Quarterly investment update Q1 2018
We continue to look beyond short-term volatility as stock markets experience a sharp sell-off and Trump announces trade tariffs
4 min read
The first quarter of 2018 saw volatility return to markets after a prolonged period of stable growth.
The market moves saw world equities fall by -1.9% over the quarter - based on the MSCI AC World Index. A stronger pound – and weaker US dollar – meant that this was -4.5% for sterling-based investors. Government bonds were generally flat over the quarter providing some cushion against falling equities.
Volatility continued in March as the prospect of a trade war, prompted by Donald Trump’s tariffs on steel and aluminium imports, sent US markets lower. We believe the risk from tariffs to the global economy is relatively low. Negotiations between the US and China continue and while it is clearly negative for sentiment, the impact on corporate earnings generally looks small so far.
Looking beyond short-term noise
Despite the current choppy markets, we remain positive on equities. While volatility – as measured by the VIX index – remains higher than the low levels seen in the second half of 2017, it has settled into a range that’s generally in line with its historical average. We continue to see global equities supported by a healthy corporate sector and global economy, with the International Monetary Fund forecasting growth to reach 3.9% in 2018 and 2019.
We maintain our preference for European and Japanese equities. Both regions offer more attractive valuations than the US and are backed by strengthening economies and supportive central banks.
Elsewhere, we have taken profit on our exposure to emerging market equity. We believe this area of the market remains vulnerable to a stronger US dollar, a Chinese slowdown and any trade war escalation. We have instead increased our allocation to developed market equities, maintaining our overall equity exposure while reducing the risk profile slightly.
Revelations about the lack of security and extent of user data held by Facebook hit the headlines in March leading many of the leading tech stocks – Facebook, Amazon, Netflix and Google, known as the FANGs – to sell off. This has led the tech sector to fall, further contributing to overall market drops in the quarter.
We see the tech sector as more diverse than just these companies. While we have some exposure to the FANGs, we favour companies producing microchips, software and tools that support the industry. Technology is one of our long-term investment themes, supported by the steady rise of the role technology plays in our everyday lives.
Great (interest rate) expectations
Inflation expectations remain high in the US following strong jobs data and Trump’s tariff announcement. The US Consumer Price Index (CPI) rose by 0.2% in February after jumping 0.5% in January. In line with expectations, the US Federal Reserve raised interest rates by 0.25% to a target range of 1.5% to 1.75% in March. The rise was the first of 2018, with policymakers signalling that a further two increases are likely this year.
In the current climate of rising inflation and interest rates, we are maintaining an underweight allocation to government bonds. We have also sold our allocation to global high-yield bonds, as spreads with investment grade bonds have narrowed and we see limited potential for gains for the time being.
Britain holding steady
Michel Barnier and David Davis announced that progress had been made on an agreement for the “orderly withdrawal” of the UK from the EU. Sterling strengthened on the news – and the promise of a Bank of England base rate rise in Q2.
This has helped our portfolios where we added sterling exposure after the result of the EU referendum in 2016. We expect further strengthening as the Bank of England makes its position on interest rates clearer and Brexit uncertainty resolves itself as the deadline approaches.
Despite ongoing Brexit negotiations, UK Chancellor Philip Hammond presented upgraded growth projections for the country of 1.5% in 2018 (compared with November’s figure of 1.4%) in his Spring Statement. While this growth is weaker than that of the UK’s trading partners, global growth continues to support the UK economy and should prove beneficial for UK equities according to our analysis.
We added to our holdings in the FTSE 100 opportunistically in February when prices fell and, later in the quarter, sold our position in UK real estate investment trusts (REITs) to buy into the FTSE 100. UK REITs have been lagging the UK equity market for some time and we believe the sector may struggle in a reflationary environment, or if global growth cools off. Brexit uncertainty is also acting as a break on the sector.
Despite market falls in the first quarter of the year and volatility increasing, albeit to more normal levels, we remain positive on equities. We see continued global growth and supportive central banks, even as tightening continues in the US and looks set to start in the UK. Against this, we believe the current tariff talks are unlikely to escalate to a full-blown trade war and Facebook’s travails won’t upset the tech sector’s long-term prospects.
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