Quarterly Market Update, July 2015

“…We stick to our comment that diversification is as important today as at any time…”

In our last update we suggested that there would be volatility in the UK markets because of the election, but we believed in all probability we would have a functioning government whether Conservative, Labour or something else. What actually happened surprised many; in this update we will consider the implications of this.

We shouldn’t ignore the fact that the Conservative victory means there will be a referendum on whether we stay in Europe or not, so we should expect some volatility in the run up to this. In Europe we continue to see positive signs in Germany, France, Italy, Spain and Ireland. Of course the worry remains Greece, as we sit and write this they have become the first developed country to fail to make an IMF repayment. We don’t know whether Greece will remain part of the Eurozone or not (perhaps by the time you read this it will be clearer) but we do know that Europe is in a much stronger position than it was in 2011.

Asia and the Emerging Markets are areas to watch. Performance between regions varies but in general terms they have outpaced developed markets this year. India and China have embraced reforms as have Brazil and Mexico but Russia faces many challenges. In Korea, concerns over ‘Middle East Respiratory Syndrome’ (MERS) have meant consumers have stayed indoors and tourism has slowed which is having a negative impact.

Japan has performed well this year without the impact of the falling yen, eyes are now focused on wage growth and consumption. The US certainly faces challenges with the stronger currency hurting the economy, corporate earnings and investor returns.

We shouldn’t ignore ISIS and the potential damage this could cause; some have estimated that the continued domination across the Middle East could force oil back up to $100 a barrel.

So as we sit and write this update, we reflect on a positive first half of the year, which has also encountered some volatility. It is fair to say that there are more positives than there are negatives. The negatives are things to watch and must always be considered.

As always the big worry is what we don’t know, but that is a fact of life and if we knew what we don’t know, well! We stick to our comment that diversification is as important today as at any time.


Cash ISA Rates remain stubbornly stuck between 1% and 2.50%. Locking money away for 4 years to get the highest rate seems to defeat the object of holding cash. We remain of the view that there are good reasons for holding cash for short term goals; for example tax bills, house repairs etc.

Cash can provide some downside protection if markets go in a negative direction. It is no longer an income producing asset class and therefore other than providing a buffer against decreasing values there remains a strong argument that keeping a minimum amount in cash is more prudent in this environment.

It is worth touching on fixed interest, perhaps too early we have been worried about this asset class for some time. We are starting to hear even fixed interest managers express concern on the asset class. There are areas where returns can be obtained even in a rising interest rate environment but investors have to take on more risk (which is not necessarily the reason why they go for fixed interest investments) and with risk comes greater volatility. There is an argument that returns will be lower and for some asset classes negative.

One final thought on fixed interest; when everyone wanted to get out of bricks and mortar property funds the liquidity in the market was squeezed which meant the fund couldn’t pay investors immediately. We are not saying this is going to happen with fixed interest investments but if it becomes a seller’s market, and demand is not there it could get messy if investors are in the wrong place. The fact that bond managers are voicing concerns is something for investors to follow with care.

There is no change in the interest rate debate. One thing that I am happy to stake my bike on is that they will go up but the big question is when. When we started the discussion a few years ago we suggested 2016 or even 2017. If I listen to the expert economists some are saying first quarter 2016, others towards the end of 2016 and some think 2017. I think it reflects the fact that nobody knows.

Some argue that when rates go up it will be slow, some think it could be 0.25% per quarter but there does appear to be a ceiling of between 2% and 3% and the time to get there could be as much as five years. The point for cash is that rates are not going to rush up any time soon.

To draw to a close the message has not changed, rates will remain low for some time to come. However zero or negative inflation means that currently cash is not a negative asset class. For those looking for income or growth this is unlikely to be the right asset class to be in. However, for those prepared to accept minimal returns but wanting to protect downside risk for all assets they hold this might be a good asset class as part of an overall mix.


The fortunes of the US remain mixed. On the positive side unemployment is down and higher wages are feeding through. There is much debate on the timing of when interest rates will rise and I would have probably said it would be towards the end of this year, now I am less certain. The IMF have urged the US to move it back to 2016, and some economists believe this is likely.

On the flipside the currency issues cannot be ignored. The strength of the dollar is impacting the economy, corporate earnings and investor returns. However, the general consensus is that this will subside by the end of 2015.

The dollar has appreciated to levels not seen since 2003 although it has dropped back slightly, it is likely to rise further once interest rates go up. Obviously a stronger dollar has a negative impact on exports as potential buyers look to cheaper alternatives.

46% of sales from the S&P500 come from international sales. This has had an impact on earnings and we have seen average returns fall back. Over 12 months international US companies on average grew by 1% whereas domestic companies saw growth of 12%. This is a big gap and therefore highlights the need for active management during this period.

Some might say that hedging the currency might be a way to harness returns during this period and certainly there could be some argument for this, but studies show over a 20 year period there is only a + / – 1% difference. Therefore if you are considering investing for the long term, trying to time when to hedge, and when not to, might be a fools game. Unless of course you are a currency expert.

Despite a strong dollar, it shouldn’t be forgotten that the US is in a healthy position and although that strength is having a negative impact many argue that this will be short lived. It does however appear that to get the maximum benefit from investing in the US it will no longer be as simple as picking a fund that tracks the index as the index, may not be as efficient as it has been in the past. Therefore, investors may need to consider blending index tracking funds with a more actively managed fund.

Europe and UK

In the last update we suggested that if we fast forward to the end of the year we would have some sort of functioning UK government. It was suggested this was going to be closest election in years and the polls and betting markets seemed unable to identify any clear winner. As the polls closed it became clear that an astonishing victory was in the offing.

The result of this is that it removes uncertainty in the short term but longer term it remains, as we near the referendum over whether the UK stays in, or goes it alone. The Scottish Referendum and the Election perhaps point to the fact that fear plays a big part in the end result; often even though people don’t like what they are voting for, the fear of the alternative is much greater. At the moment there is a small swing towards staying in but there are a large amount of undecided voters.

There is a challenge with this, the certainty of a non-coalition government means it helps households and businesses make financial decisions with greater confidence around tax and regulation. On the flip side businesses may still delay domestic and overseas investment because of ambiguity relating to the results of the referendum.

There are plus and minus points with the election; one certainty is that the Conservatives will continue to push through austerity measures. This will mean that there will be welfare cuts, with other cuts elsewhere too as they battle to reduce the debt which is having a drag on the economy.

On the plus side lower inflation is giving people the perception of having more money which means that they feel able to spend more, in time excess demand should force up inflation. And then the circle goes round! UK unemployment continues to fall and wage growth is at its fastest level for four years.

Weak productivity is something to watch as is the debt challenge. The UK is in a much better place and this does raise the prospect of interest rates rising but whether this is 2016 or 2017 there remains much debate.

Turning to Europe; Greece of course remains a worry, the IMF stated the obvious in early in June ‘Greece is likely to default on its debts unless a deal is reached with creditors. We saw it became the first developed country to do this. We don’t know the final outcome and perhaps by the time this goes out it will be much clearer. However, Europe is in a much stronger position than it was in 2011 and although there may be short term volatility, over the long term it is unlikely to have massive implications.

The general market seems a lot more positive about Europe but what is not certain is whether this resurgence reflects the strength of the dollar and the weaker oil prices, and investors buying on the reality or hope of a full blown recovery!!

If we take a whistle stop tour of Europe then there are good reasons to be positive that the recovery is more sustainable. In the last update we flagged Germany as somewhere to watch; it has posted output growth of 0.9% which is the first decent rise this year. But German companies continue to sit on large cash balances and there seems an unwillingness to invest, once this happens then this will be a positive sign.

Ireland recently moved to a A+ rating, the IMF expect it to be the fastest growing economy at 3.6% p.a over the next three years. France posted positive growth and household consumption grew but investment remains in recession. Italy posted its first positive growth since 2013 and Spain had its fastest quarter growth since 2007.

In summary there is much to be positive about in Europe with countries starting to move forward, we would want to see companies investing cash rather than holding it on the balance sheets and obviously Greece remains a thorn in the side of Europe. In the UK there is much to be positive about but austerity measures will slow growth and there will be uncertainty about what happens after the result of the referendum.

Asia, Frontier and Emerging Markets

There are worries that when US interest rates rise this could have a negative impact on Asian and Emerging Markets especially where there is dollar dominated debt. So when rates go up there could be volatility in the market.

Generally in Emerging Markets we have mixed performance but across the region as a whole it has outperformed developed markets. Clearly they have been helped by the delay in interest rates going up in the US and lower oil prices, which has particularly helped China and India. In other countries it has seen the removal of subsidies which have been a drag on growth.

Just touching further on China we have seen some heavy falls in recent days, and since the 12 June the stock market is down around 17% but it is significantly higher than it was 12 months ago. Volatility is not unusual in China and many good things are happening but it is a trend to watch carefully.

Taking a blanket view the tailwinds for these markets include as mentioned lower oil prices but also solid economic growth trends and widespread reform measures. Additionally demographics, technology and generally lower debt are playing a part. China remains like marmite for many investors but they continue to push through their reform programme as do countries like India, Brazil and Mexico.

Turkey and Greece could benefit from a recovery in Europe but Russia is one to watch. Production is weak, real wages are falling, lower oil prices, currency weakness and the Ukraine make it hard to see where Russia goes from here.

In summary there is much to be positive about and we continue to believe that careful stock selection will deliver the best returns. Greece is a concern but it could benefit from a growing recovery in Europe as could Turkey. There seems to be little to be positive about in Russia but things can change quickly.

We will leave you with one debate that has started to surface and that is whether the price of oil could rise to $100 a barrel as ISIS continues its relentless march across the Middle East. If this happens then this could slow things down across Emerging Markets and Asia but also across Europe and other developed economies. Whether this happens is anyone’s guess.


Japan has continued to shine in 2015. One aspect that is important is that much of this has been achieved without the benefit of the falling Yen. The Yen depreciation is a short term fix, it has made Japanese products more competitive generating higher revenues and profits.

But clearly it is missing the ingredients needed for sustainable growth which includes rising wages and increased private consumption. It is worth reflecting that 24% of the workforce are in part time jobs and this continues to grow at the expense of full time workers. On the positive the female participation rate is slowly increasing which reflects a slow cultural change.

Another concern is that Japanese companies have around 40% of their assets in cash. This is great when you need to protect against financial turmoil but not so good now. If this continues it will erode shareholder returns and investor confidence. To put this in context US companies have around 18% in cash and European companies between 21 and 27%.

On the positive we have seen a 20% increase in companies selecting outside directors compared to 10% between 2008 and 2012.

In summary Japan should be seen in positive light but there remains a lot to do.


We continue to be cautiously optimistic for 2015. The UK election was clearly a surprise and on one hand it brings stability in the short term, in the long term it opens up uncertainty around the referendum on European membership.

Emerging Markets, Asia, Japan and Europe have in the main benefited from lower oil prices and a weaker currency. If ISIS gain a greater foothold in the Middle East it could force up prices and this could have a negative impact.

There remains uncertainty with Europe and in particular with Greece and the Ukraine. If Greece falls out of Europe the short term impact will be negative, but long term Europe should be able to weather the storm. Russia has many challenges and possibly not the same desire with Ukraine as it did at the start of the campaign.

In summary there is much to be positive about but there remains challenges. As we have keep saying we don’t know about the unknown, and assuming that doesn’t happen and the markets remain positive we still believe 2015 will deliver a more normalised return of between 5 and 8%.

Source: Charts have been sourced from Morningstar. Other data sourced from Schroders, Templeton, Standard Life, and JP Morgan.

NOTE: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. 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 blog 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.

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