Detailed Market Overview
Recent Global Market Turmoil
The FTSE 100 index of leading shares has fallen by about 600 points in the past three months and, despite a recent rally, is almost 3.5 per cent below its peak of 7,778 in mid-January. So far the falls represent a correction rather than a crash, but they serve as a warning to investors.
April witnessed a steady trickle of downbeat news, including:
Whilst there are always conflicting signs regarding economic growth and the prospects for investors, the Reeves Investment Team remain cautious in the current uncertain environment. Our main priority at the moment is to protect our clients’ wealth. Whilst we retain a diversified, risk-averse exposure to a wide range of geographical and market sectors, we are maintaining a sizeable cash reserve and maintaining a cautious approach to our overall investment strategy for the time being.
This approach has payed off for our clients, with all of our model investment portfolios outperforming the FTSE Allshare Index over the first quarter of 2018.
Once again, all of our model investment portfolios have performed better than our FTSE All-Share Index benchmark over the past quarter. Also, our model portfolios have behaved in the orthodox manner we would expect during a market correction. In a bullish market when the FTSE All-Share index is in positive territory, we would expect our Adventurous model portfolio to outperform our Balanced portfolio and for our conservative Cautions fund to bring up the rear. Conversely, when there is a market correction and the FTSE All-Share index is in negative territory, we would expect our Cautious model portfolio to show more resistance/resilience, and perform better than our Balanced and Adventurous portfolios.
Despite a steady the flow of negative reports recently, it's not all been bad news.
For instance, British businesses are shrugging off concerns about Brexit uncertainty, with almost three quarters expecting to see trade increase over the coming year as they capitalise on the cheaper pound and rising overseas demand. A survey by HSBC of more than 6,000 companies operating in 25 markets around the world found that 72 per cent of UK companies expect trade volumes to increase over the next 12 months. This was only just below the global average of 77 per cent and higher than the EU’s average of 71 per cent. Europe’s biggest bank said UK businesses viewed the US, Germany and France as the most important target markets for expanding their business. It added that 33 per cent of businesses also thought Britain’s exit from the EU would have a positive impact on their company’s growth. However, 38 per cent thought it would have a negative impact, while 29 per cent said Brexit would not affect them.
Also, consumer confidence rose in the first quarter of 2018, amid signs that the economic pressures facing Britons over the past year may be starting to relent, according to new figures from Deloitte. The consulting group’s latest Consumer Tracker report, based on a survey of 3,000 UK consumers between March 23 and March 26, showed consumer confidence rising to -6 per cent in the first quarter, up from -7 per cent in the previous quarter.
Meanwhile, global corporate investors seem to be becoming more attuned to the valuation opportunities that now exist within the UK stock market. In recent weeks, we’ve seen bids for Fenner, Fidessa, Hammerson and Laird, from overseas companies apparently keen to snap up the bargains on offer. This flurry of deal activity is representative of the widespread undervaluation that results from the unpopularity of UK equities among global institutional investors. In turn, it may also represent something of a precursor to a re-appraisal of the UK economy’s prospects and the stocks that are exposed to it.
Overall, the UK stock market edged cautiously higher last week, with the FTSE 100 index closing at 7,502, after the release of weaker than expected growth data made a rise in Bank rate in May less likely. The news also lowered the value of the pound, boosting UK exporters.
How the FTSE 100 index has performed
+3.7% over a year (up 6.8% with dividends)
+5.6% over three years (up 17.5% with dividends)
+16.7% over five years (up 39.5% with dividends)
+23.2% over 10 years (up 77.8% with dividends)
The unexpected strength of the eurozone recovery was the big surprise of 2017 and one of the main reasons why the UK economy outperformed gloomy pre-Brexit forecasts. Eurozone output expanded by 2.3 per cent last year, the strongest growth for a decade and far ahead of the consensus forecast among independent economists at the start of the year of growth of just 1.3 per cent. Business and consumer confidence at the start of 2018 was the highest for 18 years, prompting economists to upgrade their expectations for growth this year to an average of 2.4 per cent, up from a forecast of just 1.5 per cent a year ago.
But are the wheels now coming off the recovery? A string of weak data points to a disappointing first quarter. German exports of goods were down by 3.2 per cent in February compared with January, defying consensus expectations of a 0.4 per cent rise. German industrial production also fell by 1.5 per cent in February, compared with a forecast of a 0.3 per cent rise. Fresh data this week suggests the slowdown is spreading: Italian industrial production fell by 0.5 per cent in February compared with the previous month, while manufacturing output fell in France for a second consecutive month. This disappointment is reflected in equity markets: the Stoxx 600 index of leading European stocks is down 7 per cent from its January peak.
Of course, a couple of months of weak data may not signify anything much. Most economists are inclined to think this is a temporary dip, offering explanations ranging from the cold winter across much of Europe to the strength of the euro to a bad dose of the flu that pushed up sickness rates in Germany. Others have pointed out that recent survey data, which also has been weaker than expected, still points to healthy levels of growth: the eurozone composite PMI — a broad measure of economic activity — fell from 58.8 in January to 55.2 in March, but that is still consistent with first-quarter growth of 0.7 per cent, lower than the 0.9 per cent forecast in January but a long way short of a downturn.
Even so, there are several issues that will need to be watched closely in the coming months that have the potential to turn a slowdown into something more troubling. The first is that even with growth slowing, some parts of the eurozone may still be at risk of overheating. That’s because the eurozone has already been growing for several years above its long-term potential growth rate — the rate at which an economy can grow without generating inflation — which is widely estimated to be a meagre 1.5 per cent, reflecting the Continent’s demographic challenges and the inflexibility of many eurozone economies. Already there is worrying evidence of bottlenecks in some industries and reports of skills shortages in many countries, not least in France, despite unemployment of 9.2 per cent. The risk is that supply-side constraints hold back growth while pushing up inflation, a worrying combination.
A second concern relates to the present global trade tensions. The eurozone is particularly vulnerable to any disruption to trade: it runs a vast current account surplus equivalent to 3.6 per cent of its output, which means it is highly reliant on foreign demand to fill its factory order books. Indeed, the eurozone has been the big winner from China’s booming economy in recent years: exports to China were up 21.9 per cent in 2017, while net trade was the biggest contributor to eurozone growth last year at 1.3 per cent. Even the recent pick-up in capital expenditure, which contributed 0.5 per cent to eurozone gross domestic product growth in 2017, was in large part driven by Chinese demand. Indeed, some of the present slowdown appears to reflect a slowdown in Chinese growth and tighter Chinese credit conditions.
The third concern relates to global liquidity conditions, which have been tightening all year as the Federal Reserve has raised interest rates and started to shrink its holdings of government bonds and as the European Central Bank has slowed the pace of its own bond-buying. US ten-year Treasury bond yields have already risen from close to 2 per cent in September to 2.8 per cent today and could be driven higher by a combination of increased bond issuance needed to fund President Trump’s tax cuts and expectations of higher inflation as the extra stimulus is applied to an economy already running at full capacity. Rising interest rates against a backdrop of slowing global growth could trigger fresh worries about the vast quantities of private sector debt issued during recent years across developed markets raising the risk of another bout of market-driven economic instability, notes Ian Harnett, of Absolute Strategy Research. Markets that may be vulnerable to fresh credit risks include the US corporate bond markets, which have grown by 50 per cent in four years; the Canns (Canada, Australia, Norway, New Zealand and Sweden); and highly leveraged eurozone economies, such as France and the Netherlands.
Of course, the eurozone’s ability to withstand these risks would be enhanced if it had a compelling economic story to tell in the form of reforms designed to improve its productivity at national level or strengthen its resilience at eurozone level. In recent years, the currency bloc has been able to count on remarkably benign market conditions as investors have piled into eurozone assets, eager to play the recovery trade as the economy rebounded from its debt crisis. But with growth possibly slowing and in the absence of meaningful reform efforts anywhere other than in France, that trade looks to have played out. Indeed, the eurozone’s biggest challenge lying ahead may be simply to maintain investor interest.
Meanwhile, Eurozone unemployment has fallen to its lowest level in almost a decade and inflation has picked up in a further sign that the currency bloc’s economy is gathering momentum. Joblessness dropped to 8.5 per cent in February, the lowest since December 2008. This compares with 8.6 per cent in January and 9.5 per cent a year ago. Meanwhile, inflation in March jumped to 1.4 per cent from 1.1 per cent in February, official data showed. Strong job creation and rising inflation is what policymakers want to see. The European Central Bank has been pumping cheap credit into the economy to drive growth and kick-start inflation. The efforts have paid off over the past year, with GDP growth surging above 2 per cent to a decade-long high and unemployment tumbling. However, in France unemployment is still at 8.9 per cent, in Spain at 16.1 per cent and Italy 10.9 per cent. In Germany and the Netherlands unemployment is low — at 3.5 per cent and 4.1 per cent, respectively. There are 13.9 million unemployed people in the eurozone, 1.4 million down from a year ago.
Recent figures showed that German industrial output suffered its steepest monthly drop in more than two years as protectionism’s spectre loomed over the export-driven economy. Seasonally adjusted output fell by 1.6 per cent in February after rising by a revised 0.1 per cent in January, Destatis, the statistics authority, said. It was the biggest drop since August 2015. Data already showed that industrial orders had risen by less than expected in February because of weak domestic demand.
Finally, as reported above, growth in the eurozone economy has “downshifted markedly” since the start of this year, according to the purchasing managers’ index, which is considered one of the best indicators of how the eurozone is performing;
Taking into account the overall uncertain picture of the eurozone economy and its future investment prospects for our clients, we took the decision last month to reduce our model portfolio exposure to European smaller companies funds by 50%, adding the proceeds to cash reserves, pending future investment. Nevertheless, we have retained some exposure to the European sector, as markets don’t always behave in the way analysts predict and can (and often do) surprisingly outperform expectations.
Reeves Model Investment Portfolios
Although it’s been a challenging start to the year in performance terms, we have been consistently pleased with the ongoing resilient performance of our model investment portfolios. The year ahead poses many macroeconomic & political challenges both domestically & globally, but we have positioned the portfolios to offer wide diversification, underpinned by a solid cash element whilst market uncertainty and volatility persists. Alongside extensive geographical and market sector diversification, we have recently realigned our strategic exposure special situations, in order to exploit parts of the market that are unloved, undervalued and where sustainable growth prospects are very much under-appreciated. As such, we remain very confident that the strategy we are pursuing is highly appropriate for the prevailing economic and market conditions, and capable of delivering attractive, positive long-term returns.
Below, you can see the individual fund performances of the selected investments within our model portfolios. (ordered monthly)
** The history of this unit/share class has been extended, at FE's discretion, to give a sense of a longer track record of the fund as a whole.
Source: FE Analytics software provided by Financial Express Investments Ltd (part of Financial Express (Holdings) Limited) as at Saturday 28 April 2018.
Scottish Mortgage Investment Trust PLC
The Reeves Investment Team have for some time been strong advocates of the Scottish Mortgage Investment Trust PLC, which has been established as a long-term cornerstone of our model investment portfolios. The company has served our clients well and continues to do. In the wider investment market, the Scottish Mortgage investment trust remains one of the most popular and best-performing in the UK. Part of the FTSE 100, it has a market value of £6.5 billion and returned 179 per cent over the past five years.
Recent wobbles on Wall Street have made some investors question whether the end of the nine-year bull market is near. James Anderson, the trust’s co-manager, believes the next downturn will be characterised by the demise of “old economy” stocks, such as utilities or banks, and a reinforcement of “new economy” companies, such as technology and disruptive healthcare.
“There is a presumption that we have run the course of the bull market, that when markets go down you should suffer. I think the next bear market will reveal the fragility of a lot of traditional companies. I get very worried when people say you should be safer by favouring out-of-favour investments, that they should be OK in a bear market. I think we will have a phase of destruction of old companies in favour of the new.”
This perspective is reflected in the trust’s holdings; Amazon remains the largest holding, while China’s Tencent, an internet company, and Alibaba, an online retailer, are the second and third. It also holds Facebook and Alphabet (the parent company of Google). Exposure to those companies can mean the trust is sold when sentiment towards big tech sours, which is what happened this week. However, the trust’s shares were lifted as one of its holdings, Spotify Technology, the music streaming service, debuted on the stock market.
Shares in Amazon, which have risen 521 per cent in the past five years, have been a key driver of the trust’s performance. They are trading on a price-earnings (PE) ratio of 313. Mr Anderson believes the company is “the most financially disciplined in the world. Amazon does not run the business for short-term earnings. If it didn’t make money from Amazon Prime for a decade, it won’t matter.”
He refutes suggestions that the tech giants are too richly valued. “Their opportunity is bigger, their competitive advantage and the longevity of their businesses is greater. Amazon is a good example of that. I don’t think there is anything extreme about the valuation of Facebook or Tencent compared with growing companies in the past. The fact that their share prices have risen and they have gone up in value does not matter, and the same goes for their Price-Earnings ratios.”
China remains a dominant theme in the trust. “We are worried that other investors are underestimating the importance of China,” he says, adding that the country has “probably overtaken” the US in terms of the sophistication of research and goods it produces. He recently took a stake in Nio, a company he predicts will be the Chinese equivalent of the US electric car company Tesla. Through the trust’s stake in Alibaba and Tencent, it also has exposure to unlisted companies in China, many of which are backed by the two tech giants.