Detailed Market Outlook Report – April 2017

Overview

During this month’s Investment Team meeting, it was decided to make no changes to the composition of our model investment portfolios. This follows the strategic changes we made last month, which have proven to be wise judgements, based on subsequent economic news and independent investment analysis, which is summarised below. We can’t guarantee to get everything right every time, but we are pleased that our recent judgements in particular have proven to be wise and financially beneficial for our clients.

Also of particular note is that one of our recently selected investment trust companies, Electra Private Equity, which we introduced for our Adventurous & Aggressive investment portfolios, paid out a £1.0 billion special dividend, representing 2,612p per share, to registered shareholders as at the close of business on 7 April 2017. Essentially, the company Board is returning excess capital to shareholders. This means that the market price inevitably fell to reflect the £1 billion ‘special dividend’ which is due to be paid on 05 May 2017. Following the technical price adjustment, the adjusted share price has subsequently continued to rise. Identification and selection of this investment trust company by the Reeves Independent Investment Team has proven to be a very shrewd decision for our clients.

UK

The International Monetary Fund has upgraded UK growth for the second time in six months, after conceding that it had been wrong about the short-term economic impact of voting to leave the European Union. Britain is now forecast to grow by 2 per cent this year, almost double the 1.1 per cent projected in October and higher than the IMF’s raised outlook of 1.5 per cent in January. No leading G7 nation was upgraded by more.

The IMF acknowledged Britain’s stronger-than-expected performance as it painted an unusually bright picture for world growth. “The global economy seems to be gaining momentum. We could be at a turning point,” Maurice Obstfeld, its economic counsellor, said. The prospect of another year of solid growth for Britain gives the prime minister a strong tailwind as she leads her party into an election in six weeks’ time.

Britain’s post-referendum economy has proved the doubters wrong so far, including the IMF. On its forecasts, the UK will be the second fastest growing G7 economy in 2017 for the second year running. Back in October, Britain was expected to be the third slowest.

However, cracks in the UK economy’s post-referendum resilience are beginning to show. Weaker sterling has pushed up inflation, while wage growth remains sluggish, leaving households with less money to spend. Retail sales figures on Friday showed the first quarterly fall in volumes since 2013.

Robust consumer spending helped the UK confound predictions of a sharp slowdown following the EU poll. The consequent drop in the pound — still 14% below its June 2016 level against the dollar — appears to be threatening that performance.

Official data this week is expected to show economic growth weakened in the first quarter. Even Brexit enthusiasts think the UK will struggle to sustain its robust performance since last summer. GDP rose 0.7% in the fourth quarter of last year, according to the most recent numbers from the Office for National Statistics. Economists have forecast GDP growth of just 0.4% in the first three months of the year, down from 0.7% in the final quarter of 2016 and the slowest rate in a year.

Theresa May’s recent announcement of a snap general election sent the pound soaring and shares tumbling. The prime minister’s decision triggered a sharp rise in sterling, up by more than 3 cents to $1.28 - the highest it has been since May made clear, in October, that she intended to take the UK out of the single market. Investors are wagering that the election will remove the pressure on the government to finalise the terms of the EU divorce in 2019 — just one year before the next general election was scheduled. That should help avoid the worst-case scenario for business — a chaotic Brexit where the country crashes out of the EU with no trade deal and no or transitional agreement.

The general election campaign will coincide with a growing squeeze on consumer spending. Inflation has soared — hitting 2.3% last month — as the weaker pound pushes up the cost of imported goods. Economists expect the rate to remain above the Bank of England’s 2% target for some time, and reach 3% by the year-end. Wage growth has stagnated, however, bringing more than two years of rising real incomes to an end.

“General elections tend to be called around the peak of the consumer cycle, and it looks like that may be the case again,” said Simon Wells, chief European economist at HSBC. “It seems that the consumer sector has passed its peak — inflation is catching up with households.”

Andrew Sentance, senior economic adviser to accountancy giant PwC and a former member of the Bank of England’s monetary policy committee, said the markets’ vote of confidence was about stability and continuity rather than any shift in the prime minister’s stance. “A government that is re-elected in 2017 is in a position to manage not just the Brexit process but a transition afterwards,” he said. “A smooth, managed transition is the most important thing for business.”

Meanwhile, households are significantly gloomier about medium and longer-term prospects for the economy than they were. Research by Markit, the financial information company, based on polling by Ipsos Mori, shows that in July last year nearly 39 per cent of households thought Britain’s economic prospects were better over the next ten years because of Brexit and just over 42 per cent thought they were worse; a 3.5 per cent net balance of balance of pessimist last July.

Since then, optimism about Britain’s economy during and after the Brexit process has dropped; to 35 per cent in August, 31 per cent in November and to just under 29 per cent now. Pessimism, meanwhile, has increased. Now, 53 per cent of households think the economy will do worse over the coming ten years. Net pessimism about the economy has increased from 3.5 to 24 percentage points.

Also, real wages have stopped growing in Britain, a few months earlier than expected, thanks to the combination of rising inflation and sluggish pay growth. After just over two years in which households appeared to have put the financial crisis behind them, and average earnings comfortably outstripped the rise in prices, we have the prospect of a couple of years in which real wages fall. Regular pay rose by just 0.1% in the year to the December-February period and that tiny increase looks to be the last for a while.

The unemployment rate is currently a very low 4.7%, which is good news. The last time it was this low, in August 2005, average earnings were growing by 4.7%, roughly double the current figure. So why are wage increases so weak at the moment?

Companies can point not just to the fact that the past few years have been ones of uncertainty, with another layer added to that uncertainty by Brexit, but also to other demands, from auto-enrolment pensions to business rates and the apprenticeship levy. Some have been particularly affected by the national living wage, which this month has risen by an inflation-busting 4.2%. They are in no mood to grant bigger pay increases than they need to.Employees, meanwhile, seem to be happy with a 2% pay norm and less willing to move jobs in search of higher pay than in the past. If an acceptable pay increase a few years ago was 4% or 5%, now it is 2%.

Not surprisingly therefore, many economists now expect a sharp slowdown in overall economic growth. With the consumer sector running out of steam, much will depend on the performance of exports, which have been given a boost by the weakening of the pound since June’s referendum. A booming economy in Europe has also helped, although British companies face uncertainty over the terms of their future access to markets on the Continent now that the formal process of leaving the European Union has begun.“

The ingredients are coming together for a very consumer-unfriendly environment over the course of this year,” said Martin Beck of Oxford Economics. “The onus is on other parts of the economy to take the strain. A more upbeat world economy will help. But with the Brexit negotiations now in play, the export sector faces its own challenges.”Official data and business surveys suggest the downturn is widespread, according to Fathom Consulting. Construction and manufacturing activity contracted by 1.2% and 0.9% respectively in the two months to February. Private sector service activity, which accounts for 55% of economic output, fell by 0.1% in January.

Reeves Independent isn’t reacting to this month’s economic news and investment analysis – we have already proactively pre-empted it by reducing our exposure to UK (as well as US) equities, following our monthly Investment Team meeting in March.

Nevertheless, mid-sized businesses have brushed off fears of a post-Brexit downturn as they grew more quickly than their German, French, Spanish and Italian counterparts over the last year, according to BDO, the accountancy firm. Medium-sized companies in the UK expanded their sales by almost 4 per cent to a combined £1.2 trillion during the past 12 months compared with growth of only 1 per cent among their German counterparts. There was comparable growth of 0.6 per cent in Spain and a contraction of 1 per cent in Italy, while in France their performance was flat.

British companies with sales of between £10 million and £300 million were more profitable than their German, French, Spanish and Italian counterparts over the past year and have outperformed their major continental rivals over the past five years, BDO said.

Reeves Independent is well placed to take advantage of this growth in mid-sized UK businesses, with our core holding in the JPMorgan Mid Cap Investment Trust plc, which we have retained as a long-term core holding.

UK Inflation

Monthly inflation rate figures for the United Kingdom are reported by the Office for National Statistics .

Consumer prices in the United Kingdom rose by 2.3 percent in the year to March 2017, the same pace as in February and in line with market expectations. The inflation rate remained at its highest level since September 2013, mainly boosted by rising cost of food, alcohol and tobacco, clothing and footwear, and miscellaneous goods and services. The annual core inflation rate, which excludes prices of energy, food, alcohol and tobacco, fell to 1.8 percent in March from 2 percent in February and below market consensus of 1.9 percent. Inflation Rate in the United Kingdom averaged 2.58 percent from 1989 until 2017, reaching an all time high of 8.50 percent in April of 1991 and a record low of -0.10 percent in April of 2015.Almost 22,000 companies are facing “significant” financial distress because of rising food and fuel prices, according to an analysis that predicts a serious squeeze for businesses. A report by the insolvency firm Begbies Traynor said that it was “only a matter of time” before businesses grappling with inflation and a weaker pound were forced to pass on costs to customers, risking a fall in sales. In three key sectors of the supply chain — logistics, wholesale and manufacturing — the proportion of struggling companies has risen by an average of 26 per cent in a year.

Inflation soared to 2.3% last month as the weaker pound pushes up the cost of imported goods.

So rising inflation is finally taking its toll on the economy, with retail sales falling in the first three months of the year for the first time since the final quarter of 2013. Price increases and sluggish wage growth are taking the wind out of shoppers’ sails, threatening the buoyant consumer spending that has so far enabled Britain’s economy to shrug off the impact of last year’s Brexit vote.

“Consumers are moderating their spending as markedly higher inflation eats into their purchasing power in tandem with subdued earnings growth,” said Howard Archer of IHS Markit. “It also looks highly likely that some retail sales were pulled forward to the latter months of 2016 as consumers sought to beat expected rising prices.”

US & Europe

Global investors are pulling cash out of America and sinking it into eurozone shares, in spite of the uncertainty surrounding the looming French election, according to the latest monthly poll of investor attitudes. The great majority reckon that US equities are overvalued, with allocations of fresh money to Wall Street at their lowest level for nine years, according to a survey of professional investors by Bank of America Merrill Lynch.

Global investors

By contrast, the eurozone is the most favoured location for new investment, with a large majority of institutional investors going overweight in the region. French stocks are some of the most sought after.“Investors are showing love for Europe and scrambling out of US equities, as the majority find US stocks overvalued and perceive a risk of delayed US tax reform,” Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, said.

The “rotation” out of the United States and into Europe was the fifth most emphatic since 1999. It comes despite a neck-and-neck race in France that could result in Marine Le Pen, the far-right populist leader, being installed in the Élysée Palace and even to the unravelling of the European Union.However, Britain is not benefiting from this blast of cash from across the Atlantic. The preference for eurozone equities over UK ones is within one percentage point of its all-time high, Bank of America Merrill Lynch said.European bull runs often lag those in the US as America traditionally leads the world economy into any new swing upwards. This time, while US companies have produced mammoth profits growth since 2009, their European counterparts were hit by the eurozone sovereign debt crisis.

The last big rotation from the US to Europe was in February 2015, after the European Central Bank launched its massive stimulus package.

The survey found that even in the event of a Le Pen victory, the hit to European share prices would be relatively muted. Fewer than a third of fund managers believe that it would push prices down by 10 per cent or more.

Fears of EU disintegration have eased, although they are still investors’ biggest concern. Instead, worries that promised tax cuts in the US will not materialise or will be delayed have unnerved global investors.

“Complacency is very high, given how close French election first round polls are heading into the final week,” the bank said. The main contenders, including Ms Le Pen and Jean-Luc Mélenchon, the far-left candidate, have been polling between 19 per cent and 23 per cent, with one third of voters undecided, making the first round on Sunday impossible to forecast.More than 200 institutional investors with assets of $593 billion took part in the survey between April 6 and 12.

An earlier survey found that the world’s fund managers think that shares are more overvalued than at any time since the peak of the technology bubble 17 years ago. The poll of institutional investors showed that they are starting to wobble on the attractions of Wall Street, while shunning UK shares with even greater fervour. With global stock markets at or close to all-time highs, fund managers think that corporate profits will have to grow significantly this year to justify share valuations, according to the monthly barometer from Bank of America Merrill Lynch. More fund managers than at any time since 2000 think that equities are overvalued, it found, with a net 34 per cent of respondents saying so. For most of the subsequent period until 2014, the majority thought that shares were undervalued. Most of the concern is confined to the United States, with a net 81 per cent of respondents thinking it is the most overvalued region. Share markets in the eurozone and in emerging markets are regarded by most as undervalued.

Reeves Independent isn’t reacting to this recent economic news and investment analysis – we have already proactively pre-empted it by reducing our exposure to US equities, following our monthly Investment Team meeting in March. We have added 1% to the gold and oil sectors (via selected Exchange Traded Funds (ETFs), (which individually hold positions in gold and oil commodities and trade close to the underlying commodities’ net asset market value) and adding diversification to the emerging markets via the Blackrock Frontiers Investment Trust PLC (which is a consistently strong performing investment trust company, that won Best Emerging Markets Investment Trust category in the Money Observer 2015, 2016 and 2017 Investment Company of the Year Awards and the Investment Week 2015 and 2016 Investment Company of the Year Awards). We have maintained our proportionate asset allocation within our selected European funds (JPMorgan European Smaller Comp Ord, Lazard European Smaller Coms C Acc, Schroder European Sm Cos Z Acc & Threadneedle Eurp Smlr Coms Z Inc GBP), which continue to perform well, with the prospect of further growth.

Gold

Gold soared to a five-month high and the dollar weakened after President Trump recently suggested the US currency was “getting too strong”. The precious metal peaked at $1,288.02 per ounce in early trading in London, hours after the dollar slid to a two-week low. Both stabilised later and gold pulled back to $1,286.

Gold price soared to a five month high. The precious metal peaked at $1,288.02 per ounce.

Reeves Independent isn’t reacting to this recent economic news and investment analysis – we have already proactively pre-empted it by increasing our exposure to gold by 1%, following our monthly Investment Team meeting in March.

Oil/Energy

The global oil market is “very close to balance” after compliance by OPEC with promised production curbs, the International Energy Agency has said. Oil prices have stabilised in recent weeks and could be boosted further if the cartel decided to extend its output reductions beyond the summer. An extended agreement should lead to bigger a draw down of global stock inventories, which fell in OECD nations in March as demand outstripped supply, but remain well above historical averages.

Following our monthly Investment Team meeting in March, we added 1% to the oil sectors via selected Exchange Traded Funds (ETFs), which individually hold positions oil commodities and trade close to the underlying commodities’ net asset market value.

Conclusion

We would urge all our clients to promptly respond to our suggested investment portfolio changes whenever they are communicated. We are proactive in our constant investment monitoring and market analysis, solely for the purpose of protecting our clients’ investments as best we can.