Quarterly Investment Update Q2 2018
Markets continued to be more volatile than the benign conditions seen in 2017, but we see a strong global economy creating opportunities for attentive investors.
3 min read
Volatility remained high in the second quarter, reflecting the return to more normal market conditions after last year’s unusually benign markets. This proved to be a challenging environment for investors.
At Coutts, we have been focusing on preserving client wealth while keeping our eyes open for investment opportunities. We see a global economy that’s in good shape, which should be positive for equities despite some signs of weaker growth outside of the US. Global trade remains a concern, but we believe the business-friendly administrations of the US and China are motivated to arrive at pragmatic outcomes.
In amongst the noise around trade, political instability in Europe and a particularly fractious G7 conference, there were some points worth noting.
Tech stocks bounce back
Tech stocks experienced falls at the end of Q1 as companies came under scrutiny for the way they use user data and the potential for regulation threatened current business models. However, this didn’t deter investors in Q2 with the sector retaining its place as the strongest performer so far this year. The tech-heavy Nasdaq index reached a record high at the start of June as US technology giants announced strong earnings and increased business spending.
While we may see further short term ups and downs, we continue to like the sector and it remains a core investment theme that we believe will help build on the strong investment performance we’ve delivered for clients this year.
A parting of ways
Earlier in the year we reduced holdings in emerging markets in favour of developed markets, dominated by the US. This has allowed us to capture the continued strength of the US market and reduce the impact from falls seen in emerging market equity, which has suffered this quarter as a result of the strengthening dollar.
The strength of the dollar highlights a divergence we have seen this half year in growth trends and central bank policy across the major developed economies, pointing to an end to synchronised global growth. While the US has maintained its strong growth level, the rest of the world is showing signs of slowing, and central banks are taking a far more cautious approach to tightening than the US Federal Reserve (Fed).
The Fed increased its key interest rate by 0.25% to 2% in June. Having now raised rates twice already this year, the Fed suggested two more hikes are likely with economic growth “solid” and the labour market strengthening. Inflation is expected to surpass its target rate of 2% next year, wage growth and employment remain strong, and tax cuts are providing a stimulus that is supporting stronger growth.
The Bank of England (BoE), meanwhile, kept rates at 0.5% over the quarter despite markets having priced-in a rise with a 90% certainty earlier in the year. Certainty began to falter at the beginning of the quarter when data published by the Office for National Statistics indicated a weaker outlook than expected. This included the latest GDP growth figures which remained at 0.1% for the first quarter of 2018 – the slowest rate since 2012 – while inflation surprised on the weak side in March and April.
Europe is also showing signs of slower economic growth – official figures revealed that economic growth slowed to 0.4% in the first quarter of 2018 compared with 0.7% the previous quarter. While the European Central Bank (ECB) kept interest rates on hold, it was clear they remained confident in the economy overall by indicating they will start the first steps towards monetary tightening later this year.
Sterling saw a steady weakening against all major currencies over the quarter, as the likelihood of a rise in interest rates any time soon diminished. Having reached a high of $1.40 in early March, it was stuck around the $1.32 level by the end of June.
This was good news for UK companies doing business overseas as it boosted earnings. We have recently increased our exposure to the FTSE 100, which is dominated by internationally focused companies, as we believe it offers value and attractive dividend yields.
Following the rise in yields over the past couple of years, we also took some profit by increasing the duration of our allocation to UK gilts.
Overall, the MSCI World Index returned 2.7% over the second quarter of 2018, translating to a gain of 6.8% for UK sterling investors thanks to a weaker pound. In the meantime, gilts remained more or less flat with yields rising by 9 basis points and returns of around 0.2%.
Markets remained volatile in the second quarter, reflecting the return to more normal market conditions after last year’s unusually benign conditions. Tech stocks have continued to provide strong returns despite the controversies of Q1, while a weaker sterling has helped to drive returns from our FTSE 100 holdings. At Coutts, we have been focusing on preserving client wealth while keeping our eyes open for investment opportunities.
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