Monthly Update | Why May puts spring in investors’ steps
Our investment update for May explains why the case for investing remains strong, despite geopolitical arguments and unpredictable UK inflation, both causing minor turbulence.
4 min read
Despite the rise in volatility this year compared to 2017, we see an economic environment that remains positive for equities as the global economy continues to grow.
While there are signs that growth may be peaking in some economies, expectations for 2018 are generally positive. The International Monetary Fund (IMF) has forecast global economic expansion of 3.9% in 2018, led by the US where corporate tax cuts have provided extra stimulus to the already strong growth. There is expansion in China (forecast at 6.5% for 2018 by the Chinese authorities) and the eurozone also continues to show positive momentum, with an IMF growth forecast of 2.4% for the year ahead.
However, in April fear of a trade war and geopolitical concerns around events in Syria, acted as a brake on investor sentiment. Overall, the MSCI World Index returned 1.9% over April, translating to a gain of 2.8% for sterling-based investors as the fall in the pound in the second half of the month boosted returns from non-sterling assets. We saw 10 year Gilt yields rise by 10 basis points, meaning prices fell (because rising yields reflect falling gilt prices) as investors continued to favour equities over the poor returns offered by government bonds.
Trade remained front-of-mind for investors as the US government announced additional tariffs on China’s imports. Chinese President Xi Jinping, however, reiterated his commitment to free trade in a conciliatory speech later in the month. This supports our view that a serious trade war is unlikely and the tariffs introduced so far won’t cause major disruption.
Investors remained relatively calm as US-led strikes on Syria did not appear to escalate conflict in the Middle East. Following the military action, bond prices fell (and yields increased), while the price of Brent crude, the international oil gauge, fell 1.5% after previously reaching its highest level since 2014, as the potential for a wider conflict decreased and investor confidence recovered.
Russia’s support of the Assad government in Syria combined with US sanctions, souring investor sentiment on the country and Russian equities fell by over 30% early in the month. Although we have some direct exposure to Russia, our stock-picking approach – focused on firms with strong corporate governance, stable cashflow and low debt – means we have avoided companies affected by the sanctions, and therefore the worst of the fall. Political risk is a factor in any emerging market investment and we believe Russia continues to offer contrarian value, in line with our investment principles.
Inflation remains solid despite UK surprise
The UK Consumer Price Index (CPI) fell unexpectedly, from 2.7% in February to 2.5% in March – most commentators had expected it to remain unchanged. We believe that UK inflation will stabilise somewhere close to the Bank of England’s (BoE’s) 2% target later in the year and is unlikely to return to the low levels seen in 2015 and early 2016.
We see inflationary pressures persisting around the world and expect central banks to continue their gradual tightening of monetary policy. Eurozone consumer prices rose by 1.3% year-on-year in March, up from 1.1% in February, while US core inflation remains above the Federal Reserve’s 2% target.
Against this backdrop, we sold our small position in US oil pipeline Master Limited Partnerships, as rising interest rates have made yields less attractive. In the meantime, we are holding the proceeds as cash, giving us the opportunity to be nimble when alternative investment opportunities present themselves in volatile periods.
A sterling effort
Having increased our exposure to sterling in 2016, continued sterling strength since the start of the year has been positive for our funds and portfolios. However, after reaching its highest level against the dollar since the UK’s vote to leave the European Union in April, the surprise fall in inflation and subsequent comments by BoE governor Mark Carney throwing doubt on a potential rate rise in May put a dent in the upward trend. Sterling remains positive over the year to date and substantially higher than the 2016 lows, and we believe that the long-term trend will continue to see it rise against other currencies.
Recent sterling weakness provided a boost for the FTSE 100 in April – up by more than 6% over the month – but a stronger pound and ongoing Brexit uncertainty have suppressed FTSE 100 returns over the year to date as the index is dominated by multinational companies whose earnings come from abroad. We continue to see attractive dividend yields, and the falls earlier in the year led us to add exposure opportunistically in February and March.
Performance (%tr*, local) As of: 30-Apr-18 Current -1M -3M YTD 2017 Developed Equity (MSCI) 1,570.8 2.0 -3.8 19.0 9.6 FTSE All Share 4,128 6.4 1.1 12.1 16.8 FTSE 100 7,509 6.8 1.1 11.0 19.1 S&P 500 2,648 0.4 -5.8 21.4 12.0 Nasdaq Composite 7,066 0.1 -4.4 33.1 8.9 DJ EuroStoxx 390.4 5.1 -0.9 16.0 5.0 Nikkei 225 22,468 4.7 -1.9 20.7 2.4 Hang Seng 30,808 2.5 -5.9 46.2 4.3 Emerging Equity (MSCI) 61,751 1.2 -4.5 33.6 10.1 BRIC (MSCI) 725.1 1.2 -5.9 46.3 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 August October Next Date United States 2.4 1.75 2.00 2.25 13-Jun United Kingdom 2.5 0.50 0.50 0.75 10-May Eurozone 1.3 0.00 0.00 0.00 14-Jun Japan 1.1 -0.10 -0.10 -0.10 10-May Performance (%tr, local)
As of 30-Apr-18 10-year yield*
2017 US Treasury index 2.94 -1.0 -1.1 -2.6 -1.4 UK gilts index 1.45 -1.4 0.8 -3.2 7.9 Eurozone govt bond index 0.56 -1.6 -4.8 -3.2 -1.4 US investment grade index 3.92 -1.3 -3.3 -3.0 1.8 US high yield index 6.26 0.1 -2.1 -1.0 12.0 Emerging market index 5.40 -1.1 -2.0 2.1 9.4 Source: Barclays indices; Datastream; *current yield on benchmark 10-year Treasury, gilt and bund respectively Performance (%, Dollar) As Of:30-Apr-18 Current -1M -3M YTD 16 Commodity index (TR) 183.9 2.6 0.2 3.9 11.8 Brent oil price (spot) 75.9 10.0 12.0 37.5 51.6 Gold bullion (spot, per ounce) 1313 -0.8 -2.1 13.5 9.0 Industrial metals (TR) 274.5 3.5 -3.1 25.6 19.9 Source: Datastream
Coutts House View
US - UK + Europe + Japan + Emerging Markets -
We have maintained our modest preference for equities over bonds. Despite some evidence of a slowdown in economic growth – particularly in Europe – equities are supported by strong corporate earnings, a low risk of recession and inflation pressure in the US.
Within international equities, we continue to favour Europe and Japan because of attractive valuations. Recent falls in the value of the euro and yen brighten the outlook for exporters and increase the value of international earnings. With most of the euro strength probably behind us, future earnings should benefit from the currency weakening.
We have an overall positive position in UK equity, which we believe will continue to be supported by the global economy and offers an attractive dividend yield. While the UK has suffered in recent months, we believe the long-term picture is positive. Our main exposure is to the FTSE 100, which is benefitting from falls in the value of the pound, which in turn increases the value of international earnings. Higher commodity prices are also supporting the index’s energy sector bias. In addition, falling inflation will help the purchasing power of UK consumers, which has been under pressure in the last year.
Government - Investment Grade - High Yield + Emerging Market Debt +
Our general view of bonds is that they have less potential for long-term gains than equities. Although bonds have attractive diversification qualities, we remain cautious on government bonds for now. We believe long-term returns could be poor and vulnerable to rising interest rates as long as inflation expectations are picking up in the US and Europe.
Within bonds, we prefer credit over government bonds and in particular continue to favour subordinated financial credit as a theme. We also like emerging market local currency debt because of attractive valuations and income.
Alternatives Equity Themes Commodities - Technology
+ Absolute Return + Banks + Property = Healthcare
We are underweight commodities, and in particular we see limited upside for gold in a rising interest rate environment. Positive economic activity and a weaker US dollar have boosted commodity prices in the first quarter of the year, but the upcoming increased supply and a recovery for the dollar may limit the upside from here.
Our view towards UK commercial property is neutral at this stage. Economic growth continues to be supportive and Brexit risks are discounted in the price, but it is hard to see the sector outperforming over the next 12 months.
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.
About Coutts investments
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