Monthly Investment Perspective
Bright economic outlook maintains benign markets
6 min read
The outlook for the global economy continues to be positive. As a result, markets were benign in August in spite of short volatility spikes that occurred due to geopolitical events.
The MSCI AC World Index stayed fairly flat in local currency terms, rising 0.4%, while a weaker sterling saw it rise 2.7% in sterling terms. UK gilts returned 2.1% in the month.
Bank of England governor Mark Carney cited Brexit uncertainty as one of the key reasons behind the squeeze on UK household incomes and consumer spending as prices continued to rise faster than wages.
The central bank downgraded the country’s growth forecast from 1.9% to 1.7% for 2017 in its quarterly inflation report and held interest rates at 0.25%. Meanwhile the Consumer Price Index came in at 2.6% – lower than the expected 2.9% – and sterling hit an eight-year low against the strengthening euro.
The eurozone’s recovery continues to gather pace, with the bloc’s economy expanding by 2.2% year-on-year in the second quarter – its fastest rate of growth since 2011. The euro has surged, rising almost 5% against a basket of currencies since the middle of May.
A strong euro creates a problem for the ECB though, as it looks to start trimming back its €2trn quantitative easing programme. It could also complicate the bank’s efforts to hit its inflation goal of just under 2% by making imports cheaper and exports less attractive outside the region.
US economic growth remains solid, expanding at an annualised rate of 3% in the second quarter as consumer spending increased. This marked its strongest growth in more than two years.
Despite some Federal Reserve policymakers voicing concerns over weak inflation, most commentators expect an announcement on balance sheet normalisation at the Fed’s September meeting and a third rate increase this year in December. Meanwhile, the dollar has fallen by more than 9% this year as uncertainty around the Trump administration persists.
Although the outlook for the global economy is brightening, there remain potential risks. President Trump has yet to provide clarity on his fiscal and trade policies, while his recent move to impose sanctions on firms with alleged links to North Korea has increased tensions between the US and China. Also, elections are approaching in Germany, although all current indications are that Angela Merkel will remain chancellor, and Brexit negotiations are ongoing.
Performance (%tr*, local) As of 31-Aug-17 Current -1M -3M YTD 16 Developed Equity (MSCI) 1,479.6 0.2 1.7 10.4 9.6 FTSE All Share 4,073 1.4 0.0 8.2 16.8 FTSE 100 7,431 1.6 0.0 7.3 19.1 S&P 500 2,472 0.3 3.0 11.9 12.0 Nasdaq Composite 6,429 1.4 4.0 20.3 8.9 DJ EuroStoxx 372.4 -0.4 -2.5 9.1 5.0 Nikkei 225 19,646 -1.3 0.2 3.8 2.4 Hang Seng 27,970 3.1 11.5 31.3 4.3 Emerging Equity (MSCI) 57,625 2.1 9.1 23.3 10.1 BRIC (MSCI) 648.1 3.8 13.4 29.8 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 June Sept Next Date United States 2.4 1.25 1.00 1.25 14-Jun United Kingdom 2.3 0.25 0.25 0.25 11-May Eurozone 1.9 0.00 0.00 0.00 08-Jun Japan 0.2 -0.10 -0.10 -0.10 15-Jun Performance (%tr, local) As of: 31-Aug-17 10-Year Yield* -1M -3M YTD 16 US Treasury index 2.12 0.9 0.5 1.7 -1.4 UK gilts index 1.08 1.7 -0.3 0.5 7.9 Eurozone govt bond index 0.29 1.3 1.0 4.8 -1.4 US investment grade index 3.07 0.4 0.7 2.2 1.8 US high yield index 5.61 -0.7 -0.5 1.6 12.0 Emerging market index 5.39 3.6 3.9 5.6 9.4 Source: Barclays indices; Datastream
*current yield on benchmark 10-year Treasury, gilt and bund respectively
Performance (%, Dollar) As Of: 31-Aug-17 Current -1M -3M YTD 16 Commodity Index (TR) 172.1 0.4 2.5 -2.7 11.8 Brent Oil Price (spot) 52.7 1.4 6.7 -4.6 51.6 Gold Bullion (spot, per ounce) 1316 3.7 3.8 13.7 9.0 Industrial metals (TR) 265.4 9.6 18.0 21.4 19.9 Source: Datastream
Japan's GDP Surprise
Ahead of market expectations, Japan’s economy grew by 1% in the second quarter compared with the first three months of 2017. It has now expanded in six consecutive quarters, which is the first such streak in more than three years.
The pace of growth was boosted by strong consumer spending which increased at its fastest rate since the country’s sales tax was raised in 2014.
Prime minister Shinzo Abe’s campaign to lift the economy out of decades-long stagnation through the "three arrows" of monetary easing, fiscal stimulus and structural reforms, or Abenomics as it has become known, has been struggling. Notably, political restraints have made the third arrow – reforms to Japan’s inefficient agriculture, healthcare and labour markets – hard to fire.
Yet following years of falling prices and a declining population, recent figures show economic activity rebounding. In addition to the long-awaited bounce in domestic demand, aggressive monetary easing to generate inflation has contributed to a weaker yen, which is supporting Japan’s exporting companies.
Japan’s government believes the country is on course to match a 57-month expansion in the late 1960s, which is the second-longest stretch in the post-war period. Analysts also expect the economy to continue growing at a healthy pace, and that a tight labour market will boost wages and support consumer spending.
Japan’s leading stock market index, the Nikkei 225, has been rising steadily since the middle of 2016.
Most recently, markets have become unsettled after North Korea fired a missile at the end of August that flew over Japan’s northern Hokkaido island before falling into the Pacific Ocean.
Although the situation over North Korea is a concern, we believe the long-term investment case for Japan remains intact.
Across various measures of value, Japanese equities look attractive compared with other developed regions. As home to many leading businesses, Japan continues to offer opportunities as part of a diversified portfolio.
The fork in the road for sterling and the euro
As anyone who has been on holiday to the Continent over the summer will know, the pound continues to fall in value against the euro.
Sterling recently hit an eight-year low of €1.08, having been at around €1.25 just before last year’s Brexit vote. Some predict parity by the end of the year, which would be the first time the currencies are worth the same in the euro’s 18-year history.
If the value of a country’s currency is a measure of confidence in its economic outlook, markets remain unsure about the UK’s prospects as the Brexit negotiations unfold. Although inflation is above its 2% target, the Bank of England appears unlikely to raise interest rates any time soon.
In contrast, the euro’s strength is being fuelled by the region’s improving economy. It grew at an annualised rate of 2.2% in the second quarter following a rebound in confidence and a boom in manufacturing. Notably, the region’s unemployment rate fell to an average of 9.1% – the lowest since February 2009.
So far this year, the European Central Bank has left its key interest rate unchanged and expressed concern that tighter monetary policy could endanger the eurozone’s recovery. The bank is expected to make an announcement on its plans for its bond-buying programme later this year.
We believe monetary tightening is already priced in to European stock markets and expect further positive returns. Although a strong euro should be tough for Europe’s exporters, recent purchasing manager surveys suggest they are coping well.
At Coutts, a typical Balanced portfolio has 6.5% exposure to European equities, which is our biggest relative overweight.
Meanwhile, sterling’s collapse following last year’s EU referendum has boosted the foreign earnings of large companies in the FTSE 100 and driven the index’s rally. UK markets appear unfazed by higher inflation and weakening consumer demand, which are the other side effects of a weaker currency.
Although a strong euro is bad news for holidaymakers, it could further boost returns for sterling-based portfolios.
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 compared to other major markets. We see both as offering superior earnings growth potential supported by an improving manufacturing sector.
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 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 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.
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 Bank of England Governor Mark Carney has raised the possibility of the emergency EU referendum rate cut being reversed.
Within bonds, we prefer credit over governments, 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 + 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 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