Latest Financial Developments

Market update - 1st July 2018

john.owen

As an overview, the trade paradigm is shifting and markets are being forced to play catch-up. While the actual measures implemented so far are relatively contained and represent more of a micro than a macro risk, recent proposals by Trump pose a more significant economic risk. Up to an additional $400bn in tariffs on China, and a 25% tariff on global car and auto part imports are both reportedly under consideration.

Beyond the risk to growth, the global nature of Trump’s protectionist policies threatens to upset the global political order and force a shift in supply chains, often with unintended consequences. One such consequence is the recent announcement that China and the European Union agreed to launch a group to update global trade rules to address technology policy and subsidies, and to preserve support for international trade. Notably these talks exclude the US. Although the EU has many of the same trade, investment, and business environment concerns as the US with regards to China, the proposed talks are further evidence of the rest of the world hedging against US uncertainty. Japan leading to salvage TPP; the EU pursuing trade agreements with Japan, ASEAN, Mexico, and Australia; and now trade talks between China and the EU are all indications that globalisation might not be dead, but the rest of the world is certainly looking to leave the US behind.

The economic and financial market impacts depend on whether the Trump administration pursues its more damaging proposals. With US imports valued at over $55bn facing tariffs, and retaliation from China, Canada, EU, Mexico, Turkey and India valued at over $50bn of total imports, certain sectors will be impacted but the overall growth impact will be negligible. The key to watch for whether Washington pursues the more damaging path will be domestic political pressures in an important election year.

News of Harley Davidson moving production overseas has so far received mixed reviews. As tariffs begin to impact prices and supply chains reorient, the true costs will become clearer. However, even without a full-blown trade war, increased uncertainty is already affecting investment flows and roiling global markets. While escalation is hard to predict, the current level of political discord might make it difficult to find an off-ramp.

Post Brexit update

john.owen

As an overview of the markets, it is fair to say the outcome of the recent EU referendum came as a shock to financial markets.

The implications of the UK’s vote to leave the EU are best summarised as follows:

What do we know as investors and what are the unknowns? We are most confident that:

• Political uncertainty will continue for some time
• Economic growth will be affected
• Monetary and fiscal policy will be easier globally
• Sterling will weaken
• Sector rotation will be significant
• Market volatility should rise and safe haven assets will benefit
• Global bond yields will stay lower for longer
• The financial system is more stable than in 2008
• There is a further headwind to the globalisation agenda.

The unknown aspects include:

• The UK’s negotiating stance
• The EU’s response to the Brexit vote
• The impact of the referendum on politics in other countries
• The strength, speed and effectiveness of the policy responses
• The shifts in global capital flows
• The private sector reaction function to the Brexit vote.

While “flight to safety” was prevalent immediately following the Referendum, it was noticeable that the price action in most assets was orderly in the circumstances and only took most assets to the bottom of their recent trading ranges. After a crisis it usually takes weeks or months for asset prices to find a new equilibrium.

All other things being equal (which they will not be), in the near term we would expect: a lower level of sterling and the euro versus the US dollar and yen, lower global equity indices, with greater sector rotation as longer-term investors start to react, more for domestic focused stocks in the UK and Europe than say for US stocks, lower bond yields and a propensity for a flatter yield curve depending on moves in the political risk premium, and limited credit issuance. Equities and commodities will price in lower demand and pressure on corporate earnings, government bonds and credit will be supported by expectations of lower rate cuts.

We also expect to see material declines in asset prices in coming weeks, as long-term positions adjust. Moves will broadly be in line with previous crises, such as in 2010-12 when the EMU came under pressure, but less marked than, for example, the fallout from the “tech bubble” or the global financial crisis. In general markets have only moved back to the lower end of their recent trading bands. Whether and when these declines spark a round of value buying will partly depend on the political fallout and policy making response.

Investment manager surveys showed historically high holdings of cash and generally neutral asset holdings prior to the vote. As most market attention has focused on UK assets, we could see rather more pressure on their European counterparts as the wider ramifications become clearer.

In summary, it seems inevitable that the ‘Leave’ vote will lead to considerable sector rotation within markets, towards companies with more diversified global earnings and good dividend cover and away from stocks with EU exposure, banks and consumer-orientated stocks.

1st Quarter 2016

john.owen

As an overview, following the US Federal Reserve (Fed) interest rates rise in December, global monetary policy diverged for the first time since 2008 – excepting, the ill-advised and short-lived European Central Bank tightening of 2011. Investors fretted that the Fed’s move would combine with slowing Chinese growth to drag the world into a deep recession. This fear was exacerbated by a continually falling oil price, driven by Saudi Arabia trying to squeeze US shale producers out of business. While this is good for Western consumers, it saw a number of OPEC sovereign wealth funds sell liquid assets (developed market equities) as lower oil revenues begin to bite.

This powder keg was then ignited by mixed data out of the US which made many investors see recession just around the corner. As February unfolded, redemptions by sovereign wealth funds and panicked selling by other investors saw high yield bond funds come under pressure as concerns mounted about potential bankruptcies among heavily indebted US shale oil companies. These solvency suspicions then spread to the European banking system.

In addition, rumours swirled that banks were creaking under increased regulation, poor profitability and – in particular – Deutsche Bank’s ability to make deeply subordinated debt payments. This caused a sell-off in high yield bank debt and led Deutsche to tender for its own paper to allay market fears. Anxiety about a rerun of 2008 saw investors hit the panic button and began selling European financial shares as a liquid proxy for illiquid high yield debt.

However, we believe fears of a global recession are much exaggerated. It is wrong to assume that rising interest rates are necessarily bad for asset prices. Analysis suggests that the best equity market returns occur when both interest rates and GDP growth are rising.

In summary, it takes between one and two years for monetary policy to affect the real economy; we believe that investors would do well this year to worry a little less about Fed policy and focus a little more on the outlook for growth.

3rd Quarter 2015

john.owen

As an overview, the US Federal Reserve (Fed) looks set to increase interest rates for the first time since 2006. History shows that financial markets, not just bonds but also credit and equity, can suffer in the early stages of such a tightening cycle. However, history also shows that pro-risk portfolios can make progress in this environment as and when investors realise that the only reason the central bank is tightening policy is to prolong the business cycle by ensuring that inflation remains close to target. Whether rate increases are gradual or aggressive will depend on the interaction of inflation, productivity and investment trends.

A second risk facing investors’ concerns not the US but the world’s second largest economy, China. At the time of writing, China is struggling with a difficult transition away from an economic model overly reliant on debt, infrastructure spending and exports towards one focused more on services and consumption. Industry forecasts are that policymakers can stabilise the situation, although the effects of slower growth will be seen in trade data and commodity prices across the world.

However, we remain cautiously optimistic about the outlook for equities and real estate, as long as there is a positive cashflow from the corporate sector. It is the case though that the best of the returns may have been seen in this cycle. This view is reflected as well in many of the equity and bond funds, which demonstrate that the fund managers are relatively defensive in their positioning. For example, the Standard Life fixed income team do not believe that inflation will rear its head any time soon, while as companies undertake more share buybacks so credit investors are considering the implications for corporate balance sheets. As a number of emerging market countries are no longer accumulating reserves, so currency investors are examining individual growth prospects more. All in all, a sophisticated process for active stock picking is ever more important in this phase of the investment cycle.

2nd Quarter, 2015

john.owen

As an overview, global equity markets have made a good start to the year, helped by fewer economic and political concerns about the Eurozone. Recent macroeconomic news has been broadly supportive of global economic growth edging up in 2015. This is most clearly apparent in measures of business sentiment. The developed market composite business sentiment index has picked up in recent months, led by the services sector, and is now sitting almost two points higher than its average over the past three years.

Confidence is highest in the US and UK, but now in the Eurozone it has pared almost all of its losses from the second half of last year. Japanese sentiment has fallen recently, but we see that as more of a blip than the beginning of a new downward trend. Emerging market (EM) business sentiment is more mixed. India is leading the way, as confidence in the new government’s policies continues to build. In China, sentiment in the services sector is holding up well but manufacturing sentiment is deteriorating in line with the hard data. The Brazilian and Russian business sectors remain very pessimistic about the near-term outlook.

Looking further out, the preconditions for a more durable recovery in global activity are gradually falling into place, supported by three fundamental drivers – lower oil prices, widespread monetary policy easing and steady labour market repair. We attribute most of the plunge in oil prices to favourable supply developments. If we are right about this, the shock should be positive for global growth. Indeed, IMF researchers recently estimated that if prices remain around their current levels, global GDP growth could receive a boost of between 0.3% and 0.7% in 2015.

In summary, we expect global GDP growth of around 3.5% this year and into 2016, supported by consumer spending. The main risk is that the aftershocks from any US policy tightening are too problematical for EM countries to bear.

1 Quarter, 2015

john.owen

As an overview, it has been a bumpy start to the year. Emerging market (EM) currencies and equities came under renewed pressure on several occasions, while bad winter weather has severely distorted economic data in the US. More recently, geopolitical risks intensified with the political crisis in the Ukraine causing worries about energy supplies to Europe. Meanwhile, concerns about Chinese financial instability continue to bubble along in the background.

Together, these events have combined to dampen risk sentiment. Nevertheless, our cautiously optimistic view of the global economy remains intact. In the developed world, negative weather and Chinese New Year effects will prove temporary, while more fundamental drivers such as easy monetary policy and the reduced pace of public and private sector deleveraging should support stronger growth.

We also take as a positive sign that business investment made a healthy contribution to growth in most of the major economies at the end of 2013. Stronger capital spending is the key to driving more rapid growth in productivity, corporate earnings and real household incomes. The road ahead for emerging markets is more uncertain. Although faster global growth will benefit EM exporters, the current developed market recovery is likely to be less import-intensive than in the past. Structural reforms must also be accelerated to counter declining productivity growth as well as the constricting impact of tightening financial conditions.

In summary, the House View remains Heavy in equity and property, Neutral in emerging market debt and cash and Light in government bonds. The main equity positions are in the US and the UK, two economies where economic and profits growth is expected to be more supportive into 2014.

Quarter 4, 2014

john.owen

As an overview, another year is close to passing without investors’ worst fears being realised. A sharp rise in short-term US interest rates that triggers a large rise in longer-term bond yields continues to be the big risk that investors both worry about and are positioned for. However, contrary to these fears, ten-year bond yields in most of the major markets are actually lower than a year ago, and well below where they started 2014.

The multi-speed world is shaping the profile of domestic short-term interest rates. However, there is still a single global capital market, so strengthening activity in the UK and US is being more than offset by deflationary worries in the Eurozone and massive balance sheet expansion in Japan, serving to prolong the low interest rate environment at the long end. Ten-year bond yields in Germany, after all, have almost halved over the last year

Equities are supported by low inflation and bond yields in most developed markets, particularly the US. However, the continuation of this rally is dependent on corporate earnings growth expansion into 2015. In fixed income, emerging market corporate debt and a growing real estate debt market present opportunities for longer-term value. Meanwhile, increased awareness of corporate social responsibility, for example through water stewardship, carries prospective benefits and challenges for companies and investors.

In summary, the House View remains Heavy in most of the developed equity markets, especially the US but to a lesser extent Japan and the UK, as we see better corporate earnings growth in these regions. The necessary conditions continue to fall into place for further global M&A, business investment and share buybacks, which would support the long-term uptrend in risk assets. Although we are Neutral on emerging equity markets as a whole, there are country-specific opportunities available to investors. For example, the continued rise in the US dollar, putting downward pressure on commodity prices, will affect emerging markets on a selective basis.

3rd Quarter 2014

john.owen

As an overview, we are three quarters of the way through the year and global economic developments are panning out mostly as expected. The US economy has rebounded strongly since contracting during the harsh winter, with business investment now leading the way. The resultant pick-up in import demand is giving a welcome boost to global trade, particularly in Asia. The broad-based UK recovery continues apace, supported by the strong labour market and easy monetary policy. In Japan, April’s sales tax severely distorted the timing of activity but has not blown the economy off course, while Prime Minister Abe is making slow but steady progress on much needed structural reforms.

The outlook in emerging markets however remains patchy. Growth in China continues to oscillate around the government’s target as the effects of the weakening property market are being mostly offset by domestic policy stimulus and improving export demand. As anticipated, Modi’s election victory in India lifted business and consumer confidence, but the hard work on structural reforms is only just beginning. After falling into recession in the first half of the year, Brazil is in even more dire need of reform. That realisation is also dawning on the Brazilian electorate, which has pushed Mariana Silva, the reformist challenger to Dilma Rousseff, ahead in the polls for October’s presidential election.

Meanwhile, Russia’s economy is stagnating, feeling the negative effects of the sanctions that have resulted from its destabilisation of Ukraine. The potential for geopolitical risk to rise further is the biggest downside risk to our forecast for steadily improving global growth over the coming year. For now though, the benign trends in energy and food prices are helping to calm market nerves.

In summary, global economic growth is diverging, as the US and UK speed ahead of a struggling Eurozone while the economic performance within emerging markets is mixed. Such contrasting growth, along with differences in monetary policy and valuation signals, will determine investor flows. Equities are supported by low inflation and bond yields in most developed markets, particularly the US. However, the continuation of this rally is dependent on corporate earnings growth expansion into 2015. In fixed income, emerging market corporate debt and a growing real estate debt market present opportunities for longer-term value. Meanwhile, increased awareness of corporate social responsibility, for example through water stewardship, carries prospective benefits and challenges for companies and investors.

2nd Quarter 2014

john.owen

As an overview, it has been a bumpy start to the year. Emerging market (EM) currencies and equities came under renewed pressure on several occasions, while bad winter weather has severely distorted economic data in the US. More recently, geopolitical risks intensified with the political crisis in the Ukraine causing worries about energy supplies to Europe. Meanwhile, concerns about Chinese financial instability continue to bubble along in the background.

Together, these events have combined to dampen risk sentiment. Nevertheless, our cautiously optimistic view of the global economy remains intact. In the developed world, negative weather and Chinese New Year effects will prove temporary, while more fundamental drivers such as easy monetary policy and the reduced pace of public and private sector deleveraging should support stronger growth.

We also take as a positive sign that business investment made a healthy contribution to growth in most of the major economies at the end of 2013. Stronger capital spending is the key to driving more rapid growth in productivity, corporate earnings and real household incomes. The road ahead for emerging markets is more uncertain. Although faster global growth will benefit EM exporters, the current developed market recovery is likely to be less import-intensive than in the past. Structural reforms must also be accelerated to counter declining productivity growth as well as the constricting impact of tightening financial conditions.

1st Quarter 2014

john.owen

As an overview, forecasting the direction for financial markets is never easy, especially at turning points in the policy-making cycle or when politics have a major effect on investor sentiment. The good news is that the House View remains confident about the ability of companies to generate positive cashflows into 2014-15. Together with current market valuations, this still suggests investors should remain exposed to riskier assets, primarily equity and real estate.

The bad news is that government decisions, especially about structural reforms but also fiscal policy and regulation, could periodically have a major impact on market sentiment, generating turbulence in the prices of financial assets.

In addition, the monetary cycle is slowly altering as two of the most important central banks, namely the US Federal Reserve and the People’s Bank of China (PBOC), begin to take steps to withdraw their considerable support. This will have an impact on other central banks here the focus is rather more on the risks of disinflation, even a slide into secular stagnation. Where appropriate, the House View will be positioned to take advantage of such turbulence, but otherwise we will focus on the medium-term path; a slow shift in portfolios away from ‘sustainable yield’ towards ‘sustainable earnings expansion’.

In summary, 2014 will be a battle between economic fundamentals and political obstacles. Equity markets can make new highs on the back of supportive policy and continued economic recovery. Structural reforms are necessary to prevent more economies sliding into stagnation.

Market overview - 2 Sept 2013

john.owen

As an overview, Markets are entering the second half of 2013 with a distinctly queasy feeling as risk assets have given up some of the strong gains delivered over the previous 12 months. Equity markets in particular have suffered a very difficult six weeks, as markets start to come to terms with the two things they hate most: renewed uncertainty about monetary policy and worries about the sources of future growth. The re-appearance of these worries after a period of strong returns had two inevitable consequences: the resurrection of volatility and the revival of high correlations between asset markets.

After a period when a plentiful supply of liquidity or promises of action by central banks encouraged risk taking by investors, a new phase is being seen. The Federal Reserve is debating whether, where, when and how it might begin to withdraw or taper QE from the economy. Its communications have not been as transparent as many investors would like, leading to a noticeable sell-off in US bonds and a marked rise in market volatility. Markets must also cope with a divergence in approach between the Fed and other policymakers. Over 15 Asian and European central banks, notably the ECB and RBA, relaxed monetary policy in Q2, reflecting concerns about unduly slow growth and disinflationary prospects.

Nevertheless, bond market correlations are high, so the 100 basis points or so rise in US 10-year yields, to their highest in a year, has been matched by broadly similar moves in the other major bond markets. It is vital that the authorities do not make a policy error and allow yields to spike significantly higher, and hence we expect continued central bank actions and verbal guidance to calm market nerves. Otherwise there is a danger that a sharper sell-off, and rise in prices and emerging market assets.

In broad terms, the House View remains heavy in equity and property, neutral in cash, and light in government bonds. To be more specific, we favour high-yielding bonds as we expect both interest rates and default rates to remain low. Conversely, the House View remains light in relation to most government bond markets on the grounds of expensive valuations.

Market update - 2nd September 2013

john.owen

As an overview, Markets are entering the second half of 2013 with a distinctly queasy feeling as risk assets have given up some of the strong gains delivered over the previous 12 months. Equity markets in particular have suffered a very difficult six weeks, as markets start to come to terms with the two things they hate most: renewed uncertainty about monetary policy and worries about the sources of future growth. The re-appearance of these worries after a period of strong returns had two inevitable consequences: the resurrection of volatility and the revival of high correlations between asset markets.

After a period when a plentiful supply of liquidity or promises of action by central banks encouraged risk taking by investors, a new phase is being seen. The Federal Reserve is debating whether, where, when and how it might begin to withdraw or taper QE from the economy. Its communications have not been as transparent as many investors would like, leading to a noticeable sell-off in US bonds and a marked rise in market volatility. Markets must also cope with a divergence in approach between the Fed and other policymakers. Over 15 Asian and European central banks, notably the ECB and RBA, relaxed monetary policy in Q2, reflecting concerns about unduly slow growth and disinflationary prospects.

Nevertheless, bond market correlations are high, so the 100 basis points or so rise in US 10-year yields, to their highest in a year, has been matched by broadly similar moves in the other major bond markets. It is vital that the authorities do not make a policy error and allow yields to spike significantly higher, and hence we expect continued central bank actions and verbal guidance to calm market nerves. Otherwise there is a danger that a sharper sell-off, and rise in prices and emerging market assets.

In broad terms, the House View remains heavy in equity and property, neutral in cash, and light in government bonds. To be more specific, we favour high-yielding bonds as we expect both interest rates and default rates to remain low. Conversely, the House View remains light in relation to most government bond markets on the grounds of expensive valuations.

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