As the economic horizon darkens, investors are going to need to pay close attention to the asset classes – and individual holdings – they populate their portfolios with; careful bond selection is just one element of this.
Volatility expected after UK election.
UK equities not necessarily a “sell”, however.
Property preferable to bonds.
Managers eye opportunities in Japan.
In this monthly investment spotlight a selection of experts from leading UK wealth managers give their summary of investment tips in May 2015.
findaWEALTHMANAGER.com is a gateway to the UK’s leading wealth managers and we regularly tap their expertise for the benefit of our users. These past few weeks, the UK General Election and US economics have been top of the agenda, along with opportunities in real estate and a resurgent Japan.
Tom Becket, Chief Investment Officer at Psigma, says:
The highly uncertain outcome of next week’s General Election is already spooking certain markets and investors should brace themselves for further turmoil ahead in several asset classes.
The UK General Election has rightly been depicted as the most uncertain in decades and the chances of a clean and decisive outcome are low, meaning that markets could well be volatile in the weeks after 7 May.
Nerves have started to spread through currency markets, with the pound notably weak against the dollar and starting to soften against the yen. There is a high chance that volatility will persist in the currency markets and we are surprised by how becalmed the government bond market has been, given the potentially unsavoury outcomes that are possible. Were an SNP and Labour coalition to secure power, we believe that could be a major negative in the eyes of international investors and we are deliberately underweighting UK Gilts, as there is little compensation for the risks of international capital flight. Ironically, an outright Conservative victory might not be the blessing that some have imagined for markets, given the close nature of opinion polls on a European referendum.
From an economic standpoint, we suggested that the 2010 Election was one to lose, as the economic tasks ahead were so challenging. We reiterate that view this time around; from an economic perspective the structural issues plaguing the UK should not be avoided despite the cyclical boost to growth that we are currently enjoying. Any new Chancellor will have to tackle the teetering debt pile, as well as trying to close the fiscal and current account deficits. Good luck with that, is our view.
Our portfolios are currently more internationally-focused than they have been in eight years, reflecting the unattractiveness of UK bonds and our currency. We do like UK equities and moved back to neutral late in 2014, following two years of underperformance. An improvement in UK corporate earnings, low levels of investor positioning and attractive relative valuations could easily lead to a continuation of UK equity outperformance in the years ahead.
Chief Investment Officer at Psigma
David Weller, Head of Asset Management, Private Banking at Banque Havilland, says:
The likelihood that the imminent General Election will cause a short-term fall in the FTSE 100 means there may be a case for selling off broad-based UK exposure and sitting in cash for a few weeks.
Imagine this scenario: Following a close 2010 General Election, the country has been led by a coalition. With polling nearly complete, the centre right party has around a third of the vote. The far right haven’t done as well as expected and the main left-wing party has lost substantial ground to the hard left, where support comes principally form just one part of the country. The fear is that it could take months to form a working coalition government.
Anyway, that is enough about last year’s Belgian election. Unless you happen to be from there or live there it was an event which didn’t hold much macro investment importance and nor will the UK election. Short-term trading opportunities: Yes. Near term macro significance: Unlikely.
Rational sounding opinions are that a Conservative government will be better for the economy and therefore UK equities, whilst the tax and spend policies of a Labour government will eventually lead to a sterling crisis. However, whilst the stock market under the current Conservative-led government has risen to a level that matches the two previous peaks, these both occurred under a Labour majority government.
Over 13 years of said Labour government the average sterling/dollar exchange rate was roughly 1.6850; the last five years have seen a lower average rate of about 1.5900. This just demonstrates that there are always far greater forces at work globally (currently QE, Oil, China slowing and so on) that affect the UK far more than the tie colour of the occupant of No. 10. Over recent years, the differences have been at the margins.
I see little point adding to the ungodly amount of election commentary by writing something trite about sectoral rotation, so how about this: Sell all of your broad-based UK exposure and sit in cash for a few weeks.
With the FTSE 100 at 7100, anyone invested in broad UK equity exposure is making money. It is hard to envision an election outcome that would raise the FTSE by anything meaningful in the next couple of weeks, yet somewhat easier to conceive of outcomes that could trigger a fall short term. This is before even considering external events such as a “Grexit”. As a reminder of scale, the February low is 5% below current levels and the January low is 10% away. To retrace a few weeks of gains is nothing drastic.
Okay, so perhaps you may miss a percentage point or two of gain and a few short weeks’ worth of dividends – a small opportunity cost which, viewed through the prism of having just banked profits, is something an equity risk investor should be able to tolerate. This provides the ability to sit back and watch the election debacle unfold from a position of liquidity, knowing you have sold very near the top, and ready to take advantage of any short-term opportunity that may well arise.
The “it’s time in the market” crowd won’t like this at all and will happily explain the “risk” of taking this short-term and defensive stance. The constrained “benchmark overweight/underweight” crowd will just thrash around in their straitjackets. That’s okay: making investment decisions is not for everyone, even if it is only once every five years.
Head of Asset Management, Private Banking at Banque Havilland
Jonathan Marriott, Chief Investment Officer at Vestra Wealth, says:
Some property assets represent an attractive alternative to fixed income in the prevailing low-yield environment, but one needs to be highly-selective about sectors and investments.
With the general view that interest rates will remain low for a protracted period of time, the conditions remain to benefit real estate as an asset class. Real estate’s stable income continues to attract investors looking for yield. In the current volatile and uncertain economic environment, the diversification and steady income offered by real estate is attractive.
All the major parties in the UK are committed to having some view on UK housing policy. However, there is policy divergence, with the Labour and Liberal Democrats focused on introducing a “mansion tax”. The coalition government has introduced a tapered stamp duty to counter this mansion tax proposal. However, on the lower end, we are of the view that all parties will be committed to home-ownership. We expect the rest of London to perform better than residential London in the near term. In addition to the mansion tax, the uncertainty on non-domiciled status puts a lid on appreciation on high-end residential property. As growth in the UK economy becomes more entrenched, our preference in property is on the commercial side with an emphasis on secondary and niche warehouse investments.
These assets are no longer as cheap as they were two years ago, but in a low-yield environment the rental income and indexation of the sector offers an alternative to fixed income. The extreme low yields in Europe have led to investors in the region shifting focus onto real estate investment. The initial focus was German real estate, but this is now shifting to peripheral countries. In the US, construction on new housing fell during the first quarter, but this would be purely weather driven. The US REIT sector is vulnerable to interest rate rises and therefore we remain cautious on the listed market.
Infrastructure assets have rallied massively, particularly in Europe, and valuations are no longer cheap. We have gone neutral on this sub-sector within property on valuation grounds. Overall, property is a good alternative to fixed income, however one needs to be selective about sectors and investments.
Chief Investment Officer at Vestra Wealth
Ben Kumar, Investment Manager at 7IM, says:
Investors may have got into the habit of avoiding Japanese equities, but a re-evaluation might now be due as for the first time in 25 years Japan has everything going for it.
Since late 2012 and the arrival of Shinzo Abe as Prime Minister, the Japanese equity market has been on a sharply rising trend, up over 120% in that period. The investment case still seems pretty compelling: a prime minister determined to see through structural change was reaffirmed by the population in December 2014, monetary policy remains incredibly supportive, and Japan has a prime location in one of the most economically-dynamic regions of the world. Yet international investors remain underweight Japan (according to data from Nomura Securities).
The reason is obvious: from 1990 to 2012, the Japanese stock market fell over 70%. Although there have been a few rallies over the past two decades, these were short-lived and the following declines back to the downwards trend incredibly painful. More than one generation of equity investors learnt the hard way that buying Japanese stocks was not good for portfolios, clients or careers.
Where does that leave us? Our view is that this is the first time in 25 years that Japan has everything going for it. A clear change that can be seen is the number of women entering the workforce. When Mr Abe took power, around 60% of women were employed. That number has now risen to 64%, still well below most other developed nations, but a commendable achievement nonetheless and one which goes some way towards addressing the problem of an ageing society.
Separately, the top priority for Mr Abe’s government has been corporate governance – encouraging company management to put shareholder interests first. As Japanese equity owners, that can only be a good thing, and we expect to benefit over the next few years as international investors acknowledge this. Buying a position for its future potential can be particularly profitable if other investors are still judging by the past.
Investment Manager at 7IM
Patrick Gordon, Head of Research at Killik & Co, says:
The US was a powerhouse of growth last year, but investors need to bear in mind the implications of a strong dollar and what amounts to monetary tightening from the Fed going forward.
The US was amongst the stand-out performers last year from both an economic and an equity market perspective. The S&P 500 Index outperformed the Nikkei 225, the FTSE 100, the DAX and a number of other developed market indices, and the US economy’s relative strength led the World Bank to warn that the global economy had become too reliant on the region to power growth. Set against this backdrop, and as the US Federal Reserve has moved closer towards raising interest rates, the US dollar strengthened significantly – to the extent that it has become something of a headwind for businesses in the US.
Recent US economic indicators have been disappointing, with certain data points that are influenced by a country’s currency, such as exports, weak in recent months. The stock market has also underperformed this year, with the S&P 500, whilst up on the year and close to record highs at the time of writing, nevertheless lagging many other developed market indices. Furthermore, with America home to a large number of multinational companies, many US firms with a global reach have cited the negative impact that the strength of the US dollar has had on recent earnings.
Going forward, this leaves the US Federal Reserve with a difficult decision in the coming months. Current expectations are that interest rates will rise in the US by the end of the year, however, the minutes from the March Federal Open Market Committee meeting revealed that the dollar’s strength had led the Committee to downgrade its medium-term forecasts, while some members felt that it would continue to weigh on inflation in the near term. Even by doing nothing, whilst other Central Banks continue to adopt an easing policy bias, the Fed is in effect undergoing a relative tightening of monetary conditions. It will, therefore, require a careful balancing act from the FOMC as it attempts to normalise monetary policy whilst avoiding derailing the economic recovery.
Head of Research at Killik & Co
Chris Bates, associate director at Smith & Williamson, says:
September, or even June, could bring the first US rate rise in years, and investors need to be prepared for major volatility throughout most asset classes as a likely result.
Although the European Central Bank’s belated Quantitative Easing programme is attracting attention, the timing of a hike in US interest rates is a key focus for global markets this year.
At the moment, markets continue to kick the idea of a hike in rates further into the long grass. But with the US Federal Reserve Bank removing the wording from its official statement whereby it would be “patient” before beginning to raise rates, a rate rise as early as June cannot be ruled out – particularly with hawks on the FOMC circling and seemingly anxious to get rates moving upwards.
The Fed recently lowered its rate projections towards market expectations. However, the Fed has never covered itself in glory with its forecasting ability and ultimately Janet Yellen [Chair of the Board of Governors of the Federal Reserve System] has reiterated that the future path of monetary policy is dependent on economic data.
Whilst the hawks will point to a healthy rise in employment in the US, first quarter growth has been disappointing and the strength of the dollar is becoming a genuine headwind for corporate earnings (around 30% of S&P 500 revenues come from overseas). At the same time, corporate earnings need to improve in order to alleviate the pressure of elevated equity (stocks and shares) valuations. Earnings have not kept pace with prices, as a result share prices relative to their earnings (Price Earnings ratios) have risen to fairly extended levels.
There are enough reasons to keep rates on hold. We believe Janet Yellen would prefer to err on the side of caution and keep interest rates on hold, rather than risk derailing the economy by prematurely raising them.
Historically, markets have been able to rise following an increase in interest rates and the Fed will be tightening rates against the backdrop of a strengthening economy, which should be a positive for corporate earnings. Despite this, we can expect an initial period of market volatility.
In summary, if US economic data gets back on track, a September hike in interest rates looks more likely than June. Nevertheless, a change in US monetary policy will still be a major source of market volatility throughout most asset classes.
Associate director at Smith & Williamson
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.