The impact of BREXIT is important because a vote to leave will create uncertainty in Europe which then could spread further afield
In this blog we highlight some key thoughts from the BlackRock Investment Conference which took place on 25 May 2016. These are the opinions of BlackRock and this is not an endorsement of what they have said.
In this part of the conference Rupert Harrison, Chief Macro Strategist, outlined some thoughts.
He started by explaining that in the first quarter of this year we saw net outflows for investments with only target absolute return funds seeing any real positive inflows. This reflects concerns which include BREXIT, US Election, European Recovery, Chinese Hard Landing, Terrorism, Success of Abenomics, Interest Rate Calls and the Refugee Crisis.
With this in mind the asset performance has almost been the polar opposite to 2015. Crude Oil, Gold and Government Bonds being the strongest performers with China, Dollar and Nasdaq being the weakest.
He feels that the downturn in manufacturing is bottoming out and we can expect slow growth. In the US manufacturing was hit by the strong dollar but the pulling back of the dollar has helped. The US has seen a much stronger recovery across the rest of the world and we have seen the end of QE, interest rates rise and near full employment. The biggest challenge over the next two years is going to be inflation and the rate of this will determine any impact on asset prices.
Globally equity returns have been driven by QE, and in the bond market we have $70 trillion of government bonds delivering negative rates. The challenge should not be underestimated.
As the dollar strengthened in 2015 it helped Europe and Japan. Conversely, this year as the dollar has weakened it has helped emerging market assets, currencies and commodities and the question is whether this can continue.
The Fed is aware of this and they don’t want to derail any global recovery by raising rates too fast so this is something to watch.
The impact of BREXIT is important because a vote to leave will create uncertainty in Europe which then could spread further afield. There are really two issues, economic risk and immigration. The real driver is the economic risk and this is what project fear is all about. The big swing to leaving Europe will be if there is a terrorist event in London in the days running up to the vote, and the failure of young people to vote as the evidence shows they are pro Europe.
It is clear that people are not investing in the UK and Europe and there is a chance of a rebound should there be a vote to stay. The tricky thing for the government is rebuilding the party after the vote and this will mean any legislation will be difficult to implement.
If we take BREXIT out of the equation then the UK is doing well, there is no wish to raise rates soon and there is really nothing obvious that would derail this recovery.
European Equities: Investing in a Low Growth World
In the next part of the conference we heard from Alister Hibbert who is a European Portfolio Manager.
He started by explaining that he feels that European equities are in a bull market but it is not a fun bull market! He believes returns over the long term are better than cash but Europe is just not exciting. Earnings have disappointed especially compared to the US and are effectively flat but there is an expectation that by 2017 things should start to get better. The challenge is that Europe doesn’t seem as good as the US. The US has the best technology companies and Europe just seems to have utilities and banks which are challenged!
But Alister argues despite the gloom there are some bright spots including Pandora and in healthcare with companies like Novo Nordisk and Actelion as well as European Transport Infrastructure like Atlantia and Eiffage.
Whether Alister is the right manager is for investors to decide but clearly his view is that there are opportunities in Europe but to exploit this you need to invest in companies which offer growth, visibility of earnings and / or restructuring opportunities.
Navigating Fixed Income Markets
Turning to Fixed Income Markets Ben Edwards is a lead Portfolio Manager. He opened by explaining that QE had inflated global asset prices. However, as we move to a normalised environment the argument is that fixed income will perform negatively.
Clearly Ben does not stand by this view. He explained that $7 trillion of government bonds are now providing negative yields and yet for example five year German Government Bonds have delivered 2.5% since 1 June 2015 to 30 April 2016. He believes that bonds can deliver positively even in a normalised environment and more importantly they can protect against increased volatility.
He did add that with any bonds and in particular bonds it is about choosing the right ones. He used an example of Barclays where there are 450 bonds in circulation and returns over 6 months varied between -13.3% and 25.2% so choosing the right one will reflect in the long term returns.
One interesting point to consider is whether the UK will move to negative yields. His argument is that inflation will remain low and that the estimation is that rates will rise no sooner than 2019 assuming that there are no shocks along the way. He feels this is highly unlikely and therefore we could see negative yields in the UK and this shouldn’t be discounted.
Generating Income in a “VUCA” world
The next discussion was with Mark Wharrier who manages the BlackRock UK Income Fund.
VUCA stands for volatile, uncertain, complex, ambiguous and he feels this is the environment we are in. There are many things to worry about and the volatility in the markets in the short term don’t tend to matter over the long term.
The focus is not to get distracted but see the volatility as opening up opportunities. The UK is a diverse market with only 25% having a domestic focus, the balance is global and there is always a bull market somewhere!
There are he feels opportunities in the UK market if you look a little deeper. To explain he highlighted earnings which appear to be poor but as he added if you take out resources earnings are modest especially in a low inflation world. We are also seeing strong wage growth again helped by low inflation.
Equities are fairly valued but not overvalued and yields are higher than from fixed income. Importantly although there have been high profile dividend cuts 80% of the FTSE 350 are increasing dividends. He also believes strongly in emerging markets and the opportunities which means companies like Unilever, IHG and BAT all have opportunities to grow.
Domestically he likes companies like Lloyds who have moved back to being a bank who do a few things well. It is focusing on returning value to shareholders through being a very simple bank. Dividends he expects to grow to 6 or 7% over the next few years.
On the flipside companies to avoid are the big utilities like Centrica and SSE where he sees balance sheet risk, falling dividends and no shareholder value.
Outlook for Asian Equities – normalising China
In this discussion with Jean-Marc Routier the main focus was on China.
Jean-Marc started by explaining the importance of the region with 60% of the global population come from this region. Since 2000 it has seen its share of global GDP grow from 10% to 26% and yet it is still just 8% of the Global World Index.
It is also an unloved region with its largest outflows for 15 years, from the summer of 2015 to January 2016 over $40 billion came out of the region. Valuations are at such depressed levels that they are down near the levels of the Asian Financial Crisis. His view is that a correction is due and that the probability of good positive returns over the next twelve months are high.
Some economies are better especially where there is a cyclical rebound – this includes China, India and Indonesia. But other economies are slowing reflecting a slowdown in the tech super cycle, so countries like Korea and Taiwan.
Turning to China he highlighted that the view outside China focuses on:
RMB depreciation, slowdown, corruption, leverage, hard landing, overcapacity, property bubble, capital outflows, pollution
Whereas in China and we have to accept there is some state control on what is printed:
One belt one road, infrastructure, reform, development, innovation, rule by law, partnership, sustainable
The point is that the perception of China is very different to the reality. For example, Tencent has 850 million active user accounts and a market cap of $200 billion. eCommerce far surpasses that of the US. For example, on their equivalent discount day $19 billion was spent vs $2.8 billion in the US.
There are many examples but the message from Jean-Marc is that China is moving from abnormal to normal. Any reform is a learning process and is not easy but there are unique opportunities.
To end the conference Paul Craven discussed behavioural finance.
There were many aspects to this but below as some of the key messages from this:
- Bubbles – often we can see ourselves as rational, analytical humans but all too easily we can be sucked into following crowd. All rational thoughts go and this always ends badly – tech bubble, US property market, boom and bust of commodities to name just a few
- Confirmation bias – “we must do the wrong things for the right reasons…” – this is about having a view and seeking out people and facts that support that view even if deep down we don’t necessarily believe it ourselves
- Sunk cost fallacy – this is where you have spent money on something and it isn’t going to plan so you spend more money on it. An example is the London Garden Bridge which the new London Mayor has said they will continue with it rather than waste the money spent so far. The reality is that it might be cheaper to stop. One good question is if I am starting something today would I do it
- BREXIT – BREXIT is focusing on two things – immigration and economics. Immigration is the emotional side of the argument and has little to do with the argument, it will happen whatever the outcome. Economics is the rational and analytic part of the argument, are we financial better in or out of Europe
So how do we approach this. Any project we are looking at it is best to start with a blank sheet of paper and write down all the pros and cons however strange they might seem. This stops us following the crowd and challenges our beliefs.
Note: This is written based on the views shared by BlackRock in May 2016, they do not necessarily represent our views. The reader should accept that by its very nature many of the points are subjective and opinions of BlackRock. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this summary must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.