Monthly Investment Perspective
US stocks soar and sterling strengthens
6 min read
September was another record-breaking month for US stock markets with the Dow Jones and S&P 500 indices reaching new highs, although the FTSE 100 struggled.
World equities (represented by the MCSI AC World Index) grew by 2.1% in local currency terms in September, but a strong sterling meant this showed up as a -2.1% loss for sterling-based investors.
Hints from the Bank of England that it may soon raise interest rates boosted sterling and led to a sell-off in gilts, which fell -2.7%, giving back all the gains made over 2017. Gold rose slightly in response to ongoing geopolitical tensions over North Korea’s nuclear programme, but financial markets were largely unmoved by the sabre rattling.
The UK Consumer Price Index saw a surprise rise from 2.6% in July to 2.9% in August, with higher prices for clothing and household equipment contributing to the increase. With wages growth still sluggish, the squeeze on consumers represents a potential headwind for the UK economy. Consumer sentiment and spending remain buoyant for the time being, but at Coutts we have focused our UK equity holdings on quality companies with global customer bases that are less vulnerable to any potential domestic slowdown.
At its September meeting, the Federal Reserve (Fed) announced it would begin the process of unwinding the $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities it has accumulated since the global financial crisis. Fed President Janet Yellen pointed to the strengthening labour market and increasing economic activity as support for a gradual retreat from quantitative easing. The reference rate was left unchanged, but Yellen indicated that a rise before the end of the year was still a distinct possibility.
Similarly, the European Central Bank (ECB) signalled that it was ready to start gradually winding down its own stimulus programme. Despite continuing low inflation, ongoing economic growth across the eurozone supported a tightening of policy, although ECB chief Mario Draghi pushed any specific decisions out to October.
As widely expected, Angela Merkel won a fourth term as Chancellor of Germany, but the election saw higher than expected support for the far-right AfD. Meanwhile, in France, thousands marched against President Macron’s proposed labour reforms. Political risk in Europe has retreated substantially since the French election earlier in the year, although the Italian election, scheduled for some time in Q1 2018, may see further disruption.
Prime Minister Shinzo Abe announced a snap election in Japan to be held this month. Polls suggest he will return to office, but whatever the outcome we believe the economic reforms of the last few years will continue to stimulate the country’s economy.
Performance (%tr*, local) As of 30-Sep-17 Current -1M -3M YTD 16 Developed Equity (MSCI) 1,511 2.4 4.1 13.0 9.6 FTSE All Share 4,050 -0.4 2.1 7.8 16.8 FTSE 100 7,373 -0.7 1.8 6.6 19.1 S&P 500 2,519 2.1 4.5 14.2 12.0 Nasdaq Composite 6,496 1.1 6.1 21.7 8.9 DJ EuroStoxx 389 4.5 4.6 14.1 5.0 Nikkei 225 20,356 4.3 2.3 8.3 2.4 Hang Seng 27,554 -1.2 8.6 29.8 4.3 Emerging Equity (MSCI) 57,793 0.5 7.7 23.9 10.1 BRIC (MSCI) 655.1 1.2 13.2 31.4 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 Nov Jan Next Date United States 1.9 1.25 1.25 1.50 01-Nov United Kingdom 2.9 0.25 0.50 0.50 02-Nov Eurozone 1.5 0.00 0.00 0.00 26-Oct Japan 0.6 -0.10 -0.10 -0.10 30-Oct Performance (%tr, local) As of: 30-Sep-17 10-Year Yield* -1M -3M YTD 16 US Treasury index 2.33 -1.0 -0.2 0.6 -1.4 UK gilts index 1.40 -3.1 -0.9 -2.6 7.9 Eurozone govt bond index 0.46 -1.9 0.1 2.8 -1.4 US investment grade index 3.16 -0.6 0.2 1.7 1.8 US high yield index 5.45 0.4 0.3 2.1 12.0 Emerging market index 5.39 5.41 0.6 7.2 9.4 Source: Barclays indices; Datastream
*current yield on benchmark 10-year Treasury, gilt and bund respectively
Performance (%, Dollar) As Of: 30-Sep-17 Current -1M -3M YTD 16 Commodity Index (TR) 171.2 -0.1 2.5 -2.9 11.8 Brent Oil Price (spot) 57.0 8.2 21.1 3.3 51.6 Gold Bullion (spot, per ounce) 1284 -2.5 3.3 10.9 9.0 Industrial metals (TR) 255.4 -3.8 9.9 16.8 19.9 Source: Datastream
Has the US economy peaked?
It is more than 10 years since the start of the global financial crisis. The US government and Federal Reserve (Fed) reacted swiftly and decisively to pull the economy out of recession, which is now nine years into recovery. It is one of the longest expansion periods in US economic history.
The US has been ahead of the rest of the world in the current economic cycle and the past two years have been particularly strong. One of the most closely watched measures of activity is the manufacturing purchasing managers index (PMI), which is now approaching a relative high.
These recent figures could suggest the cycle is about to turn. Any slow-down is likely to be gradual, however, and more importantly we see no signs of the US economy falling into recession. Inflation remains low and, although unemployment continues to fall, wage pressures have not begun to build.
In recent months we have been taking profits from some of the ‘risk assets’ that have performed well, including emerging market equities and high yield bonds. We have taken this money and added to more traditionally defensive sectors – specifically healthcare and investment grade bonds – that have the potential to do well should US growth begin to moderate.
In our Coutts Global 30 portfolio of direct equity investments we have reduced exposure to the energy and consumer staples sectors while increasing allocations to consumer discretionary and technology companies. These industries have demonstrated they can continue to generate profit growth regardless of the economic outlook.
In the meantime, the Federal Reserve has recently announced that it will begin to unwind the $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities that it has accumulated since the financial crisis. Policymakers have increased interest rates twice this year and could hike again in the autumn. These are not the actions of a central bank that believes its economy is in trouble and shows that our faith in US growth is shared by the Fed.
Should the heart rule the head?
Many private investors seeking to diversify their portfolios look beyond shares and bonds to art and other passion investments, including fine wine, luxury properties, classic cars and even rare musical instruments. To help guide their thinking, we compile the Coutts Index, which captures investment returns from these markets.
Since 2005 our index has risen by 77%. This is only slightly lower than the returns from global equities over the same period but higher than government bonds. Some sectors have done better than others. For example, the ‘classic cars’ category has been one of the best performers, rising by more than 330% during this time.
Although the performance of passion assets tends to be negatively correlated with equity and fixed income markets, they can be volatile. In the Coutts Index, Coins is the only category to have increased every year since 2005. On the other hand, Fine Wine rose by 50.4% in 2007, then 12.1% in 2008; in 2009 it fell by 9.8%. After rising by 32.7% and 22% in 2010 and 2011, it has fallen every year since.
Have wine investors done well? It depends very much on when – and presumably what – they bought. But that kind of volatility suggests that sentiment plays a significant factor in returns. Unlike traditional financial markets, there is much less in the way of economic and financial data behind performance.
Also worth considering is that these markets can be illiquid – it can be hard to sell when you need to, and you may not be able to get the price you want when you do. In this regard, traditional equities and bonds provide a more dependable way to manage your money than passion assets.
The key point about these assets is passion - financial performance is only one part. The pleasure that collectors take from owning and sharing beautiful items is just as important, indeed perhaps more so.
When compiling the Coutts Index, we ask collectors and owners of extraordinary things what drives them and what advice they might give to others. Their stories reveal that the motivation to buy often comes from an emotional connection through the appreciation of fine design and a sense of history, which inspires their enthusiasm. An element of fun also plays a part – fine wine can rise in value but is also something to be enjoyed with family and friends.
We encourage our clients to invest in passion assets that they like and which reflect their interests. Any collection should be founded on the pleasure you obtain from owning passion investments. Use your head when you are planning for your future; but when indulging your passions, invest with your heart and you should never be disappointed.
Coutts House View
US - UK - Europe + Japan + Emerging Markets -
The outlook for the global economy and global equities continues to be 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 80% 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 to 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 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.
About Coutts investments
With unstinting focus on client objectives and capital preservation, Coutts Investments provide high-touch investment expertise that centres on diversified solutions and a service-led approach to portfolio management. Our investment process is as disciplined as it is creative – ensuring tailored solutions with robust results.Discover more about Coutts investments