It may well be holiday season, but there are several important investment trends affluent individuals need to have very much on their radars this summer, explains Tom Becket, Chief Investment Officer at Psigma.
Of course we should have expected it in the “quiet” summer months, but the last few weeks have been extremely volatile for financial markets and tensions are running high across the investment community. I’m sure investors are reading their morning newspapers nervously, given the pervasive bearishness about the global economy that they read. Having created material nerves in June, Europe and Greece have moved to the backburner, whilst the latest major summer wildfires are being lit under China and the resources markets. With oil firmly back in a bear market and all commodities falling hard through the last few months, deflation fears have been rising again and question marks are being raised over the viability of the interest rate hike we have been expecting from the Federal Reserve in the US in September.
The global economy
We have seen nothing in the last few months to deflect from our “solid, but unspectacular” growth prediction at the start of the year. Our view of 3.5% GDP growth still seems appropriate. The US is slower than consensus expected, but in line with our forecasts of circa 2.5% growth, whilst Japan and Europe are recovering and contributing positively. The UK economy is perfectly solid (even if unbalanced towards services), as confirmed by the latest GDP report.
The major concerns with growth lie in the emerging world and, in particular, in the commodity-producing nations. However, we do not share the chorus of the investment bears’ miserable views on China and believe that the ratcheting down of growth to current levels is sensible, even if it causing nerves over current growth.
Some of the leading indicators in the emerging world are pointing downwards and deserve further attention, but again we are still not overly concerned about the world economy tipping from growth into recession. From an emerging markets asset perspective, the slower rate of growth is arguably already factored in to current valuations, with, as an example, “real” valuations of Asian equities now down below levels from which major rallies have been triggered in the past (Asian equity price to book at 1.37 times).
We are right in the middle of the ongoing reporting season and, outside of the calamitous drop in energy company profits, overall earnings are sound. European and Japanese profits are strong and suggestive of a continuation of further gains in regional equity markets later this year. For the first time since 2008, European earnings are surpassing those of American companies, as European banks stage a long overdue recovery in profitability. US corporate earnings are OK, but markets there are being impacted by the strong dollar and high valuations, as we expected. In short, current trends are supportive of our pro-cyclical bias and overweights in Europe and Japan. Valuations of most equity markets are fair rather than cheap and will need further enhancements to corporate earnings to justify further gains. We have confidence that this will be the case, but earnings growth is certainly likely to be strongest in Japan, Europe and the UK, rather than the US.
We still fully expect the Fed to raise rates for the first time in nine years at either its September or December meetings. The precise timing is of course a moot point, but as long as China’s financial system doesn’t collapse between now and then, or the US suffer an unexpected major slowdown, the Fed will raise rates.
Our view remains that both the Fed and the Bank of England are late to the party and they should be raising rates now. We expect the BoE Monetary Policy Committee to raise rates in January, but would state that with growth sound, inflation starting to come back and distortions being created by low rates, we just wish the BoE would get on with it. Our views still lead us to be wary of government bonds and persisting with a low duration, high yield credit bias. Notably our fixed income mandates have had a good year, because of this positioning.
Psigma’s core investment themes
Equity recovery – Positive outperformance has been secured this year from Europe, Japan and certain cyclical themes. This has been a positive driver this year. Our sector themes have been mixed, but healthcare has been very strong.
Emerging market growth – This has been mixed, but as a whole positive. Emerging markets equities have had another tough year, but our active fund selections in Asia have been very strong. Despite all the “doom and gloom” emerging market debt has been a mild benefit to returns. China’s equity market chaos comes after a period of real strength in Asian equities and we feel comfortable with our current positions and the medium-term opportunity in Chinese and Indian investments; (we are notinvested in Chinese domestic equities, but rather in Hong Kong-listed companies that have been far less volatile. We continue to avoid opportunities in Russia, Brazil and South Africa, where we have no confidence in the regional outlook.
Inflation protection – This element in our portfolios has been negative this year; resources have been dire investments, gold has been very poor and inflation-linked assets miserable. It is quite extraordinary how bearish investors have become on the entire commodity complex and we are starting to see extreme positioning against resources and a uniformity of bearish consensus. Indeed, valuations are now getting down to levels that we saw in 2008.
We certainly feel that the “all at one side of the room” positioning could lead to a major contrarian opportunity and we expect a significant snapback rally in such investments in the coming quarters. Judging the level from which a recovery might come is certainly challenging, but with wage price inflation now coming back, commodities near their lows and consumer spending rising, inflation protection will likely be vital as we progress forward.
Hunt for yield, “carry” opportunities – Our fixed interest positions have been strong outperformers this year, with some positions such as TwentyFour Focus and City Financial HY Opportunities generating strong positive returns. US High Yield credit has once again come under pressure in a mini-redux of the negative sentiment of late last year. We have spent some considerable time speaking to our managers in the asset class and remain comfortable with valuations and the outlook. In a world where bond investing is generally becoming more difficult, we believe we are well-positioned to meet income requirements and achieve the recovery potential we have identified in certain credit investments.
I have found myself talking about crisis after crisis far too often in the last few years and this could well be the case in the future. However, our view is that the latest round of Greece, China and commodities concerns are not sufficiently negative (yet) to deflect us from our view of modest positive performance this year and next. Given that we have not lowered our expectations for economic growth, monetary policy or corporate profits, we are yet to change our forecast that once the summer wobbles have been extinguished, equity and credit markets should rally in to the year end.
Finally, we believe that we are appropriately positioned to reflect the fine balance of risks and opportunities in markets and the economy. While we are undoubtedly worried about some of the recent events we are comforted by the valuations on offer from some of our themes and specific investments. We could just do with some peace and quiet – but the experiences of the last eight years suggest that this is unlikely.
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