Financial markets have been hit by two political shocks this year – first Brexit and then Donald Trump’s victory in the US elections. The reaction was similar on both occasions with investors initially seeking safe havens from policy uncertainty, and their currencies weakening. However, stock markets soon regained lost ground.
In the US, investors were encouraged by prospects for a boost to the economy from promised tax cuts, reduced regulation and an increase in government spending on infrastructure. The Dow Jones Industrial Index climbed 5.9% in US dollar terms in the month and the S&P 500 index gained 3.7% in US dollars in the month. The FTSE 100 index notched 0.28% over November in US dollars but lost -2.% in sterling terms in the month as the domestic currency regained some of its earlier losses.
Broadly positive Q3 earnings data acted as a further prop to share prices.
One particular area of gain was healthcare, which had been under pressure from the expectation of a Clinton win and subsequent regulation on prices and the US health system. The sector has recovered since the election result, which has been a benefit to clients after we took a position in US healthcare before the election.
Global government bond markets suffered as investors digested the impact of a Trump presidency. Yields rose (prices fell) on the expectation of inflationary policies that will speed the pace of interest rate rises. Following recent losses, many government bonds would deliver negative real returns if held to maturity. With inflation and rates likely to rise, investors sought assets with more attractive returns. A key gauge, the Barclays Global Treasury index, was trimmed -1.6% in the month in US dollar terms.
Although investors are unclear about the economic direction of travel of Mr Trump, the US economy continues to power global growth – in fact real GDP increased an annual rate of 3.2% in the third quarter versus 1.4% in the previous quarter – and a recession seems unlikely in the next year. A US rate rise in December is widely expected, and we believe rates are then likely to increase faster than previously expected. Conditions in markets could become more volatile as political events unfold in the US and Europe over coming months.
At the end of the month, the OPEC nations announced an agreement on cutting production, which immediately saw oil prices rise. This is likely to fuel inflationary pressure as price rises are passed on to consumers. Elsewhere in commodities, gold prices have been falling and are now over 12% down from their earlier highs.
Sterling had its best month since 2009, gaining 5% against the euro, 2% against the dollar and almost 10% against the yen.
Developed and Emerging Equity Markets
Equity Markets Performance
Performance As of: 30-Nov-16 Current -1M -3M YTD 15 Developed Equity (MSCI) 1,328 2.7 2.3 6.6 2.6 FTSE All Share 3,692 -1.6 0.6 11.2 1.0 FTSE 100 6,784 -2.0 0.8 13.0 -1.3 S&P 500 2,199 3.7 1.8 9.8 1.4 Nasdaq Composite 5,324 2.8 2.4 7.6 7.0 DJ EuroStoxx 327 -0.3 0.9 -1.9 11.1 Nikkei 225 18,308 5.1 9.2 -2.1 11 Hang Seng 22,790 -0.5 -0.1 8.0 -3.9 Emerging Equity (MSCI) 47,720 -2.2 -1.1 9.9 -5.4 BRIC (MSCI) 522 -2.0 0.0 10.8 -5.3 Source: Datastream Performance shown as % total return in local currency terms
Performance As of: 30-Nov-16 10-Year Yield* -1M -3M YTD 15 US Treasuries 2.37 -2.9 -4.5 -1.1 -1.6 UK Gilts 1.42 -1.8 -8.2 6.2 -2.3 Eurozone Government Bonds 0.20 -4.3 -6.1 -1.7 3.4 US Investment Grade -3.1 -4.9 1.5 -5.6 US High Yield -1.0 0.9 10.3 -10.1 Emerging Market -4.9 -0.6 5.1 20.6 Source: Barclays indices; Datastream
*current yield on benchmark 10-year Treasury, gilt and bund respectively
Performance shown as % total return in local currency terms
Performance (%, dollar) As of: 30-Nov-16 Current -1M -3M YTD 15 Commodities (TR) 173.8 1.3 4.0 9.8 -24.7 Brent Oil Price (Spot) 49 5.0 6.3 34.6 -33.5 Gold Bullion (Spot) 1174 -7.9 -10.3 10.5 -10.5 Industrial Metals (TR) 230.2 10.3 17.6 26.3 -26.9 Source: Datastream
Inflation & Interest Rates Current Inflation (%) Interest Rate Forecasts (%) Rate Announcement Current Dec Mar '17 Next Date United States 1.6 0.50 0.75 0.75 14-Dec United Kingdom 0.9 0.25 0.25 0.25 15-Nov Eurozone 0.6 0.00 0.00 0.00 08-Dec Japan 0.2 -0.10 -0.10 -0.10 20-Dec
In the UK, an infrastructure spending programme was proposed by then-shadow Chancellor Ed Balls as part of the Labour Party manifesto in 2010. Since then, and in the face of headwinds raised by the vote to leave the EU, the idea has crossed the floor and was a key element of the Chancellor Philip Hammond’s Autumn Statement. Hammond has proposed a series of measures centred on a fund for infrastructure that will pump £23bn into the economy, and a plan to fund rebuilding in the ‘Northern Powerhouse’.
We have been anticipating rising rates and inflation for some time. We reduced our exposure to government bonds on the view that they did not offer good value in the face of high prices and low yields. While yields have improved as prices have fallen, the extent of the price falls has been such as to counteract any gain that might have been had in yields, a trend that’s been in evidence across the major developed market bonds.
Emerging markets holdings demonstrate the benefits of diversification
Emerging markets have performed well in the year to date, outperforming developed markets and demonstrating once again the benefits of a diversified asset allocation. A typical Coutts Balanced portfolio includes a 7% allocation to emerging markets, and so performance in the sector has provided a solid boost to client returns. Dimensional Emerging markets fund, for example, one of our main emerging market holdings, has returned 29% in the year to date, while the M&G Emerging Markets fund has returned 28%.
Greater stability in commodities prices and the benefit to emerging markets currencies from the US Federal Reserve holding off on rate rises, have helped fuel a rally in both equities and emerging debt over the year.
Strong performance has come from Brazil, China and India. While Brazil’s economy remains a concern, the country has seen a strong rally in its financials and energy sectors that has seen it become one of the year’s star performers. Strong economic growth in India continues to fuel good market returns supported by economic reforms in land, labour and tax that have boosted investor confidence. China, meanwhile, continues to show robust manufacturing purchasing managers index numbers, although other data has been softer.
No rally lasts forever, of course, and it is possible that the strongest gains in emerging markets are behind us. Investors have been looking for returns over a period when developed markets have been flat. With volatility potentially returning to developed markets, emerging equities may lose their allure.
In addition, imminent rate rises in the US and bellicose statements on trade policy from US President-elect could have a chilling effect on emerging markets equity, while ongoing economic stresses in Brazil and Russia also strike a cautious note. Over the longer-term however, we believe our emerging markets holdings continue to offer good potential for returns as well as the protective benefits of global diversification.
The outlook for global equities continues to be positive, supported by a strong US economy and a moderating of negative sentiment following the outcome of the US presidential election. US incomes continue to rise at a modest pace, contributing to consumer spending and growth. President-elect Trump’s plans for cutting taxes and spending on infrastructure could also reinforce domestic growth longer-term.
There is increasing sentiment that UK equities will generally stay buoyant, largely against a backdrop of healthy retail and jobs data. While fears of a post-Brexit recession continue to fade, some political uncertainty remains as we await UK negotiations on exiting the EU.
We have taken some profits in global equities that have benefited from sterling weakness and redeployed the proceeds into assets denominated in sterling, which we believe will benefit as sterling recovers from its historically low level.
Within international equities, we favour Europe and Japan on relatively attractive valuations compared to other major markets. In this regard, Europe has what we see as superior earnings growth potential, while we view Japan as all about quality earnings and robust company management.
Emerging market debt
Our general view of bonds versus equities is that the latter provide the potential for better long-term returns. Although bonds have attractive diversification qualities, we are cautious on government bonds, believing long term returns could be poor and vulnerable to rising interest rates and inflation. There is a strong expectation that the US Federal Reserve will hike rates at its mid-December meeting, while a UK rate rise remains less certain given a more fragile post-Brexit environment.
We favour quality corporate bonds, both investment grade and high yield, which can provide attractive yields relative to government debt and are overly discounting the risk of a global recession.
ALTERNATIVES EQUITY THEMES Commodities - Energy + Absolute Return + Technology + Property + Banks + Dividend Income + Healthcare +
We have a neutral view on commodities, and in particular we see limited upside for gold. Despite a recent agreement among the OPEC nations to reduce oil production beginning 2017, we still see oversupply as an issue while demand is growing slowly.
While we see some headwinds within UK commercial property, and the weak post-Brexit sentiment has yet to abate, our positive view towards this attractive sector remains. Economic growth continues to be supportive and Brexit risks do appear to be priced in. In this regard we are maintaining our property overweight.
Alternative asset types with a low or negative correlation to equities can help mitigate the risk of large falls in equity markets and continue to be attractive in our view. For example, absolute return strategies, which we favour, have the potential to make money in most market environments.