian Armbruester, Chief Investment Officer at Blu Family Office, says:
Very few financial instruments are getting worse press at the moment than the UK currency. Maybe the euro comes close and here we have also had many pundits predicting doom and gloom, only for the currency to still be flourishing some 18 years on after being introduced in 1999.
So, where are we headed and is it all reliant on what happens with Brexit? Certainly, a historic vote to leave the EU after 40 years will have a large impact not only on exchange rates but also the economy in general. We are now two years on from the 23 June referendum and sterling has depreciated against the US dollar and the euro by about 10% and 15%, respectively. In the next nine months, we are going to learn how disruptive the exit will be and there will certainly be further downside to sterling if the UK decides to leave without a deal. Some of the smart investment bank analysts have put targets of 90 cents against the US dollar in such an event, but we know how (in)accurate these analysts have been in the past, so it is probably best to ignore such headline-grabbing apocalyptic forecasts.
Certainly, a historic vote to leave the EU after 40 years will have a large impact not only on exchange rates but also the economy in general.
If, however, cooler heads prevail and we enter a transition period to allow things to assimilate, sterling could see a rebound and probably revert back to the pre-referendum levels above 1.4 versus the US dollar and 1.25 against the euro.
Does anything else matter? Not really, apart from any other geopolitical shockers, Brexit is the only game in town as far as sterling is concerned and good luck with that.
Chief Investment Officer at Blu Family Office
Opportunities versus threats
Violent price movements seem to have served to distract investors from the underlying positives. But politics have also again played their part. Donald Trump aside, Italy hit the headlines and ruffled EU feathers. The UK also continues to see high levels of drama played out due to the ongoing dominance of the Brexit discussions.The US equity market was the only exception to the downwards 1H trend. It appears that the positive sentiment coursing through the US economy is enough to outweigh investors’ fears. However, the US multi-faceted trade war could cause that momentum to falter. The current question as to whether there could be relative winners could see the US fair best…well, so far. Chinese equities have fallen 20% from their peak, Mexican stocks are down 15%, and other global trading nations such as South Korea have felt similar pain. European retaliation has yet to bite, however, and has been carefully choreographed to hit in swing states given the upcoming midterm elections. Watch this space!
Investment Manager at Seven Investment Management (7IM)
Readying for a new regime
Tom Becket, Chief Investment Officer at Psigma Investment Management, says:
We spent much of 2017 referring to market events as ‘boring’; asset prices basically went up in a straight line and there was a near-total absence of volatility across all major asset markets. We have firmly left that ‘Easy Street’ environment and investors are now once again being forced to think about the possibility of markets going down, as well as up.
The ‘Regime Change’ that has taken place over the last few months brings both a number of risks and opportunities, as well as an overarching necessity for investors to reassess the likely bumpy future path for asset markets and to recognise that investment returns are likely to be lower in the future than they have been over the short, medium and long-term history.
The days of the certainty of low interest rates, low levels of inflation and ever-widening corporate profit margins are now behind us.
When one combines the changing events of the last few months with the threat of a full-blown trade war between the US and its economic ‘friends’ and ‘foes’, it is clear to see why we have seen growing tensions across financial markets and frequent negative days in markets.
While we don’t view the new ‘Market Regime’ as one where investors should sell up entirely and head for hills, it is a time to assess whether the investments and asset allocation that you have held for the last decade are still appropriate for a time when risks have risen and returns are likely to be lower. The days of the certainty of low interest rates, low levels of inflation and ever-widening corporate profit margins are now behind us.
Chief Investment Officer at Psigma Investment Management
Global equities continue to be led by US tech companies
Daniel Casali, Partner at Smith & Williamson, says:
Global equities continue to be shown leadership by the US tech sector. Collectively, the market capitalisation of the top five US tech companies (Facebook, Amazon, Apple, Microsoft and Alphabet’s Google) is worth more than the 50 largest stocks in the eurozone, while Apple is close to becoming the world’s first trillion dollar-valued company.
Though there are concerns about a bubble in US tech sector stocks, there are considerable differences compared to the valuations during the dot.com frenzy of 2000. The current, equal-weighted forward price-to-earnings (PE) multiple for the top five US tech companies is 25x, compared to 63x for the equivalent ranked stocks (Microsoft, Cisco Systems, Intel, Oracle and Sun Microsystems) at the time of the peak of the tech boom in March 2000.
More fundamentally, and unlike 2000, the tech sector continues to be backstopped by strengthening tech demand. For example, real investment in US information technology products and software grew 8.2% from a year ago in Q1, the fastest rate in more than a decade.
Real investment in US information technology products and software grew 8.2% from a year ago in Q1, the fastest rate in more than a decade.
Meanwhile, Emerging Market (EM) risk assets (equities, bonds and currencies) have come under selling pressure over the past few months. Part of the reason lies with the renewed strength in the US dollar, which raises concerns about how these counties will service their USD-denominated debt.
However, there are a number of reasons why it could be argued that financial contagion spreading to the EM complex is limited. For example, Argentina and Turkey have been overheating for some time, as evidenced through higher inflation and widening current account deficits, and are an idiosyncratic risk, as against a systemic risk to the EM complex. We continue to look for opportunities in Far East markets, where we view risks as more balanced with improving underlying fundamentals.
Partner at Smith & Williamson
Headwinds holding back equities
Alex Brandreth, Deputy Chief Investment Officer at Brown Shipley, says:
Trade tension, European politics and central banks grabbed the headlines during June. The US increased interest rates for a second time in 2018, with two more hikes now looking likely this year. The Bank of England (BoE) signalled that they will likely do the same before year-end and the European Central Bank provided details on the reduction in their bond purchasing programme and hinted if the data remains strong, interest rates in Europe could change from next year.
The ratcheting up of trade tensions remained in the news and is the widely cited headwind for equity markets. The Wall Street Journal reported Chinese President Xi told a group of 20 mostly American and European CEOs at a Global CEO Council meeting in Beijing that China would strike back at US trade measures. Harley Davidson said it would shift production overseas to avoid EU tariffs on its motorcycles. This occurred after EU raised tariffs on motorcycles to 31%, from 6%, in response to the Trump administration metals tariffs, which would have the increased export cost of each bike by around $2,200 (WSJ).
The BoE caught investors by surprise. As widely expected, interest rates in the UK were kept at 0.5% by the Bank’s Monetary Policy Committee. Significantly however, the balance of the vote changed as the chief economist Andrew Haldane changed his stance. This is important because it’s the first time the BoE’s chief economist has dissented since 2011. This wasn’t anticipated by the markets and has boosted the probability of an interest rate rise later in the year. The probability of an August hike has now increased from 35% to 58%, and the probability of a hike by November has increased to over 70% from below 50% at the end of May.
The ratcheting up of trade tensions remained in the news and is the widely cited headwind for equity markets.
It was against this backdrop that stock markets delivered mixed returns; Emerging Markets and Asian equities came under pressure as a trade war hit them more specifically, also a stronger dollar tends to be a negative backdrop for the region – this continued in the month. Meanwhile, the strong economic data out the US pushed the equity market higher; UK government bonds delivered a negative return during the month as bond yields moved higher – perhaps partly linked to a changing of interest rate policy in the UK.
Deputy Chief Investment Officer at Brown Shipley
Why we are not going for gold
James Horniman, Portfolio Manager James Hambro & Partners, says:
We are now sitting on 16% cash within our most popular ‘steady growth’ mandate – the most cautious position since JH&P launched in 2010. To be fair, we are actually only modestly underweight equities (66% exposure instead of 70%). The issue arguably lies with bonds. In normal circumstances, the end of the cycle is the time when you might increase exposure to bonds (particularly gilts). But these are not normal times. Years of QE have arguably destabilised the asset class and we’re therefore not keen to leave clients too exposed.
Gold is often seen as an alternative to cash, but it is really only a proxy for the dollar when the dollar is not working. Trump’s expansionist strategy means the dollar is proving popular as the currency of last resort, so we prefer to hold US equities as these offer us dollar exposure and generate income.
Trump’s expansionist strategy means the dollar is proving popular as the currency of last resort, so we prefer to hold US equities as these offer us dollar exposure and generate income.
Yes, equity valuations look on the high side against historic measures (and that’s why we’re only neutral US), but Trump’s tax cuts are driving up company profits and generating plenty of upward earning revisions to underpin those valuations – for now.
Closer to home, we are underweight UK. The Investment Association has just reported that investors withdrew more than £1bn from UK equity funds in May – Brexit and sterling fears seem to be contagious.
On a more positive note, we are overweight Japan. Equities there look historically cheap and Japanese companies are awash with cash, creating opportunities for activist investors and potential benefits for the rest of us.
Portfolio Manager James Hambro & Partners
Signals to watch for this earnings season
Caspar Rock, Chief Investment Officer at Cazenove Capital, says:
As we move in to the earnings season where companies will report their second quarter results, investors will be watching closely for a couple of reasons.
First, this will give a good indication of the strength of the global economy. In the case of the US it would be to confirm the continuing strength that we have seen anecdotally; for Europe, it would be an indication of whether the weaker first quarter was a mid-cycle slowdown (which is what we believe) or something more serious. For emerging markets, it is to see if there has been any impact from the first moves in the trade spat emanating from the Trump administration.
Secondly, the impact on company margins of a higher oil price and the recent currency moves, especially the stronger US dollar, will be interesting to follow.
Thirdly, it could indicate whether there has been an impact on company order books of accelerating order patterns – in anticipation of an escalation in trade sanctions between the US and the rest of the world.
<blockquote”>The impact on company margins of a higher oil price and the recent currency moves, especially the stronger US dollar, will be interesting to follow.
Following the recovery in markets since lows in February, investors are now focused more on the forward-looking comments of companies, and what they intend to do with the profits made – to reinvest in capital expenditure or to buy back shares. Last quarter there was clear bifurcation in performance between the two groups, and it will be interesting to see if the same thing happens this time
Chief Investment Officer at Cazenove Capital
Feeling the heat
Dean Turner, Economist at UBS Wealth Management, says:
Soaring temperatures haven’t just been confined to the glorious summer weather of late – the government is also having its own heatwave. After Brexit Secretary David Davis and Foreign Secretary Boris Johnson both handed in their resignations, media reports quickly changed from ‘Brexit victory for May’ to ‘Government in crisis’.
The Chequers meeting resulted in Theresa May’s rumoured preference for a softer form of Brexit being confirmed. On the trade front, the UK will seek to remain closely aligned to EU rules on goods, including agriculture, with the hope of preserving single-market access for those sectors.
In our view, the fragile nature of Brexit negotiations will continue to pile pressure on the pound in the short term, and keep activity subdued in the second half of the year.
It has been my view for some time that the UK would make enough concessions to secure the transition phase. Moreover, when it comes to trade, the UK’s large deficit with the EU on goods always suggested that this was the sector where there would most likely be room to find common ground. At home, the Prime Minister seems to have broken the deadlock, but we await the EU’s response. The negotiations still have a long way to go.
For the time being, concerns over a leadership challenge will linger. However, we question the potency of this threat. It could have unintended consequences for Brexiteers, as a May government at least guarantees Brexit will be delivered.
From an investment perspective, we’ve long been advocates that economics not politics should drive markets, and businesses have been rather resilient faced with Brexit doubt. Yet, we cannot deny that events in Downing Street are taking on increasing prominence when it comes to the economy. In our view, the fragile nature of Brexit negotiations will continue to pile pressure on the pound in the short term, and keep activity subdued in the second half of the year. On this basis, we see the Bank of England keeping interest rates on hold for the time being.
Economist at UBS Wealth Management
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