Investment Bulletin:
May 2018

This month:

Path set for global growth to continue

  Bank of England keeps rates on hold.

  Sterling weakens following stunted first quarter growth.

  US tax cuts and investment spending increase risks of overheating.

  Value investing becomes a notable outperformer.

Featuring this month’s experts:

First quarter corporate earnings are expected to have been strong and global economic growth is also looking good for the year. Yet risks risks abound – many of them emanating from the US.

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.

Dig a little deeper

Insights from:

Investment Tips, Expert Opinion

Dean Turner, Economist at UBS Wealth Management, says:

After a volatile month for those who follow the UK economy, all eyes were firmly on the Bank of England last week as the Monetary Policy Committee met to discuss interest rates once again.

In the end, the decision to keep rates on hold and the two dissenting votes came as little surprise to markets, given the adjustment in expectations in recent weeks. The cut to this year’s growth forecast from 1.8% to 1.4% garnered the most attention. But digging a little deeper, it becomes clear that this only reflects a disappointing first quarter for growth and says little about the outlook. Interestingly, the Bank indicated that it believes the weaker-than-expected first quarter was nothing more than a blip. Time will tell if this is the case, but other data currently suggests that this is likely to be so.

In terms of immediate reaction, sterling markets interpreted the decision and accompanying inflation report as moderately dovish with the pound initially falling. In our view, this reaction looks overdone. Undoubtedly, the tone from the Bank shifted from a hawkish stance in February to a more balanced one this month, but we don’t see this as outright dovish. We expect the pound to recover some of its losses in the months ahead as the data confirms that the first quarter slowdown was nothing more than a temporary glitch.

Looking further ahead, the Bank has conditioned its assumptions for growth and inflation on a path for interest rate rises of around one hike per year for the next three years. Given that growth is expected to be higher than the Bank’s view on potential, this does not seem unreasonable.

Whether or not the Bank of England actually hike rates or not over the next couple of years is still an open question. As always, and as was clear last week, it will depend on how the data unfolds.

Looking further ahead, the Bank has conditioned its assumptions for growth and inflation on a path for interest rate rises of around one hike per year for the next three years. Given that growth is expected to be higher than the Bank’s view on potential, this does not seem unreasonable.

Investment Risk, Stock Market

Dean Turner

Economist at UBS Wealth Management

Political change continues apace

Insights from:

Investment Tips, Investment

Colin MacKenzie, Director, Investment Management, at Arbuthnot Latham & Co., Limited, says:

A sell-off in the US Treasury market during April saw 10-year yields briefly surpass 3%, a level last seen back in 2014.  The US dollar reacted positively and oil prices rallied considerably on the back of strong demand and heightened tensions in the Middle East. These events conspired to hamper the advance in the US equity market, which gained only modestly during April.

Equity returns in Asia and emerging markets were also modest during April despite an easing in global trade tensions. Interestingly, both regions held up well during the recent bout of volatility owing to greater fiscal budget prudence, reasonable currency valuations and attractive earnings growth relative to developed markets.

European equity markets fared rather better than the US. The energy sector performed well due to rising oil prices. Business activity continues at a steady pace even though business sentiment declined in Germany. As was widely expected, the European Central Bank kept monetary policy unchanged, with its President Mario Draghi highlighting the recent moderation in economic growth and subdued inflation. Despite extensive talks and mediation since the election on 4 March, Italy has yet to form a government; it looks like there will be another general election. There have been 65 governments in Italy since 1946, a number only exceeded in Europe by France at 67.

Equity returns in Asia and emerging markets were also modest during April despite an easing in global trade tensions. Interestingly, both regions held up well during the recent bout of volatility owing to greater fiscal budget prudence, reasonable currency valuations and attractive earnings growth relative to developed markets.

In the UK, economic growth during the first quarter was the slowest quarterly rate since the end 2012. Retail sales were weak, the weather was partly to blame, so the prospect of higher interest rates has been pushed back for a time at least. Consequently, the pound weakened and a raft of corporate activity, including Sainsbury’s proposed merger with Asda, and Whitbread’s plans to demerge Costa, helped power the FTSE 100 higher.

What continues to surprise is the rate of political change. It seems like yesterday that missiles were being fired over Japan by North Korea with many market participants citing the escalation as one of their key risks. Fast forward to today and denuclearisation is being discussed, a positive Trump effect.

Investment Tips, Investment, Investment Portfolio

Colin MacKenzie

Director, Investment Management, at Arbuthnot Latham & Co., Limited

Expect the unexpected

Insights from:

Psigma Investment Management

Tom Becket, Chief Investment Officer at Psigma Investment Management, says:

The first few months of 2018 have seen a return of market volatility, following strong returns and calm markets over the last two years. Many of the themes that we discussed at the end of 2017 have started to play out in the early months of 2018, with fears over rising inflation and interest rates at the forefront of investors’ minds. In addition, there have been concerns over the outlook for global trade given the protectionist policies proposed by the US government, which have unsettled global markets over the last few months.

At this time we have not changed our core investment views that 2018 should be a solid year for the global economy and we are not currently expecting a marked deterioration in the outlook for equity or corporate credit markets.

At this time, we have not changed our core investment views that 2018 should be a solid year for the global economy and we are not currently expecting a marked deterioration in the outlook for equity or corporate credit markets. However, we are pursuing a diversified approach within our investment strategies and deliberately keeping very open-minded as to how this year might play out. Our portfolios remain defensively positioned, with high levels of diversification and a healthy cash buffer.

Thomas Becket - Psigma Investment Management

Tom Becket

Chief Investment Officer at Psigma Investment Management

Sweeping out the bunkers

Insights from:

Economy, Expert Opinion, Markets, monthly investment tips, Portfolio

James Horniman, Portfolio Manager James Hambro & Partners, says:

The economic cycle remains in growth mode and sentiment indicators suggest investors remain bullish in aggregate, but risks abound – many of them emanating from the US.

Tax cuts and investment spending in the US increase the risks of overheating, higher rates and ultimately recession. Fiscal stimulus is being introduced at a point in the cycle when it would not normally be expected given the US is near full employment and inflation has reached the central bank target.

The US budget deficit will probably grow, due to increases in military, infrastructure and welfare spending coupled with lower tax rates. This is not typical at this stage of the economic cycle and over the longer term will likely put downward pressure on bond markets and the dollar, barring any exogenous shock.

We’re reviewing our exposures to factors like currency, commodity or interest rate moves to stress-test portfolios. In short, we’re not retreating to the bunkers yet but we’re sweeping them out and making sure the shutters and locks all work.

The threat of protectionism and the spectre of a trade war is elevated. A diplomatic solution is still possible but events must be watched carefully as any escalation beyond current rhetoric could negatively disrupt global growth, impacting both corporate and investor confidence.

Cash weightings in our portfolios have risen modestly from the beginning of the year and now sit marginally above the ten-year average. Equity allocations have fallen to an 18-month low but investors remain overweight equities largely because of our general antipathy to bonds as the quantitative easing taps are turned off.

We’re reviewing our exposures to factors like currency, commodity or interest rate moves to stress-test portfolios. In short, we’re not retreating to the bunkers yet but we’re sweeping them out and making sure the shutters and locks all work.

James Horniman - James Hambro & Partners

James Horniman

Portfolio Manager James Hambro & Partners

Value Investing comes to the fore

Insights from:

2016, Investment Tips, Bonds, Dividends, Investment,May

Caspar Rock, Chief Investment Officer at Cazenove Capital, says:

After the first quarter, where there were falling equity and bond markets and an increase in volatility compared to the relatively tranquil markets of 2017, April saw a recovery in equity markets alongside a continued sell off in bond markets.

Perhaps the most interesting feature of the month was the notable outperformance of ‘value’ as an investment style – whether it be ‘value’ managers or ‘value’ markets like the UK, and after a considerable period of underperformance. Whether this is the beginning of a trend or just a recovery from an oversold and unloved style and market is not yet clear. It is a surprise that it has not happened yet given the normal conditions that tend to lead to value outperforming when interest rates and bond yields are rising – a phenomenon which has been apparent for some time in the US and, since last summer, in the UK.

Perhaps the most interesting feature of the month was the notable outperformance of ‘value’ as an investment style – whether it be ‘value’ managers or ‘value’ markets like the UK, and after a considerable period of underperformance.

Some have postulated that the acceleration in the pace of change and disruption bought on by the rise of the use of technology and the internet has led to both fewer winners (who take a larger share of the spoils) and more losers amongst the incumbents, than in the past. This would lead to a few market leaders with high profits and market share, many more losers that eventually go out of business, and a smaller pool of companies that are able to bounce back, and revert to more normal valuations and margins. The last group of companies is what the typical value investor searches for.

Academic studies consistently show that the lower the valuation you pay for a business, the better the future return, but what seems apparent is that there is a wider distribution of outcomes than in the past.

Caspar Rock, Cazenove Capital

Caspar Rock

Chief Investment Officer at Cazenove Capital

Stay aboard the equities train (for Now)

Insights from:

Economy, Expert Opinion, Portfolio

Fahad Kamal, Senior Market Strategist at Kleinwort Hambros, says:

One percent up or down moves in equity markets hardly raise eyebrows anymore: there have been four such moves for the MSCI AC World index of global equities in April alone – and 19 so far this year – compared to eight in all of 2017. Yet, for all the furious movement, the bellwether equities gauge is essentially flat on the year. Instead, the real action is in the bond market, where a sharp sell-off has resumed: the 10-year US Treasury yield – as close to a global proxy as you get in the world of fixed income – has crossed the 3%-mark for the first time since January 2014.

After the long rally, should investors ditch equities to hold less risky assets offering a real return? In a nutshell, no. And probably not until yields are significantly higher than now, perhaps between 4% and 5%.

It marks a significant milestone in the post-crisis era, with yields pushed up by six Federal Reserve rate hikes, a burgeoning economic recovery and the return of elusive inflation. After the long rally, should investors ditch equities to hold less risky assets offering a real return? In a nutshell, no. And probably not until yields are significantly higher than now, perhaps between 4% and 5%.

First, a loose rule of thumb puts the 10-year yield equal to the economic growth rate plus the rate of inflation. For the US, that is 3%, the approximate GDP growth rate, plus 2%, the target CPI figure, which gives a yield 5%. So, as bond yields rise further, as we expect, they will lose value. Second, stocks are still much attractive in relative terms, particularly in light of the smashing earnings picture that is shaping up for the first quarter.

Investment Advice, Risk Profile

Fahad Kamal

Senior Market Strategist at Kleinwort Hambros

Global equities have recovered from oversold levels

Insights from:

Expert Investment Views, Extreme currency volatility, monthly investment tips, Portfolio

Daniel Casali, Partner at Smith & Williamson, says:

Global equity markets recovered from oversold levels in April. This followed two consecutive monthly declines in February and March, when stocks were rattled by factors ranging from greater social media regulation to rising geopolitical risks in the Middle East.

Market nerves have since been placated by a combination of less volatility in US long-term interest rates and the delivery of healthy company earnings in the States. On the latter point, with many companies in the S&P 500 composite index now having reported, US Earnings Per Share (EPS) growth is up 22% from a year ago, the fastest expansion since early 2011. This is supported by a combination of tax cuts, faster economic activity and record-high profit margins.

The International Monetary Fund (IMF) projects global real gross domestic product (GDP) growth of 3.9% (the fastest rates since 2010) in both 2018 and 2019, up from 3.8% in 2017, on the back of expansionary US fiscal policy and still-accommodative monetary policy.

Looking forward, the global macro backdrop appears favourable for Earning Per Share (EPS) growth. In its latest semi-annual outlook report, the International Monetary Fund (IMF) projects global real gross domestic product (GDP) growth of 3.9% (the fastest rates since 2010) in both 2018 and 2019, up from 3.8% in 2017, on the back of expansionary US fiscal policy and still-accommodative monetary policy.

Meanwhile, should Prime Minister May include a customs union in the EU Withdrawal Bill, which is due to be voted in Parliament around October, it is likely to alienate pro-Brexit Tory MPs and consequently result in a leadership challenge. For UK markets, domestic political turmoil from a resulting snap general election could delay UK-EU negotiations and increase the likelihood of the UK leaving the EU in March 2019 without a deal. Moreover, with the Conservatives broadly tied with the Labour party in opinion polls, investors’ fears of a left-wing Jeremy Corbyn government will continue to weigh down on UK equities. We continue to prefer opportunities in overseas markets, where political risks are lower.

Investment Tips, Investment

Daniel Casali

Partner at Smith & Williamson

Consider the cost of cash

Insights from:

Investment Tips, Investment

Christian Armbruester, Chief Investment Officer at Blu Family Office, says:

People are worried that the markets are overheated, everything is expensive and there is little trust in central banks and governments to sort out the headwinds they have caused. Quite a few people are therefore sitting in cash, waiting for a better entry price.

The reasoning I can understand, but there are some rather large costs. For sterling and euro investors, the interest one can earn on cash is virtually zero. With inflation running close to 2%, that means it costs at least 2% per year to do nothing. You could almost think of this as a (very expensive) management fee for your cash.

For sterling and euro investors, the interest one can earn on cash is virtually zero. With inflation running close to 2%, that means it costs at least 2% per year to do nothing. You could almost think of this as a (very expensive) management fee for your cash.

But that’s not all. We know that there are yields to be gained: one just has to look at the performance of property, equity markets and even the fixed income markets. All have produced large gains in the last nine years and, by some measure, the cost of sitting in cash during this time is more than 400% (!) in missed performance.

If you are still not convinced, and you think that you have the ability to predict the future, consider this: I too once thought that I was blessed with this divine gift.  And there it was, I predicted the greatest financial crisis the world has ever seen and bet against the markets to great abandon. Only to suffer through five long years as the greatest commodity boom the world has ever seen, ripped apart my resources (pun intended) to withstand such losses. Ironically, I stopped out just a few months ahead of the beginning of the great crash of 2008.

Expert Investment Views,Investing Tips,Investment Tips, Brexit

Christian Armbruester

Chief Investment Officer at Blu Family Office

Important information

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.

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