Investment Outlook. In this issue: Investment review. Market highlights. Market returns. House view. March 2016

Transcription

1 Investment Outlook March A monthly round-up of global markets and trends In this issue: Investment review Headwinds anticipated in run up to referendum Market highlights Equities, fixed interest, and FX and commodity markets Market returns Asset class by asset class House view How we rate the markets

2 Investment review Headwinds anticipated in run up to referendum Volatility has remained a key feature in markets so far in. Persistent themes, including oil prices, China, global growth and the potency of central bank policy have remained the dominant factors impacting global markets. Signs that commodity prices are finding a floor have caused a rebound in the energy and materials sector, which has mainly driven equity markets back up from their lows in mid-february. However, appetite for risk (i.e. equities) has yet to gain real traction. Demand for safe-haven assets, including gold and the Japanese yen, have remained strong. In addition, the continued fall in US treasury yields (which move inversely with prices) suggests global growth and deflation concerns have yet to abate. Closer to home, the announcement of the in/out referendum on EU membership for 23 June has added the risk of Brexit to the cocktail of issues for markets to ponder. In March, the focus of markets is likely to swing back to the world s major central banks, particularly the ECB* after President Mario Draghi hinted strongly in January that further economic stimulus is in the pipeline. With the date now set for the EU referendum, the uncertainty surrounding the possible outcome is already impacting sterling, the UK equity market and the economy. The sell-off in sterling has accelerated in recent weeks and sterling has now depreciated over 11% since mid-november. Sterling weakness has also been driven by market expectations of a UK interest-rate hike being pushed out even further. Indeed, markets (as measured by interest-rate futures) are now pricing in a 40% chance of an interest-rate cut by the end of. Persistent sterling weakness could feed through to higher import costs that could eventually erode real disposable incomes. The MPC* has already stated that it is alert to downside risks to the economy and is prepared to inject stimulus into the economy if a slowdown materialises. The potential costs and benefits of a Brexit scenario remain unclear and the main damage to the economy in the run up to the June vote comes from the postponement of investment activity. In our view, the sustained uncertainty that would follow a Brexit vote is likely to create significant headwinds for the economy. However, in the near term we see the fall in sterling as a net positive for both the UK economy and equity markets. A weaker sterling makes UK exports more competitive. For the market, with over 70% of FTSE 100 revenues coming from overseas, a weak sterling should provide a boost to earnings. Moreover, many of the larger FTSE 100 companies (around 40%) pay their dividends in dollars; sterling weakness means dollar-based income is worth more. Among the lingering market concerns has been the outlook for the US economy. Recent economic data has pointed to a loss of momentum, but we believe fears over a US recession look overdone. GDP* growth of around 2% this year looks achievable, particularly if consumption growth remains supported by lower oil prices. However, bond markets remain unconvinced, with treasury yields continuing to fall. The Fed s* decision to raise interest rates last December is beginning to be been seen as a policy mistake as it limits its ability to reverse policy if the US economy starts to slow at a faster rate. This increases pressure on the ECB to deliver a package in March that will restore market faith that the central bank stimulus still has the power to lift markets. The volatility in financial markets is likely to remain. Equity markets continue to be dictated by swings in the price of oil, although prices appear to be moving within a higher range. It has been encouraging to see that fears over China appear to have been easing of late, as the data has shown further signs of stabilisation. Our view remains that although the Chinese economy is likely grow at a slower pace, the worst is probably behind us. The key risk continues to come from any further heavy-handed policy moves by the Chinese authorities. QE* in its current form has lost some of its power over markets. Indeed, concerns have now crept in over the potential impact of negative interest rates, particularly on the ability of the banking sector to operate properly. Global growth will need to take over as the main driver behind markets. The message from the bond market is that growth is slowing; however, we believe a recession is unlikely. Economic data and leading indicators over the coming months will be closely observed and provide a better gauge of whether the global economy is on firmer ground. Our view remains that in this volatile and uncertain environment the best strategy is to hold a balanced portfolio of equities, good quality bonds and cash to protect against recession and deflation risks, while benefiting from any upswings in equity markets. *For the definitions of these terms, see the glossary on the inside back cover. 2 Agricultural Bulletin Winter 2012

3 Market highlights Equity markets A rebound in commodity exposed and more cyclical (pro economic growth) sectors helped pull equity markets up from their lows in mid-february. Equities have remained closely correlated with oil prices, which look to be bottoming after markets were cautiously optimistic that a proposed deal between Saudi Arabia and Russia to freeze production would stabilise the current over-supply of oil. Whether this is the start of a sustained turnaround in sentiment towards commodityrelated sectors remains to be seen. The sector is likely to continue to face headwinds of low prices and weak demand. We prefer to wait until we see material cuts in production and for earnings to inflect higher before turning more positive on the sector. The FTSE 100, with its 18.5% weighting in the commoditysensitive materials and energy sectors, has continued to be one of the top-performing developed markets this year, despite heightened Brexit concerns. This shows the international nature of the FTSE 100. Sectors such as materials, healthcare and energy, which derive over 90% of their revenues from outside the UK, should be relatively well insulated from risks to the UK economy should a Brexit scenario materialise. Indeed a weaker sterling should also help support earnings in these more internationally exposed sectors. In the near term, Brexit risk and a weaker sterling favour the FTSE 100 over the more domestically focused FTSE 250. Japanese equities have continued to underperform, with markets unconvinced by the Bank of Japan s half-baked move into negative interest rates. Japanese markets remain closely but inversely correlated with the yen (Japanese equities have fallen as the yen has strengthened), with the currency appreciating further in February as investors continued to move into safe-haven assets. Eurozone and Japanese equities two markets where central banks continue to keep their foot to the floor with QE have underperformed this year, perhaps evidence of the diminishing returns of central bank policy. Despite this, we believe QE can still be a key driving force behind markets. Clearly there is scope for further easing, with both economies still under threat from deflationary forces. Focus will be on the ECB in March, although we suspect Mario Draghi will have to go above and beyond to excite markets Mar Apr UK cyclical stocks relative to defensive and the oil price May Jun Jul Aug Sep UK cyclical/uk defensive Oct Nov Dec Oil price (RHS) Jan Feb Source: Bloomberg/Smith & Williamson Fixed interest Despite the rebound in equity markets, government bond yields have remained at very low levels. The US ten-year yield (a proxy for GDP growth) has fallen and remained below 1.8%, continuing to signal the US economy is on a lower growth trajectory and the move by the Fed in December to raise interest rates may have been a policy error. Despite the pick-up in US inflation last month, markets are now sceptical whether global central banks have the ammunition and willingness to deliver self-sustaining recoveries in economic growth and their ability to combat deflationary headwinds. Indeed, measures of inflation expectations have continued to fall. We remain more optimistic on the global economic outlook, however, the message from the bond market cannot be ignored and we continue to see the benefits of holding longer-dated treasuries and gilts as part of a balanced portfolio as protection against a recessionary outcome. Yields on treasuries and gilts are likely to remain low in the near term, while the growth outlook seems uncertain and the prospect of a rise in interest rates looks increasingly unlikely. Prices within the corporate bond space have remained volatile. Spreads (e.g. the difference between the corporate bond yield and the benchmark government bond yield which represents risk) on high-yield bonds have levelled off but remain elevated, particularly in the energy sector where the risk of defaults is high. We continue to avoid the high-yield bond sector. Yield spreads on good quality investment grade bonds have widened since the start of the year, mainly due to gilt yields falling at a much quicker pace. However, we believe the risk of default is low among investment grade companies and, as a result, we continue to believe good quality corporate bonds offer an attractive yield at these levels for those looking for income Mar Apr May Jun Corporate bond spreads over gilts Jul Aug Sep Oct Nov Dec Investment grade High yield High-yield energy Jan Feb Source: Bloomberg/Smith & Williamson Agricultural Bulletin Winter

4 Market highlights continued FX and commodity markets There s no doubt the continued fall in sterling has been a key feature in currency markets. Brexit concerns and falling interest-rate expectations have pulled sterling to its lowest level against the dollar since early However, the direction of sterling from here is dependent on a number of factors, including the monetary policy of central banks elsewhere. With the ECB likely to ease policy further in March, we could well see the euro weaken against sterling in the near term if Mario Draghi announces bigger-than-expected stimulus measures. Clearly, much will depend on how the Brexit debate progresses over the next three to four months. Should the momentum shift towards an Out vote then we are likely to see sterling fall further. Gold has staged a comeback, rising over 16% since the start of the year, benefiting from its status as a safe-haven asset during times of market volatility and the wider pick-up in commodity prices. Although gold pays no income, it has a relatively strong negative correlation with US real (inflationadjusted) yield (as the yield falls the price of gold rises). There are a number of (often conflicting) reasons behind this, however generally when real yields (or interest rates) are very low or negative the opportunity cost of not owning assets with greater return potential (such as gold) increases. Recently, US real yields have fallen on the back of lower growth and inflation expectations, which has set gold higher. With interest rates and yields likely to remain low and even negative in some cases, interest in gold could well continue in the near term Feb 11 Feb 12 Feb 13 Feb 14 Feb 15 Feb 16 Gold price Gold vs US real yield US TIPS yield (RHS, Inverted) Source: Bloomberg/Smith & Williamson 1 UK sector performance Oil and gas Basic materials Industrials Consumer goods Healthcare Consumer services 1 month 1 year Telecom Utilities Financials Technology Source: Thomson Reuters Datastream/Smith & Williamson as at 29 February 4 Agricultural Bulletin Winter 2012

5 Market returns Equity markets by region Yield 1 month (%) 3 months (%) 1 year (%) FTSE All World FTSE USA FTSE Japan FTSE All Share FTSE Asia Pacific ex Japan FTSE Europe ex UK FTSE Emerging Markets Equity markets by country Yield 1 month (%) 3 months (%) 1 year (%) FTSE All Share FTSE FTSE FTSE Small Cap S&P CAC DAX Swiss SMI Japan-Topix India-Sensex Hong Kong-Hang Seng

6 Market returns continued Fixed interest Yield 1 month (%) 3 months (%) 1 year (%) FTSE Govt All Stocks FTSE Govt Index-Linked US Treasuries UK Corporate Bonds Commodities and FX 1 month (%) 3 months (%) 1 year (%) Oil (Brent Crude) Gold Copper GBP vs USD GBP vs Euro Benchmarks 1 month 3 month 6 month 1 year 3 year FTSE WMA Balanced FTSE WMA Growth FTSE WMA Income Macro data UK GDP (YoY%) 1.9 UK Retail Price Index 1.3 Bank of England base 0.5 Spot rates 29 Feb GBP/USD 1.39 GBP/Euro 1.28 Euro/USD 1.09 Note: All values as at 29 February. Total returns in sterling. Sources: FTSE, Thomson Reuters Datastream, Bloomberg FTSE International Limited (FTSE) FTSE. FTSE is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE s express written consent.

7 House view We continue to favour quality developed market equities, although volatility is likely to persist. The inflationary pressures remain weak in the US, UK and Europe, in this environment we prefer conventional bonds over index (inflation)-linked. Glossary of terms Regional equities UK US Europe Japan Asia Pacific ex Japan Emerging markets Fixed interest Government bonds UK US Germany Index-linked bonds UK US Corporate bonds (Good quality investment grade) Currencies (v GBP) US $ Euro - N + - N + - N + ECB European Central Bank. The euro area s central bank which sets key interest rates and monetary policy. Fed The Federal Reserve. The central banking system of the US. Sets key interest rates and monetary policy. FOMC Federal Open Market Committee. The branch of the Federal Reserve board that determines the direction of monetary policy. It meets eight times a year to set key interest rates. GDP Gross Domestic Product. The monetary value of all the finished goods and services produced within a country s borders in a specific time period. This includes all of private and public consumption, government expenditure, investments and net exports. MPC Monetary Policy Committee. The Bank of England s interest rate and monetary policy setting committee. QE Quantitative Easing. An unconventional monetary policy in which a central bank purchases assets (mainly government securities) from the market in order to lower interest rates and increase the money supply. This, in turn, encourages financial institutions to lend to the wider economy. Bonds the relationship between price and yield. Yield is the return you get on a bond. When the price of a bond changes prior to maturity, due to supply and demand pressures, so does its yield. When the price of a bond goes up due to demand, the yield goes down to compensate. This is so the bond s fixed rate of return (coupon) remains relatively constant and vice versa. A bond s price and its yield are inversely related. A key factor which influences a bond is the prevailing interest rate. When interest rates rise, the prices of bonds fall, thereby raising yields. This is because the older bonds are sold in order to buy new higher-yielding bonds. Important information Please remember the value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance. Agricultural Bulletin Winter

8 For further information Contact Office Direct line address Philip Lawlor London Christopher Bates London Whether you are interested in accountancy, tax or investment management issues, you can register to receive our newsletters by completing the online newsletter registration form: smith.williamson.co.uk/investment-management Our offices: London, Belfast, Birmingham, Bristol, Cheltenham, Dublin (City and Sandyford), Glasgow, Guildford, Jersey, Manchester, Salisbury and Southampton. Smith & Williamson Investment Management LLP authorised and regulated by the Financial Conduct Authority. We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Smith & Williamson Holdings Limited. code 31916db