Detailed Market Overview
Recent Global Market Turmoil
Everything was perhaps going a little too smoothly before global markets hit a rough patch in early February. There have been a range of explanations offered for this, but the US was at the epicentre of market stress, following further indications of inflationary pressures and higher interest rates.
The Dow Jones Industrial Average lost 5.2% of its value and was down nearly 10% from last month’s all-time high. The FTSE 100 index of leading shares fell 200 points as it retreated further from its all-time high of mid-January. During the slide, the FTSE 100 endured its worst weekly percentage fall since 2016 and its largest one-day fall since Britain voted to leave the EU in June 2016. The index was down 10 per cent from a record high glanced on January 12. A “bear market” is categorised as a slide of greater than 20 per cent.
Experts blamed the market correction on the threat of rising inflation which will ensure that the US Federal Reserve continues to raise interest rates — possibly at a faster rate than expected. As central banks wind down their quantitative easing policies, which provided the liquidity that fuelled share-price rises, investors are worrying about what will underpin the markets in the future.
Investors were clearly shaken out of complacency after a long period without any sharp market falls. Strategists at Blackrock, the investment company, think that the fall was due in part to the unwinding of bets tied to the VIX index of share volatility, known as the fear gauge. Investors had bet on the VIX remaining low, but when it shot up to its highest level since August 2015, they were wrong-footed and this set off a bout of market jitters.
The market downturn was exacerbated by technical issues, with many believing that ‘systematic, volatility constrained trading strategies’ compounded the downward spiral. Also known as algorithmic, or black box trading, it is a system based on the use of complex mathematical models and formulas which enable professional (typically institutional) investors to make automated transactions. Some commentators have suggested that these trading models and sophisticated algorithms are partly to blame for the volatility witnessed across markets last week. Banks and hedge funds have subsequently been ordered to tighten their controls over computer-driven trading.
The MSCI global equity index subsequently lost 9% of its value in the space of a week, as the global market slashed billions from the value of investments.
Meanwhile, economists are warning that the rollercoaster ride of volatility is likely to continue. Ben Broadbent, a deputy governor at the Bank of England, rejected the suggestion that the recent volatility on global markets was “somehow parallel” with that of the financial crisis of 2007 and 2008. His remarks were echoed by Andreas Dombret, a Bundesbank board member, who suggested that the market correction “may be healthy”.
The following graph helps to put recent events into perspective:
The entire drop in the Dow Jones industrial average from its January 26 peak was only 9 per cent, which took it back to the level of last November. It has since more than recovered from the recent dip.
So it didn’t take long for analysts & investors to refocus on fundamentals. Global growth looks to be on track to hit a multi-year high in 2018, helped by a broad upswing across developed and emerging economies. Labour markets continue to heal from the long lasting fallout after the financial crisis. Central banks across a range of economies have started to signal a very gradual withdrawal of their still accommodative policy settings as conditions improve.
Even gloomier observers are wary about quitting a market that could resume its march higher. “The situation looks bad, but it’s tough to play as an equity investor. If you cash out now, you might miss the last 30%,” said John Roe, the head of multi-asset funds at Legal & General Investment Management. This dilemma, which is echoed by money managers around the world, recalls a famous remark made by Citigroup chief executive Chuck Prince in the run-up to the financial crisis: “As long as the music is playing, you’ve got to get up and dance.” This time round, however, Roe senses that the festivities may be drawing to a close. “The party is still going, but someone has spiked the punch,” he said. “It’s not time to leave yet, but we’ll be hanging around by the door.”
“In the equity market we have enjoyed a period of quite remarkable returns,” said Andrew Wilson, European head of Goldman Sachs Asset Management. “That’s unlikely to be repeated over the next few years,” he said, adding that he expected “mid single-digit” annual percentage gains for stock markets.
The Reeves Investment Team will continue to analyse market trends, comments & events and monitor the performance & future prospects of the individual funds held within our model portfolios, with the aim of beating our underlying benchmark of the FTSE All-Share Index. Below, we look at the future prospects for individual global markets.
Future Prospects for Global Markets
Despite recent stock market events, the world is enjoying its best period of growth since emerging from the global financial crisis because of US tax cuts and rapid expansion in Europe and Asia, according to the International Monetary Fund. The IMF has raised its global growth forecasts for this year and next and proclaimed the “broadest synchronised global growth surge since 2010”. Christine Lagarde, the IMF’s managing director, said world trade was expanding and consumers were more confident. “Global growth has been accelerating since 2016 and all signs point to a continuous strengthening,” she said. In a boost to President Trump, Ms Lagarde said that lower US corporate tax rates would drive increased investment and help America’s economy to grow 2.7 per cent this year. In contrast, Britain is expected to grow 1.8 per cent in 2018, dropping to 1.5 per cent next year as it leaves the EU. The IMF upgraded global growth figures for this year and next from 3.7 per cent to 3.9 per cent and revised its estimate for last year from 3.5 per cent to 3.7 per cent — the strongest statement for economic prospects since the 2008 financial crash.
Below, we compare six world regions, looking at their shares’ Cyclically Adjusted Price/Earnings (CAPE) ratio — a key measure of valuation — and their long-term CAPE average ratio.
UK- CAPE 17.8; long term average 19.3
Despite the FTSE 100 index of leading shares being within several hundred points of its all-time high, its present valuation is slightly lower than its long-term average. Laith Khalaf of Hargreaves Lansdown, the wealth manager, says: “Sentiment towards the UK stock market is poor right now, which means it’s probably a decent time to invest, even if it feels uncomfortable.” Jason Hollands from Tilney Group, the wealth manager, says that contrarian investors could benefit from the fact that, over the past 18 months, it has been comparatively out of favour.
US- CAPE 32; long-term average 24.8
The US economy opened 2018 in seemingly good health. Arguably, US stocks look expensive compared with other markets and their long-term average. However, Romain Boscher of Amundi, the fund manager, says that earnings-per-share growth is strong, and this will help to bring down expensive valuations. On top of this he argues that the Trump tax reforms and strong economic growth will boost certain consumer and retail stocks.
The recent market correction looks less shocking when placed in the context of a long period of robust returns. Indeed, while the S&P 500 Index is broadly flat over 2018, it stands some 16% higher than this time last year.
EUROPE- CAPE 18.2; long-term average 20.6
The eurozone economy expanded at its fastest rate in a decade last year. GDP in the 19 countries in the single currency rose 0.6 per cent in the final three months of 2017, according to a flash estimate from Eurostat, the European Union’s statistics provider. Annual growth was 2.5 per cent, compared with 1.8 per cent in the UK. Germany has experienced its strongest economic growth in six years. Full order books have prompted increasing demands for pay rises from unions, with workers at Daimler and Porsche preparing to strike this week.
Mr Boscher says: “After a period of relative [stock market] underperformance in 2017, we expect Europe to return to the spotlight, thanks to a strengthening economic outlook, good growth in earnings per share, rising capital expenditure and dynamic merger activity.”
JAPAN- CAPE 26.8; long-term average 43.0
The valuation for Japan may look superficially expensive, but as Mr Khalaf points out, it is the cheapest developed market compared with its history.
“The Japanese government is throwing the kitchen sink at the economy in order to get it going, and it is one to consider.”
ASIA PACIFIC- CAPE 19.5; long-term average 22.3
Although Asian equities have risen strongly in the past six months, the region’s stocks remain some of the best value.
Mr Khalaf says: “The region is home to some of the most dynamic economies in the world and more adventurous investors the potential for some exciting long-term growth.”
EMERGING MARKETS- CAPE 16.3; long-term average 19.4
This is the market that stands out as cheap, says Mr Hollands. He says: “Valuations still look attractive, even though there were really strong returns in the sector over the past 12 months. A lot of the rise was concentrated in a small number of Chinese tech stocks, so there are still a lot of opportunities.”
Adrian Lowcock of Architas, the fund manager, warns that investors need to distinguish between different countries. India, for example, is expensive because markets are pricing in some of the benefits of Prime Minister Modi’s reforms. Russia, on the other hand, remains cheap, because of the recession a few years ago and its poor record of corporate governance.”
Reeves Model Investment Portfolios
Once again, all of our model investment portfolios have performed better than our FTSE All-Share Index benchmark during February. 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 (as happened in January). 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. This is exactly what happened in February, as reflected in the graph below. Moreover and very importantly, all of our model portfolios performed better than the FTSE All-Share Index benchmark during February.
Also of note is the fact that all but one of the considerable number of funds held within all three model portfolios outperformed the FTSE All-Share index, as at the date of our Investment Team meeting on Thursday 22 February.
During our monthly Investment Team meeting, the Reeves Investment Team met with a Regional Representative for AXA Investment Managers UK Limited. The meeting focused on the 3 investment funds which we currently hold within our model portfolios, namely AXA Framlington Biotech GBP Z Acc, AXA Framlington Financial Rl Acc & AXA Framlington Global Technology Z Acc. All three AXA Framlington funds have produced strong positive returns and continue to perform well. The AXA Framlington Biotech GBP Z Acc maybe pausing for breath, but it has consistently outperformed its benchmark (‘IA Specialist’) by some considerable margin and the future prospects for biotech developments already in the pipeline offer the prospect of further opportunities for further positive returns.
Having made a number of strategic changes to our model investment portfolios in January, we are now allowing time for these changes to bed in and for the markets to settle down and regain their equilibrium. We therefore do not propose to make any further changes at this time.
As stated above, our model portfolios are performing well and behaving as we would expect in different market conditions. As more volatility is expected in coming months, we feel that our model investment portfolios are well-placed to continue performing in a similar fashion, depending on which direction the market goes and the underlying risk profile of each portfolio.
Meanwhile, we are pleased with the changes we made last month, namely increasing our exposure to emerging markets and Europe, reducing our cash balance and buying in to a market correction, and selling our direct exposure to the oil market. During February, European stocks posted their best week since 2016, following the temporary global sell off in early February. “Europe has jumped higher out of the blocks,” said Fiona Cincotta, market analyst at City Index, in a note. “This indicates that the market has quickly adjusted to the prospect of higher future inflation and a more hawkish Fed. Let’s not forget, the backdrop hasn’t changed, earnings remain strong and company outlook’s encouraging,” she said.
Also responding to this month’s market correction, Justin Urquhart-Stewart, co-founder of Seven Investment Management made the following observations: “As far as buying opportunities are concerned, the UK mid-cap sector is, for the first time in a long while, cheaper than the large caps. There hasn’t been a better moment to buy domestic British stocks in years, as long as you can hold your nose on the Brexit negotiations.” In addition, “A number of [overseas] markets look relatively inexpensive, usually because the initial reaction is one of fear. Many European banks trade at less than their book value, and many frontier markets such as Vietnam and Argentina, while seeming scary, have solid fundamentals for the long term.”
These comments support our selection & strategic long-term retention of the JPMorgan Mid Cap Investment Trust plc (which has increased in value by around 26% over the past year even after the recent market correction) and BlackRock Frontiers Investment Trust plc (which has increased in value by around 16.5% over the past year; 9.5% over the past 6 months). Urquhart-Stewart’s comments also support our recent strategic investment decisions, which have strengthened our exposure to Europe and consolidated our exposure to global emerging markets, via the Aberdeen Emerging Markets Investment Company Limited.
Evidently, the Reeves Investment Team has the capacity & expertise to identify the right sectors and best individual funds at the right time. The obvious ongoing challenge is to get it right every time, which we steadfastly strive to achieve.