Monthly Investment Perspective
Global stock markets continue to ride high as European manufacturing bounces back and the Bank of England relents on interest rates.
6 min read
October can often cause a sense of unease among investors – the stock market crashes of 1987 and 1929 both happened in this month. But the so-called ‘October Effect’ did not seem to apply this year as equities defied the spooks and continued rising.
By the end of the month, the MSCI World Index was up by 2.7% (in local currency terms, 3.1% for sterling investors) while government bonds remained weak, with gilts more or less flat on +0.3%.
In the US, investors were encouraged by strong Q3 earnings and President Trump’s tax reform proposals, boosting the S&P 500 to another record high and sending the Dow Jones Industrial Average to over 23,000 for the first time. The FTSE 100 also rose as sterling weakened, while Japan’s Nikkei index closed at its highest level in more than two decades as the economy continued to grow and companies announced strong profits.
The current broad-based global economic upswing is maintaining its momentum. International Monetary Fund forecasts have world GDP rising by 3.6% in 2017 and 3.7% in 2018, driven by increasing levels of trade, investment and consumer confidence.
The UK economy grew by a higher than expected 0.4% in the third quarter of 2017, compared with 0.3% in the first two quarters, according to the Office for National Statistics. The Consumer Price Index reached its highest level in over five years in September, climbing to 3%. Continuing economic growth and rising inflation saw the markets pricing in an increased chance of a rate rise by the Bank of England. In the end, the bank lifted the base rate by 25 basis points on 2 November.
US banks reported solid earnings for the third quarter of 2017. Capital ratios are stable and interest margins are up, but trading revenues are down compared with the same period in 2016. We believe the financials sector offers good value and will benefit if the Federal Reserve follows through with expectations of an interest rate rise before the end of the year.
China’s Communist Party held its 19th National Congress to select leaders who will govern the country for the next five years. As expected, the event did not yield many surprises as president Xi Jinping consolidated his power. We remain moderately positive on China’s prospects and have some direct exposure through a single country fund, and indirect exposure through our general emerging markets and Asia-Pacific holdings.
European and Japanese equities have performed well so far this year. We retain a preference in our portfolios for these regions as we believe they provide better value and a stronger earnings outlook than other developed markets. Europe has been one of the year’s best performing markets, despite the reappearance of political tensions in the shape of movements toward Catalan independence in Spain.
Despite the broadly positive global picture, we remain aware of the risks ahead. Brexit remains a potential headwind for investors in the UK and the growth outlook is slowing in the face of relatively high inflation and low wage growth. Elsewhere, Trump’s tax reform plans face widespread opposition and divisions seem to be deepening within the Republican Party, fuelling the sense of uncertainty surrounding his presidency.
Performance (%tr*, local) As of: 31-Oct-17 Current -1M -3M YTD 16 Developed Equity (MSCI) 1,548.7 2.6 5.2 15.9 9.6 FTSE All Share 4,118 1.9 2.8 9.8 16.8 FTSE 100 7,493 1.8 2.8 8.5 19.1 S&P 500 2,575 2.3 4.8 16.9 12.0 Nasdaq Composite 6,728 3.6 6.3 26.1 8.9 DJ EuroStoxx 397.8 2.3 6.6 16.8 5.0 Nikkei 225 22,012 8.2 11.3 17.1 2.4 Hang Seng 28,246 2.6 4.5 33.2 4.3 Emerging Equity (MSCI) 60,011 3.9 6.6 28.7 10.1 BRIC (MSCI) 677.1 3.4 8.7 35.9 8.2 Source: Datastream, all returns in local currency; *tr=total return, including reinvested dividends.
Inflation & Interest Rates Current Inflation (%) Interest Rate Forecasts (%) Rate Announcement Current Jan Mar Next Date United States 2.2 1.25 1.50 1.50 13-Dec United Kingdom 3.0 0.50 0.50 0.50 14-Dec Eurozone 1.4 0.00 0.00 0.00 14-Dec Japan 0.7 -0.10 -0.10 -0.10 20-Dec Performance (%tr, local)
As of: 31-Oct-17
US Treasury index 2.38 -0.3 -0.5 0.3 -1.4 UK gilts index 1.38 -0.1 -1.5 -2.7 7.9 Eurozone govt bond index 0.36 -0.6 -1.3 2.2 -1.4 US investment grade index 3.15 0.0 -0.2 1.6 1.8 US high yield index 5.43 -0.1 -0.3 2.0 12.0 Emerging market index 4.29 1.6 5.9 7.9 9.4 Source: Barclays indices; Datastream; *current yield on benchmark 10-year Treasury, gilt and bund respectively Performance (%, Dollar) As Of: 31-Oct-17 Current -1M -3M YTD 16 Commodity Index (TR) 175.6 2.1 2.4 -0.8 11.8 Brent Oil Price (spot) 61.4 7.6 18.0 11.1 51.6 Gold Bullion (spot, per ounce) 1269 -1.1 0.0 9.7 9.0 Industrial metals (TR) 270.3 5.8 11.7 23.6 19.9 Source: Datastream
European Manufacturers drive markets higher
The eurozone’s economic recovery has had several false starts over the past few years. But at last the region appears to be enjoying a period of growth across all 19 countries.
The latest manufacturing Purchasing Managers’ Index data shows the recovery that started in earnest a year ago is continuing at a healthy pace. And at 9.1%, the unemployment rate is the lowest since February 2009 amid a wealth of surveys indicating a rebound in confidence and a boom in manufacturing.
In response to this positive data, the European Central Bank (ECB) has announced a further scaling back of its quantitative easing programme. From next January it will halve its monthly bond-buying to €30 billion and continue at that level until at least September 2018.
Improving economic growth and market-friendly election results have helped to boost the region’s share prices further in 2017. European equities (excluding the UK) have made solid gains of around 11% since the start of the year, measured in euros. Valuations remain reasonable with markets trading on 15 times forward earnings compared with 18 times for the MSCI World Index.
Europe’s sovereign debt crisis delayed its economic recovery and the region is still playing catch-up with the US in the current cycle. As a result, Europe has greater potential for further growth, which is why we believe its equity market remains more attractive than the relatively expensive US.
Political risks have receded despite uncertainty in Spain associated with Catalonia’s bid for independence and elections in Italy next year. Against an improving domestic environment, European exporters can deliver superior earnings growth as they take advantage of a strong global economy.
We believe the euro will continue to appreciate against sterling and the dollar, which would benefit portfolios. Our favourite sector remains financials, where banks are poised to benefit from any gradual increase in interest rates and rise in bond yields. With attractive valuations, investing in European financials is consistent with our key investment principle of seeking value.
Bank of England rate rise – a new level or first step on the hill?
Yesterday, the Bank of England (BoE) ended the longest run of flat or falling interest rates in its history to raise the interest rate by 25 basis points. The rise brings the rate back up to 0.5%, which is where it sat between March 2009 and last year’s rate cut that was intended to buffer the economy after the EU referendum result.
That period between 2009 and 2016 was notable not just because there was no rise, but because there was no move at all. Granted, with the rate so low there wasn’t much room for manoeuvre but, even so, it was an unprecedented period of stability – as the graph of rate moves since 1950 shows.
Yesterday’s move was widely anticipated by markets, to the extent where any other decision would have been perceived as a serious failure of nerve. But the question investors are now asking is, what next?
The bank’s inflation report suggests that inflation is likely to rise in October but start falling after that back towards its 2% target. The effects of ‘imported costs’ – specifically rising oil pices last year and the fall in sterling – are going to drop out of the annual comparison, leading to lower year-on-year price rises. However, they also highlight that domestic inflationary pressures are likely to build, largely in the form of wage rises which have been constrained in recent months despite high employment.
However, this was a split decision – with two members of the nine-person committee voting against the rise - and the bank’s language has been very dovish. The official press release spoke of rises coming ‘at a gradual pace and to a limited extent’.
BoE governer Mark Carney highlighted the UK’s exit from the European Union as the biggest factor determining the economy’s long-term future. Bank analysis suggests that Brexit is already having a ‘noticeable impact’ on prices and growth.
Combined with the BoE's stated comfort with inflationary pressures, this all suggests that the next rise may be some time away. At the press conference following the announcement, Mr Carney suggested two rises over the next three years was a likely timetable given the current circumstances. This has clearly dashed some investors’ hopes as the announcement was followed by a small fall in sterling.
The BoE’s cautious stance is in line with our own long-term view that rates are unlikely to rise quickly, and we may well be looking at a 0.5% rate well into 2018. This means we remain comfortable with our low allocation to gilts in preference for investment grade corporate debt and alternative investment strategies.
Coutts House View
US - UK - Europe + Japan + Emerging Markets -
The outlook for the global economy and global equities remains positive. Within international equities, we favour Europe and Japan because of relatively attractive valuations and a strong macroeconomic upswing compared to other major markets. We see both as offering superior earnings growth potential supported by an improving trade outlook for these export-oriented economies.
While there remain short-term fears about UK equity following the EU referendum, it’s worth remembering that the FTSE 100 generates about 70% of its revenue from outside the country. We therefore believe UK equities will continue to be supported by the robust global economy. In simple terms, global markets matter more to most large UK companies than developments in Britain.
While fears of a post-Brexit UK recession continue to fade, political uncertainty remains after the shock general election result left the UK with a hung parliament. It now looks like the government is more likely to pursue a pragmatic stance towards Brexit negotiations, which should prove supportive for more domestic UK businesses predominantly found within the FTSE 250.
We have taken some profits in global equities that have delivered strong returns off the back of sterling weakness and redeployed the proceeds into assets denominated in sterling, which we believe will recover from its historically low level. We believe that sterling will return to its longer-term levels against other currencies and expect a slow movement back towards our judgment of fair value.
Government - Investment Grade - High Yield + 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.
The US Federal Reserve has hiked the US reference rate twice so far this year and there is the potential for a further rise before the end of the year. In the UK, we believe rates will remain low for some time, although we now see a reversal of the emergency EU referendum rate cut as more likely than not in the near future. We don’t believe this modest rate rise will have a significant impact on UK households.
Within bonds, we prefer credit over government bonds, and in particular continue to favour subordinated financial credit as a theme. Earlier this year we added emerging market local currency debt to portfolios and funds which we saw as attractively valued for the level of yield available, and with the potential to benefit from local currencies appreciating against the US dollar. We believe markets overestimated the protectionist risks presented by President Trump.
Alternatives Equity Themes Commodities - Energy INFRASTRUCTURE + Absolute Return + Technology + Property + Banks + Healthcare +
We are modestly underweight commodities, and in particular we see limited upside for gold in a rising interest rate environment. We are broadly neutral on oil. Despite an agreement among the OPEC nations to reduce oil production at the start of the year, we still see oversupply as an issue – but demand is growing in emerging markets led by India and China.
Our view towards UK commercial property remains positive in the long term. Economic growth continues to be supportive and Brexit risks are discounted in the price, so we are maintaining our property weights. Recent overseas purchases of large London office blocks by overseas investors would appear to support this view.
Alternative asset types with a low or negative correlation to equities can help mitigate the risk of large falls in equity or bond markets and continue to be attractive in our view. For example, absolute return strategies, which we favour, have the potential to make money in a range of market environments.
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