Quarterly Market Update – July 2017

All change!

Just two years’ ago the Conservatives secured a surprise election majority. At the time, the UK was broadly on the same path as the US with an expectation of interest rates rising, economic growth and political stability. But all of that has coming crashing down; we are leaving the EU, Cameron is gone and the Conservatives are on life support hounded by Robin Hood (the hero of the people)!

The UK has gone from hero to zero; we are the problem child of Europe, the laughing stock of the world and face the real possibility of a recession.

As we press the self-destruct button, much of the political unrest facing Europe has gone. Wilders was nowhere to be seen in the end. I thought it unlikely even if Le Pen became President, that she would get the seats she needed in the June elections. So, like Wilders, Le Pen faded away but a new political force emerged.

Emmanuel Macron formed “En Marche!” or “La Republique En Marche!” in April 2016. Not only did he win the French Presidency, his new party became the country’s largest party in the National Assembly. So, the impossible is actually very possible, unfortunately I don’t think the same could happen in the UK! (Sadly!)

Macron is pro-European, and it now seems Europe has the upper hand in the Brexit negotiations. Just as the UK seems to have committed economic and political suicide, Europe is showing healthier economic data and political stability. Unsurprisingly we expect Europe to start performing strongly particurly versus the UK.

The “Trump-Show” continues to be played out on social media and television, and there is much debate on whether it ends with impeachment. But actually, the US is doing ok. One thing that is challenging not only the US but global economies, is wage inflation which remains subdued; is this due to increased international competition, a collapse in trade union power, technological disruption or something else?

There seems no answer to this, but perhaps we might need to get used to below inflation pay rises; this in turn could be a danger to global growth especially if it dents consumer confidence.

What is interesting is that although we are something like eight years into a recovery phase (normally after six we would expect a global recession), it seems because global growth is much lower than we have seen before the recovery phase could be much longer. This means a recession might be two or three years away (or perhaps longer).

Asia is another region to watch. Generally, we are not seeing any immediate signs of stress within the global economy. Interestingly the Vix Index (which is a good sign of investor fear), although spiking over Brexit and Trump, is now hitting all-time lows. It seems that political fear is the greatest short-term concern, but then the focus turns to macro fundamentals which globally look pretty good.

In summary, of course there will always be global concerns. Could something happen in China, will North Korea pursue a war with South Korea, will Trump be impeached and of course what about the one thing we don’t know about. But if we take these away, the global picture (with the exception of the likes of the UK) is pretty good.

DEVELOPED MARKETS

Five year returns 1 July 2012 – 30 June 2017

Special note to graph: You should note that past performance is not a reliable indicator of future returns and the value of your investments can fall as well as rise. The total return reflects performance without sales charges or the effects of taxation, but is adjusted to reflect all on-going fund expenses and assumes reinvestment of dividends and capital gains. If adjusted for sales charges and the effects of taxation, the performance quoted would be reduced.

I will start with the UK first and get that out of the way. Two years ago, things didn’t look that bad. Wage growth was coming through, growth was improving and we seemed to be on a similar journey to the US.

Cameron was on a high with a surprise majority, and we had a good economic climate. The EU referendum was the first sign that not everything was going to plan, with many economists getting the immediate impact wrong. However, 12-months on, the drop in sterling is now being felt through rising inflation and subdued wage growth.

At the start of 2017 we started to see consumer spending slow, with many retailers struggling (particurly those focused on the high street). Growth expectations are as low as 0.5% for 2017, and there are real concerns that the UK will fall into a recession.

With this backdrop May called a snap election thinking herself invincible; the reality is that snap elections never work, and all this has done is to add political uncertainty to the mix. May was not the only one to lose; Sturgeon has shelved her calls for a second referendum (for the time being). Corbyn despite losing and failing to beat a deeply unpopular May, seems to see himself as a modern-day Robin Hood hero.

It is fair to say that politics in the UK are more divisive than perhaps we have seen for decades. Interestingly markets are being warned to prepare for a Labour government; my humble view is that we are more likely to see May go than an election. I think this quote from the BBC best sums up how the Sherriff of Nottingham (May), Robin Hood (Corbyn) and media barons should behave:

“The Institute for Government think-tank says that for minority governments to last and work, ministers, MPs and the media have to change the way they think.

Ministers have to be less majoritarian in their outlook, and be less ambitious and more realistic about what they can achieve. MPs need to learn how to do deals and make compromises.

And the media have to stop viewing every defeat as a confidence issue.

But this does not always happen.”

So, we enter the Brexit negotiations as a wounded soldier with political instability and a weak economy. At the same time Europe is brimming in confidence especially with the results in France, and the Netherlands. Expect to see a lot of negativity over the coming months and years! Whatever our view of the referendum, it is what it is, and no-one will know the impact of any agreement. But my immediate concern is whether we can avoid a recession?

If sterling stabilises then we could see inflation fall back; there is a strong argument for this to happen. As it stands consumer confidence is being dented as inflation rises, and this isn’t being helped by below inflation wage rises.

But not all is bad when sterling is weak; it is good for manufacturing, and for businesses generally with increased foreign investment. It is also good for tourism as it makes it cheaper for overseas travellers and when people have less money to spend abroad, they stay at home (“staycation”). One other factor is that we could see a retraction on austerity which could be another positive factor (the Queen’s speech has indicated more spending on infrastructure).

So, the UK is potentially the new Greece!!! Well perhaps that is a little extreme. If it gets to grips with its politics and uses a weak sterling to its advantage it might not be that bad.

Talking of Greece, the papers hardly mentioned (nor did the markets flinch) as it unlocks the last bailout of e7.7 billion in July, and a further e800 million over the summer. Greece has a long way to go but it doesn’t seem to be the problem child which drove down the markets in 2011.

The big fear that was holding back investors seemed to be politics, but that appears to have gone away. Macron is more likely to unite rather than divide France, Merkel is likely to win in Germany and in Italy even if the Five Star Movement gain seats, they would need to form a coalition and that is unlikely to happen.

There is strong growth coming in across Europe with Portugal and Spain being two bright spots. Compared to the US; valuations are cheaper, and there is a sense that with the political uncertainty out of the way, focus will fall on economic data. For example, there has been an expansion in this data for 47 consecutive months moving to its highest level since 2011. Unemployment is falling across Europe and is at its lowest level for eight years.

Sentiment is buoyant in terms of consumers and businesses; it is worth adding that although businesses are positive they are not euphoric which perhaps is a good sign. Inflation remains a challenge which links in with wage growth but GDP is improving.

Turning to the US. (Inward eyeroll!)

There is close to full employment after reaching a near 10-year low. First quarter economic data was strong, consumer spending is positive and this is before any proposed changes to taxes which we expect at some point. Although the US recovery is eight years in, there are no signs that a recession is on the cards.

The US seems to be leading the global recovery but here is the thing; firstly, what about Trump, will he be impeached, and will he actually do anything other than tweet? Secondly and this is a global conundrum, the US continues to have weak wage inflation; this in turn could impact consumer spending.

Whilst wages are restricted costs are kept low and inflation doesn’t increase. There is much debate about this; whether a more globalised economy pushes down wages, or whether the weakness of trade unions has an impact, or disruptive technology naturally drives down the wages people can demand. If inflation rises above wage rises, people will naturally spend less, and questions are asked if this is one thing that will drive the global economy.

The general view is that the US will continue to be positive but there are better opportunities especially in Europe, and Asia. We believe that much of what happens now in the US depends on what Trump does next.

Just briefly touching on Japan; there is not much to report other than like the rest of the global economy we are seeing strong corporate earnings coming through, with better than expected GDP figures.

In summary, as you will have guessed we are pessimistic about the UK; we are on a precipice and the question remains as to whether we are strong enough to pull back or we go over. It seems for a long time Europe has been the butt of our negativity but there are now many positives, and we think with cheaper valuations compared to the US as well as strong economic data 2017 could be the year for Europe to shine. We don’t have any immediate concerns with the US but we shouldn’t ignore the possibility of impeachment or inability to drive through the expected tax changes.

EMERGING, ASIA AND FRONTIER MARKETS

Five year returns 1 July 2012 – 30 June 2017

Special note to graph: You should note that past performance is not a reliable indicator of future returns and the value of your investments can fall as well as rise. The total return reflects performance without sales charges or the effects of taxation, but is adjusted to reflect all on-going fund expenses and assumes reinvestment of dividends and capital gains. If adjusted for sales charges and the effects of taxation, the performance quoted would be reduced.

We remain optimistic for Emerging, Asian and Frontier markets. These have been pretty beaten up over the last five years but even with the “recovery” over the last few months, they are still relatively cheap. It is important to add that there are a number of different economies and some will perform better than others!

We voiced our concerns over Korea but political stability seems to be returning, with reforms including unwinding cross-ownership structures within corporations, taking a more shareholder friendly approach. The economic fundamentals are good, with the strongest upward earnings revision in five years driven by the export sector.

The ‘One Belt, One Road’ Forum saw China sign deals with 68 countries and international organisations in the hope of fostering trade and connectivity between Eurasian countries. It is unclear whether this is more political than economical, but time will tell. Interestingly as China builds its semiconductor/smartphone production capabilities this impacts countries like Taiwan. China is also seeing a stabilisation of its economy removing fears of a hard landing.

Additionally, far from a trade war with the US it seems that we are seeing trade deals, with the latest signed in May covering beef, poultry and natural gas.

India is about to roll out the Goods and Services Tax. It is expected that Modi’s party will continue to strengthen their hold across India, which will see him re-elected enabling greater reform. Other Asian economies to watch include Thailand (entering a phase of accelerated growth), Indonesia (disruptive factors beginning to fade) and Philippines (moving towards tax reform and infrastructure spend).

Russia seems to be emerging from recession but challenges remain with low gas and oil prices and sanctions from the US. Brazil is finally showing signs of expansion after being in recession, and there are growing signs of greater investor confidence but a fresh political scandal playing out could derail this. Mexico suffered from fears over Trump but this seems to be fading, and valuations are cheap at a time where country risk is falling and unemployment remains at decade lows. But inflation is rising and consumer confidence remains subdued.

Chile has benefited from a positive trend in copper prices and improved sentiment following the presidential elections. Argentina is another story to watch with a return to growth. In emerging Europe, Poland is seeing some of its fastest growth for nine years, and Turkey has posted strong GDP data.

In Africa, there are still challenges in economies like South Africa with depreciating currency and political uncertainty.

In summary, across emerging markets we are seeing stronger growth earnings, higher economic growth and robust consumer trends. We can see that even where countries are going through change, with strong underlying economics such as low debt, reduced volatility and consumer confidence. In terms of businesses there are significant numbers of innovative companies focusing on technology and higher value-added goods and services. We are also seeing global brands originating from emerging-market countries (Haier, Huawei, Lenovo, Tata Motors, Havaianas, Café de Colombia etc).

It is worth ending with the debate on whether rising rates in the US will impact Emerging Markets and Asia. Many believe the pace and rate of increases are such that any impact will be minimal.

CASH

Five year returns 1 July 2012 – 30 June 2017

Special note to graph: You should note that past performance is not a reliable indicator of future returns and the value of your investments can fall as well as rise. The total return reflects performance without sales charges or the effects of taxation, but is adjusted to reflect all on-going fund expenses and assumes reinvestment of dividends and capital gains. If adjusted for sales charges and the effects of taxation, the performance quoted would be reduced.

There was some excitement that interest rates might go up in the UK, but the three people who voted for this are external members of the board. The UK has a very tight balancing act.

Rather than repeating myself these are words from Mark Carney:

“From my perspective, given the mixed signals on consumer spending and business investment, and given the still subdued domestic inflationary pressures, in particular anaemic wage growth, now is not yet the time to begin that adjustment [rate rises].

“In the coming months, I would like to see the extent to which weaker consumption growth is offset by other components of demand, whether wages begin to firm, and more generally, how the economy reacts to the prospect of tighter financial conditions and the reality of Brexit negotiations.”

We may not see rate rises for perhaps two years and even then it may only go back to 0.5%. Interestingly it seems that investors still seem to hold onto cash rather than investing. A recent survey by BlackRock indicated that over 60% of investors’ assets are in cash. After ten years of pitiful returns, it seems that investors are still not ready to move away from cash.

Although we think inflation will drop back, this won’t happen unless sterling stabilises and as this seems to react to any news (positive or negative), it may be some time before we see inflation reduce. To put this into perspective I saw a Leeds 5 Year Fixed Rate ISA offering just 1.6% p.a. Inflation is now 2.9%; in real terms that plan is losing 1.3% p.a. If inflation rises then it will just get worse.

We understand why people hold cash in the short term, but longer term it doesn’t make sense. We have recently put together blogs entitled “Time in the market”, and “Cash”. It was interesting that a paper by Fidelity showed there was a 16% chance of losing money in the stock market over a 5-year period, and this drops to zero over 12 years. The point being, that for those who have held cash since 2008 in the hope that rates would go up have significantly lost out, and might have been better to invest in the market over that time.

Interestingly we speak to people who hold cash because they try to time when it is best to invest; Fidelity showed that over a ten-year period, being out of the market for the best ten days delivered a negative return of -4.64% and missing 30 days a negative return of -49.08%. Being invested returned 68.96%.

Of course, there are good reasons to hold cash, and clearly to get the best rates it needs to be managed. The FCA have indicated that 90% of people do not look for the best rates, which compounds poor returns.

I have been writing about cash for the last six years, and no doubt the message will be the same in six years’ time! Fundamentally, the reason for holding cash is simply if I have £100 I know I will have £100 in five years’ time. The difference will be that I can buy less with £100 in 5 years’ time compared to today, so I will have lost money!

CONCLUSION

I will err on the side of caution but it is hard to ignore the fact that globally company earnings growth is providing optimism within the global economy. In Europe political uncertainty has subsided, and the focus has turned to positive macro data with valuations more attractive than in the US. We still think there is more to come from the US but much will depend on what Trump does next.

Asia is another bright spot especially the likes of India and Korea. There is some debate over the direction of oil prices; some think they will start to rise but this seems unlikely in the short term as supply outpaces demand. Someone also pointed out that with fuel efficient cars, and electric cars, demand could fall further. We think oil prices might hover around the $50 mark but certainly we can’t see any reason for it to go up to $100.

Investor fear is at an all-time low but this does have short term spikes over political events. Inflation is something to watch and in particular wage inflation.

I started with the UK and so will end with it. It is funny how we have laughed at Europe tearing itself apart; how the US could be so stupid to vote in Trump and yet in 2015 we appeared to have the world at our feet. Today, we are starting to suffer from our decision to leave the EU with weak sterling and rampant inflation, and far from political stability we have perhaps one of the most unstable political situations of all of Europe.

Far from being united, our politicians seem blind to the fact that what they and their followers are doing is dividing us. In fact, it is fair to say that the UK is becoming the butt of the world’s jokes (although are we on a par with the Trump administration?). We might have the last laugh but it is hard to see this happening as we slowly tear ourselves apart!

So globally things look good, UK not so good, but as we have always argued when investing it is good to have a globally diversified portfolio of assets.

Source: Charts have been sourced from Morningstar. Other data sourced from BBC, Fidelity, Standard Life, BlackRock, Schroders, Templeton, Hermes and JPMorgan.

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. 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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