Monthly Investment Perspective
This month saw further record highs for equities and Bitcoin dominating investment headlines
6 min read
Markets ended 2017 on a high, with the S&P 500 and FTSE 100 both hitting record levels as the synchronised global growth that has characterised the last 12 months continued.
By the end of the month, world equities - as measured by the MSCI AC World Index - climbed by 1.3% (in local currency terms). Meanwhile, 10-year UK government bonds gained 1.6% by the end of the month. By the end of the year, world equities had risen by 19.8% while UK government bonds had returned 2.0%.
With deadlines looming for phase one of negotiations to come to an end, Prime Minister Theresa May struck a last-minute deal with the European Union (EU) to move Brexit talks on to the second phase, providing a modest boost to sterling. According to the deal, there will be no hard border with Ireland, and the rights of EU citizens in the UK and UK citizens in the EU will be protected.
The Bank of England (BoE) kept interest rates on hold at 0.5% in its December meeting, but stated that the reduced risk of a “no deal” Brexit could boost confidence in the UK economy in the coming months. The Consumer Price Index rose to 3.1% in November – its highest level in nearly six years – but the BoE maintained that inflationary pressures would decline in 2018.
The European Central Bank (ECB) has upgraded its economic growth forecast for the eurozone from 2.2% to 2.4% in 2017 as the region continues to recover. Policymakers kept interest rates on hold and confirmed that the asset purchase programme would drop from €60bn to €30bn a month at the start of 2018 until at least September. The eurozone Purchasing Managers’ Index (a measure of European economic health) reached 58 in December, up from 57.5 in November and its highest since February 2011, exceeding many economists’ expectations.
In December 2017, the US Federal Reserve raised the reference rate by 25 basis points to 1.5%, the third rate rise of the year. The central bank said the increase was due to “solid” gains in the economy and boosted its GDP growth forecasts to 2.5% in 2017 and 2018. Fed officials forecast unemployment will drop to 4.1% in 2017 and 3.9% in 2018.
Republicans have agreed to a deal that will see the biggest overhaul of the US tax system in 30 years, marking a major policy victory for President Trump. The changes include tax cuts for corporations and middle-income earners and are expected to provide a modest boost to US growth in 2018.
The digital currency Bitcoin dominated headlines as it hit US$20,000 in December, before plummeting again to US$16,000. Since the beginning of the year it has risen in value by a staggering 1,400%, despite many mainstream commentators seeing it as a speculative bubble.
This has fuelled wider concerns about the tech sector, one of the standout performers of the year. Having risen by about 35% in dollar terms in the year to December, almost double the return of US equities generally, there was speculation that a correction is imminent, with Bitcoin’s meteoric rise a symptom of investor over-enthusiasm.
The tech-dominated Nasdaq did see some profit-taking in December, but we see this as a healthy pause rather than the start of a rout. There is still value to be found in the technology sector and strong results in Q3 support the case for continued growth for now.
Performance (%tr*, local) As of: 31-Dec-17 Current -1M -3M YTD 16 Developed Equity (MSCI) 1,586.2 1.1 5.4 19.1 9.6 FTSE All Share 4,222 4.8 5.0 13.1 16.8 FTSE 100 7,688 5.0 5.0 12.0 19.1 S&P 500 2,674 1.1 6.6 21.8 12.0 Nasdaq Composite 6,903 0.5 6.6 29.6 8.9 DJ EuroStoxx 385.5 -1.0 -0.6 13.4 5.0 Nikkei 225 22,765 0.3 12.0 21.3 2.4 Hang Seng 29,919 2.6 8.8 41.3 4.3 Emerging Equity (MSCI) 60,879 2.6 5.7 31.0 10.1 BRIC (MSCI) 699.1 2.9 7.0 40.6 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 March June Next Date United States 2.2 1.50 1.50 1.50 31-Jan United Kingdom 3.1 0.50 0.50 0.50 08-Feb Eurozone 1.5 0.00 0.00 0.00 25-Jan Japan 0.5 -0.10 -0.10 -0.10 30-Jan Performance (%tr, local)
As of 31-Dec-17 10-year yield*
2016 US Treasury index 2.41 0.1 -0.5 0.1 -1.4 UK gilts index 1.23 1.3 1.1 -1.5 7.9 Eurozone govt bond index 0.42 0.5 -0.5 2.3 -1.4 US investment grade index 3.25 0.6 0.0 1.6 1.8 US high yield index 5.72 -0.1 -0.9 1.1 12.0 Emerging market index 4.49 -0.2 0.5 6.8 9.4 Source: Barclays indices; Datastream; *current yield on benchmark 10-year Treasury, gilt and bund respectively
Performance (%, Dollar) As Of: 31-Dec-17 Current -1M -3M YTD 16 Commodity index (TR) 180.0 3.0 4.7 1.7 11.8 Brent oil price (spot) 66.7 5.0 17.0 20.9 51.6 Gold bullion (spot, per ounce) 1303 1.9 1.5 12.6 9.0 Industrial metals (TR) 282.8 9.2 10.7 29.4 19.9 Source: Datastream
Portugal bounces back
We have held Portuguese sovereign debt in our multi-asset funds for some time owing to the country’s economic recovery and the additional yields on offer compared with other European government bonds. We believe the potential returns continue to look attractive.
Portugal was one of the worst-affected economies during the eurozone’s sovereign debt crisis. In 2012, the major credit ratings agencies downgraded its government bonds to junk status after the country was forced to negotiate a €78bn bailout with the European Union and International Monetary Fund.
Although the remaining traces of the crisis are still fading, conditions throughout the region have improved substantially. A recovery has taken hold in Portugal over the past two years as the government has taken measures to reduce unemployment, repair public finances and bolster its banking sector.
In acknowledgement of the cyclical recovery, strong labour market performance and improved short-term outlook, S&P returned Portugal’s credit rating to investment grade in September 2017, and Fitch followed suit in December. From a high of above 16% at the height of the crisis, yields on Portuguese 10-year debt have fallen below 1.8%.
Portugal is benefiting not only from the recent credit ratings upgrade and its own economic recovery, but also from the fall in government bond yields across Europe. Political risks have mostly receded throughout the region over the past 12 months and a broad-based recovery is under way.
The yield on Portugal’s bonds has now fallen below that of Italy, which has seen its sovereign debt face pressure over growing political noise. Italy’s 10-year yield rose above 1.8% following the news that elections are to be held on 4 March 2018. This change of relative fortunes is emblematic of Portugal’s return to favour and the opportunity for investors.
Energy sector ready to flare up
The energy sector is an area of the UK market where we believe there may be an improvement in sentiment and, in turn, price momentum. Energy is likely to be an important theme for equity investors in 2018 following a period of stable oil prices, improving fundamental factors and attractive valuations.
Following the plunge in oil prices at the end of 2014, the energy industry has been through a period of restructuring. Oil companies have focused on high-grading (drilling the most productive and profitable wells), driving through operating efficiencies and enforcing capital discipline. As a result, companies are reporting improved performance.
Oil prices increased over the second half of 2017, with Brent crude trading consistently above $60 a barrel in November and December. They are likely to remain steady following OPEC’s agreement to extend its production cut to the end of 2018. Yet the share prices of the oil majors have lagged this recovery, and we believe valuations are attractive.
Energy companies offer the additional benefit of relatively high dividend yields. Reflecting renewed confidence about their financial positions and cash flow outlook, BP and Shell have announced they are cancelling their austerity dividend policies. Both companies introduced scrip schemes in early 2015 following the sharp drop in oil prices, through which investors could opt to receive dividends in shares or cash.
As well as increasing our allocation to equities in the energy sector, our portfolios are exposed to commodities in other ways, such as through master limited partnerships (MLPs) – US companies that own oil and gas pipelines. These firms make money by renting their infrastructure to energy producers, and have provided an attractive dividend yield even during times of market stress.
We also have broad exposure to Russia’s stock market, where energy is the dominant sector and drives the country’s economy. In addition, our investments in emerging market debt and equities tend to be closely correlated to the performance of global oil and gas prices.
Coutts House View
US - UK - Europe + Japan + Emerging Markets -
The outlook for the global economy and global equities remains positive. Within international equities, we continue to favour Europe and Japan because of 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 hiked the US reference rate three times in 2017 and indicated the possibility of further rises in 2018 depending on economic data. In the UK, we believe rates will remain low for some time, despite the reversal of the emergency EU referendum rate cut in November. 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 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 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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