The year of the "fade trade"?
Markets unsettled by UK macro-political risk.
Growth concerns augur subdued second half.
Diversification becomes ever-more urgent.
Non-sterling exposure seems wise.
Featuring this month’s experts:
The shock UK General Election result has manifold implications for sterling, inflation and FTSE companies, while the US and Europe should also be front of mind.
Here, leading professional money managers tell us how they foresee the investment landscape developing.
Why markets are hung up on the lack of clarity
Caroline Simmons, Deputy Head of the UK Investment Office at UBS Wealth Management, says:
With the UK General Election delivering an unexpected hung parliament, markets have been left with a lingering sense of uncertainty. The questions over government leadership, domestic policy and the impact on Brexit negotiations hang like dark clouds over the City of London.
The purest way of playing UK macro-political risk is through sterling. We have already seen a sell-off in sterling and expect it to remain soft. With the FTSE 100 generating 70% of its revenues from outside the UK, the price of the pound has a domino effect on other UK assets.
Under a Conservative minority government, we believe the performance of the UK market this year will accordingly be intrinsically linked to domestic uncertainty. We expect the FTSE 100 to outperform the FTSE 250, which has 50% exposure to the domestic market. UK tourist stocks could also perform well as the weak pound drives tourists to our shores.
However, if the market focuses on concerns that a Conservative minority won’t last and that we may ultimately end up with a Labour-led parliament, the currency-related boost for the FTSE 100 is likely to be offset by concerns over the potential for increased corporate tax rates and possible nationalisation of certain industries.
Our preferred investment strategy in the UK is diversified dividends. Through this strategy, investors can capture the attractive UK dividend yield of 4%, while investing across a broad range of sectors in globally diversified companies.
Markets will remain unsettled while a lack of clarity reigns supreme, but it isn’t all doom and gloom for savvy investors.
Deputy Head of the UK Investment Office at UBS Wealth Management
2017 could be the year of the ‘Fade Trade'
Alexander Balfour, Associate Director at Smith & Williamson, says:
The focus for UK investors in the near term is clearly going to be on the fall-out from the General Election. During this period of heightened political uncertainty sterling is likely to remain on the weaker side and we would continue to favour the overseas earners of the FTSE 100 over more domestically-focused small and mid-cap stocks.
Weaker sterling could lead to a further increase in inflation expectations. In this environment, we believe index-linked will fare better than conventional gilts, which remain fully valued, and as a result we do not believe they will make significant gains from current levels.
Overseas, there remains some optimism about the prospects of the US economy, but we have yet to see analysts upgrading their forecasts for company earnings. This has left equity valuations in the US looking stretched as hopes for President Trump’s fiscal stimulus plan decline.
Given the improving relative economic outlook, we view Eurozone equities as the most attractive amongst developed markets. We maintain the view that 2017 could be the year of the ‘fade trade’ – that is, a good start for equities followed by a more subdued remainder of the year as optimism over the global growth outlook falls.
But with interest rates likely to remain low for the foreseeable future, the ‘hunt for yield’ theme doesn’t look like it’s waning. With this in mind, we feel equities will deliver superior returns over bonds but continue to prefer a balanced portfolio as volatility is likely to pick up from current low levels.
Associate Director at Smith & Williamson
Diversification and an international focus remain imperative
Thomas Becket, Chief Investment Officer at Psigma Investment Management, says:
As we currently stand, we do not see that the UK Election vote has major implications for our investment strategy. Our portfolios have become gradually more defensive over the last 18 months, as markets have performed well and asset valuations have risen. A key influence behind our decision to progressively de-risk has been concern over politics on both sides of the Atlantic. The ongoing events in the UK have strengthened our view that high levels of diversification and an international focus are the two most important investment philosophies for any investment strategy at this time.
From an individual investment viewpoint, the biggest factor for us to consider is the impact that fresh political uncertainty will have upon the pound. Our exposure to international assets and investments that benefit from a weak pound will be something we will think about majorly in coming weeks; but we continue to hold healthy allocations to international currencies and our exposure in our comparatively low UK equity allocations are biased towards internationally-focused companies, which will continue to benefit from weaker pound.
Our key message from this result and recognising the experience of recent ‘shock’ political events is that investors should not panic. We are comfortable with our positioning and this is not a reason to make snap decisions. Our portfolios are diversified in terms of asset class, global regions and sectors and we always remind our clients that the UK economy and politics are merely small inputs into our investment philosophy and positioning; events in Washington and Beijing arguably carry far more weight to our thinking. We are hopeful that our international focus helps our portfolios in the very short term, following a very healthy start to the year, but as always we stand ready to change course within our strategies at any point we deem necessary.
Chief Investment Officer at Psigma Investment Management
Look to Brexit after the election side show
Michel Perera, Chief Investment Officer at Canaccord Genuity Wealth Management, says:
What’s the definition of uncertainty? Well, a hung parliament, possible bids for the leadership of the Tory Party, an unstable government and unclear directions on Brexit negotiations, probably comes pretty close.
In light of that, it’s amazing we have seen so little reaction – only sterling has registered a loss. Internationally-exposed UK large-cap equities have risen to reflect currency depreciation, but domestically-focused stocks are taking a hit, with housebuilders and retailers suffering the most. With Trump and Brexit, we saw an over-reaction from markets, but it doesn’t seem to have happened this time. At the moment there doesn’t seem to be any obvious discrepancies an investor could benefit from, but the nature of uncertainty means this could change at any time.
So how are we positioning client portfolios? We already have a significant underweight to UK equities and to sterling in our portfolios. UK equities are also made up of a majority of foreign earnings, particularly for large-cap stocks. We have also reduced equities overall to a neutral level, bearing in mind the valuations and seasonality, and diversified our themes to include global infrastructure, healthcare, Indian equities and European banks, so we are not entirely dependent on UK stocks and sectors. We feel none of these themes have lost their validity following last week’s Election result.
But let’s not forget this Election has been a side show, with Brexit negotiations the main event that will move sterling and UK securities for at least two years. As a result, we will be measuring the short-term reaction against the probability of a favourable or unfavourable Brexit deal.
Chief Investment Officer at Canaccord Genuity Wealth Management
Benefitting from non-sterling exposure
Chris Darbyshire, Chief Investment Officer at Seven Investment Management, says:
Another year, another British political upheaval. 2015 had everyone expecting a hung parliament and we got a Conservative majority; 2016 gave us the delights of Brexit; 2017 completes the hat trick.
It is a strange turn of events when there is a swing to the governing party of 6%, the Tories share of the vote on 8 June was 42.2% (not far off Thatcher’s 42.4% share of the vote in the 1983 Election) and yet the result is a hung parliament (versus Thatcher’s 144 seat majority). Even if the deal with Northern Ireland’s Democratic Unionist Party (DUP) for a ‘confidence and supply’ deal will go ahead, much would still remain up in the air. Would a deal survive? Many are concerned that it won’t even make it through the Queen’s Speech vote. Given the direction of travel, what will it mean for the 60-or-so hard-line Brexiteers in the Conservative Party, not to mention the Government’s required neutrality in Northern Irish politics?
Meanwhile, the increased political risk is playing out in the currency markets. On the night of 8 June, the pound dropped almost immediately following the exit poll, from US$1.295 to $1.275, where it largely stayed throughout the course of the night. Although this was higher than the $1.255 when the Election was called on 17 April, this is more a reflection of the weakness in the US dollar over that period. Against a broader range of currencies such as the yen and the euro, sterling is now weaker than when the Election was called. We got our call wrong on the night of the Election, believing that a hung parliament would imply a softer Brexit (positive for sterling). It now seems though that markets have lost confidence in the Government’s ability to navigate Brexit at all, irrespective of the likely end-game.
On the night of the Election, our portfolios benefitted from non-sterling exposure (this is around 25% in the Balanced portfolio). We see no real need to change that position. The political situation is extremely uncertain, but the Government’s ‘trust-me’ Brexit strategy has already been found wanting.
Chief Investment Officer at Seven Investment Management
The investment strategy explanations contained in this piece are for informational purposes only, represent the views of individual institutions, and are not intended in any way as financial or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
We always advise consultation with a professional before making any investment decisions.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.