Financial markets around the world have remained relatively stable, although the sharp post-Brexit rally cooled somewhat in September given remaining political and economic uncertainty.
The MSCI AC World Index posted a gain of 1.3% (in sterling terms), while bonds generally fell. Global investment grade corporate bond indices posted a 0.3% fall (in sterling terms), while gilts dropped by 2.4% and US Treasuries were nearly flat with a 0.1% drop.
The UK economy appears to be getting on with business as usual while waiting for Brexit negotiations to begin. Unemployment continues to fall, consumer spending is buoyant, and business activity has been strong, particularly in the services sector.
Domestic UK equities recovered strongly from their post-Brexit selling, and commercial property has regained some of its composure. However, the pound remains depressed owing to the remaining uncertainty about the economic outlook.
While the FTSE 100 reached new highs for the year and the S&P 500 set a new record, political uncertainty remains a risk for equities in the short term. The temperature has increased in the US presidential campaign between Donald Trump and Hillary Clinton, and populist anti-austerity and anti-immigration parties are gaining ground in Europe.
Having cut rates to a record low of 0.25% in August, the Bank of England left them unchanged in September as the economy appeared to weather Brexit uncertainty. Conversely, the US Federal Reserve opted to hold fire on a rise given some soft economic data.
Having reached new record lows in June and July amid vigorous easing measures in the UK, gilt and other major government bond yields drifted higher (prices lower) over the month. Ten-year US Treasury yields also continued to drift higher and the German 10-year yield, which dropped into negative territory in late June, was marginally positive by the time of writing.
Our analysis suggests the outlook for world equities remains positive, and we continue to favour Europe and Japan, given their relatively attractive valuations compared with other major markets. Though we see ultra-low-yielding government bonds as expensive, we don’t anticipate significant weakness given expectations for interest rates and inflation to remain low in developed markets.
Investment grade (higher credit quality) corporate bonds have performed well this year, and we believe they still offer attractive additional yields relative to government bonds.
While UK commercial property still faces some headwinds we believe that concerns over a post-Brexit exodus are exaggerated and it offers reasonable value.
Developed and Emerging Equity Markets
Equity Markets Performance
Performance As of: 31-Sep-16 Current -1M -3M YTD 15 Developed Equity (MSCI) 1,306 0.5 3.3 4.3 2.6 FTSE All Share 3,697 1.9 9.0 10.5 1.0 FTSE 100 6,782 1.7 10.1 12.1 -1.3 S&P 500 2,171 0.1 4.1 7.8 1.4 Nasdaq Composite 5,213 1.2 5.7 5.0 7.0 DJ EuroStoxx 326 1.3 0.2 -2.7 11.1 Nikkei 225 16,887 2.0 -1.8 -10.3 11 Hang Seng 22,977 5.2 12.5 8.1 -3.9 Emerging Equity (MSCI) 48,425 2.8 9.0 11.1 -3.9 BRIC (MSCI) 524 4.6 11.9 10.7 -5.3 Source: Datastream Performance shown as % total return in local currency terms
Performance As of: 31-Sep-16 10-Year Yield* -1M -3M YTD 15 US Treasuries 1.57 -0.7 1.5 3.6 -1.6 UK Gilts 0.64 2.8 10.6 15.6 -2.3 Eurozone Government Bonds -0.13 -0.8 2.6 4.6 3.4 US Investment Grade -0.2 2.7 6.6 -5.6 US High Yield 1.7 4.3 11.4 -10.1 Emerging Market 2.4 6.2 11.8 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: 31-Sep-16 Current -1M -3M YTD 15 Commodities (TR) 167.1 -1.8 -2.9 5.6 -24.7 Brent Oil Price (Spot) 46.1 11.4 -5.9 26.7 -33.5 Gold Bullion (Spot) 1308 -3.1 7.7 23.1 -10.5 Industrial Metals (TR) 295.8 -4.1 5.6 7.4 -26.9 Source: Datastream
Inflation & Interest Rates Current Inflation (%) Interest Rate Forecasts (%) Rate Announcement Current Nov Dec '16 Next Date United States 0.8 0.50 0.50 0.75 02-Nov United Kingdom 0.6 0.25 0.25 0.25 03-Nov Eurozone 0.2 0.00 0.00 0.00 20-Oct Japan -0.5 -0.10 -0.10 -0.10 31-Oct
Our outlook for global equities remains broadly positive, based partly on our view that robust US demand and spending will continue to support global growth and earnings. In the UK, the internationally-focused FTSE 100 has stayed buoyant following its post Brexit recoveryas investors anticipate a boost to overseas revenues from sterling weakness.
We have taken advantage, though, of the recent strong run in global equities to take some profits and reduce our pro-equity position further. By early September, for example, the MSCI World index was up nearly 20% from its February low.
Within equities, we continue to favour Europe and Japan, given their relatively attractive valuations compared to other major markets. Both also have more encouraging profit outlooks, coupled in Europe with signs of recovering economic growth and company profitability.
Emerging market debt
While expectations for interest rates remain lower for longer across the major markets, we still see government bonds as generally expensive. The EU referendum result pushed aside any chance of UK rate rises in the near future, and we believe monetary policy is likely to remain loose for a long time. The US Federal Reserve, meanwhile, has indicated that a rate rise may be on the cards late in 2016, although the pace of further rises is likely to be slower than anticipated earlier in the year.
At the height of the sell-off in risk assets in February, investment-grade bonds (higher credit quality) – led by the bonds of financial institutions – were pricing in a global recession, which we still see as unlikely in the near future. At the time, we added to holdings in financial debt and investment-grade bonds in general. These positions have performed well, and continue to offer attractive additional yields relative to government bonds, providing more than adequate compensation, in our view, against the risk of default.
ALTERNATIVES EQUITY THEMES Commodities = Energy + Absolute Return + Technology + Property + Banks = Dividend Income +
We have maintained a neutral stance on oil prices, which continue to be volatile. We still see oversupply as a problem while demand is growing very slowly.
UK commercial property took a major blow after the EU referendum, fuelled by fears of multinationals leaving the UK due to their access to EU markets being cut off. Some funds were forced to suspend redemptions temporarily and many marked their assets down, though most have now recovered much of their lost ground. While the sector faces some headwinds, we believe these fears are exaggerated and that UK property remains a desirable asset globally, and are holding on to our positions.
We continue to look out for bond-like alternative assets that have a low or negative correlation to equities and can mitigate the risk of large falls in equity markets. Some examples already in our portfolios are absolute return strategies, which have the potential to make money through most market environments, and strategies for gaining exposure to dividend income while minimising correlations with price moves in equities.