With unemployment falling rapidly in many developed economies and close to record lows in some, the debate is no longer about shortages of demand but whether inflation will take off. Government bond yields, for so long seen as proof of the existence of secular stagnation, are rising. Talk of a large global co-ordinated fiscal stimulus has also gone out the window. Instead, the talk is of how soon and how quickly interest rates will rise, following the latest recent hike by the US Federal Reserve.
Overall, the global economy is looking a bit more normal. Growth in the advanced industrial economies is respectable, inflation is picking up and interest rates are rising. The US has expanded for the past 30 quarters and unemployment remains low. The eurozone has grown for 14 quarters; last quarter’s GDP growth, at 0.4 per cent, meant that growth for the year amounted to 1.7 per cent, just shy of Britain’s figure.
Yet the global economy remains in a fragile state. The recovery is starting from a position of serious fragility. High overall debt levels leave the global economy vulnerable to shocks, whether from a cyclical downturn in a major economy, rising interest rates, or political shocks including economic nationalism.
During March, the Bank of England voted to hold interest rates at 0.25 per cent, although traders were surprised by a vote for a rate rise by the outgoing Bank policymaker Kristin Forbes and a number of other monetary policy committee members indicating that they might soon follow suit. Earlier on the day, the Bank of Japan maintained its rate. A “doveish ” interest rate rise by the US Federal Reserve helped to push the FTSE 100 to a new record high in March. In a widely expected move, the Fed voted on Wednesday to raise interest rates by a quarter of a percentage point, marking its second increase in three months and only the third since the financial crisis. More importantly for investors, the central bank also dampened growing speculation that it would raise interest rates further and faster than it had previously indicated. Investors interpreted the Fed’s position as doveish, sending shares up on both sides of the Atlantic and yields on US government bonds down sharply. Gold prices have seen a rebound after the U.S. Federal Reserve raised its benchmark rate by 25 basis points. Since then, the weakness in the dollar has led to further strength in gold prices.
Wall Street fell last week as investors worried that President Trump would struggle to deliver the promised tax cuts that have helped to boost confidence and propel America’s markets to record highs in recent months. The sell-off came as a new 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 latest poll of institutional investors shows 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
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 IWM is aware of the fragility of the global economy and all of the challenges and uncertainties which might throw the recovery off course. This is why we maintain a widely diversified investment portfolio and retain a prudent cash balance within this balanced approach. A market correction is inevitable following a prolonged rally; it’s just that the accurately predicting the timing is extremely difficult. Research has repeatedly shown that trying to beat the market by pre-empting a envisaged market correction are costly and it is better to ride such fluctuations over the medium to long-term and avoid missing the equally unpredictable bounce-back recovery. Such volatility is part of the risk-reward nature of stock market investment, but it can be mitigated by a diversified portfolio (both geographically and sectorally) in well-managed, low-cost funds with consistently strong performance records. This is the approach taken by Reeves IWM.
Following our latest Monthly Investment Meeting, it has been judged appropriate to reduce our exposure to US and UK equities, whilst adding 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).
UK Special Situations
UK Equity Income
The table above represents the adjustments advised to our Model Portfolios. This will result in a temporarily increase in cash holdings, this is a short term measure.
Inflation surged faster than expected in February to 2.3 per cent from 1.9 per cent in January, manufacturers claimed to be as confident as they had been in two decades and official data showed that public borrowing was running at its lowest level since the financial crisis. The trio of upbeat releases buoyed foreign exchange traders and the pound has climbed against the dollar and the euro. The pound has fallen by 15 per cent against the dollar since last June’s referendum, driving up import costs and pushing up prices.
The resilience of British industry after the Brexit vote has been underlined by a study revealing that the majority of small manufacturers grew orders over the final six months of last year. The national manufacturing barometer found that 57 per cent of small and medium-sized companies increased sales while two thirds expect revenues to rise over the first half of this year. There was a 9 per cent increase in the number of companies expanding their turnover compared with the survey results six months ago. Manufacturers are being boosted by the weakness in sterling, which makes their goods more competitive overseas, and solid domestic demand.
Meanwhile, the lower pound has helped manufacturers to deliver the highest rise in export orders in more than three years, making companies more optimistic about the future than at any time in the past two decades. Indeed, businesses expect the pace to quicken still further and to grow at the fastest rate since February 1995. The rising orders have generated higher output at factories, which rose at its quickest pace since July 2014 in the three months to March.
However, rising inflation has sent household confidence into a decline that threatens to drag down the economy, separate surveys have warned. Families are more pessimistic about their finances than at any point in the past three years, with household budgets under as much pressure as they have been since late 2014, according to IHS Markit. Research by the Bank of England, meanwhile, indicates that consumer demand is waning.
Both reports blame the deteriorating outlook on the collapse in the pound since Brexit. Cheap sterling has driven up inflation, which is accelerating faster than wages and is squeezing household incomes, official data shows. Such factors will mitigate the instinctive inclination to raise interest rates in response to rising inflation, which is driven by rising costs rather than excessive consumer demand.
At last, we seem to have some explicit acknowledgement by the Bank of England at least (Gertjan Vlieghe) that it's not inevitable that interest rates must always automatically rise in response to higher inflation, irrespective of what is causing prices to rise. Automatically raising interest rates is not the universal silver-bullet solution to every inflationary scenario. Markets expect a first rate rise in the second half of next year.
Britain’s shoppers flooded back on to the high street in February but it was not enough to prevent retail sales recording their biggest quarterly fall in nearly seven years, according to official figures. Rising inflation, and higher fuel prices in particular, ate into households’ disposable income, leaving less for other purchases, the Office for National Statistics said. Sales volumes for the three months to February fell by 1.4 per cent, the largest decline since March 2010 and only the second fall since December 2013. Economists had expected the poor quarterly performance to be even worse. February’s sales increased by 1.4 per cent on the previous month, beating forecasts and lifting the pound by half a cent against the dollar to $1.2504.
In recognition of the increasing uncertainty around the foreseeable prospects for the UK economy, we have judged it appropriate to reduce our UK market exposure within our model investment portfolios.
Consumer prices in the United Kingdom increased 2.3 percent year-on-year in February of 2017, above 1.8 percent in January and beating expectations of 2.1 percent. It is the highest inflation rate since September of 2013. On a monthly basis, consumer prices increased 0.7 percent.
Economists said that inflation’s surge to its highest level since September 2013 suggested that the Bank of England may have been complacent about the risk of escalating prices since Brexit. Inflation is already above the Bank’s 2 per cent target and is accelerating faster than expected. Last month, the Bank forecast prices to rise at only 2.05 per cent in the first quarter. Core inflation, which strips out volatile food and energy prices, has also hit 2 per cent, suggesting that price rises are embedded in the domestic economy.
For the first time, the Office for National Statistics published three measures of inflation this month. The consumer prices index (CPI), until now the headline measure and the measure targeted by the Bank of England, the retail prices index (RPI), the longest standing measure, having being first calculated in June 1947, and the CPI including owner occupiers’ housing costs (CPIH), which for the first time is presented as the ONS’s preferred or headline measure. Headline inflation measures don’t change very often. Indeed until today there has been only one such change — when the CPI superseded the RPI — in all the time that regular measures have been produced.
(Last Ever) UK Spring Budget
- Healthcare An extra £2 billion will be spent on social care to ease pressure on the NHS.
- National insurance Contributions paid by self-employed people earning more than £8,000, will rise from 9p to 11p in the pound. The move will land 1.2 million basic rate taxpayers with an average tax increase of £205 a year.
- Personal taxes Income tax will become payable at £11,500 in April, up from £11,000.
- Tax-free dividend allowance will be cut from £5,000 to £2,000 — which will affect more than 400,000 pensioners and raise £2.6 billion over five years.
- Business rates A £435 million relief package
- Economy Growth this year is forecast by the OBR to reach 2 per cent, up from previous predictions of 1.4 per cent
Budget Changes In More Detail:
MPs will vote in the autumn on the proposed class 4 national insurance increases from 9 per cent to 10 per cent in April 2018 and then to 11 per cent in April 2019. The increases apply to earnings between £8,060 and £45,000. The change will mean an average annual increase of £240 for the self-employed from April 2018. Class 2 national insurance, a separate, flat-rate contribution paid by self-employed workers who make an annual profit of more than £5,965, will be scrapped as planned in April next year.
Personal tax allowance
The amount that you can earn before paying tax will increase from £11,000 to £11,500 in April. The higher-rate income tax threshold will rise from £43,000 to £45,000.
The tax-free dividend allowance
This will be reduced from £5,000 to £2,000 from April 2018, a move that will affect small business owners who pay themselves in dividends, as well as investors with large share portfolios. Dividend income paid on investments held in a stocks and shares Isa will remain tax-free.
The government-backed bond from National Savings & Investments will launch next month paying 2.2 per cent on deposits of up to £3,000.
Money purchase annual allowanceFrom April the Treasury will cut the allowance from £10,000 to £4,000. This means that those who have started drawing an income from their pension plan will be allowed only to pay in additional contributions of up to £4,000.
Those seeking to move their pensions abroad to take advantage of different tax regimes will be hit with a 25 per cent tax charge.Corporation tax
By 2020 corporation tax (the amount paid on company profits) will fall from 20 per cent to 17 per cent. This could benefit those who hold properties within limited companies.
Digital tax returns
Small businesses, landlords and self-employed people who have a turnover of less than £83,000 a year will have to file quarterly digital tax returns from April 2019. Originally it was April 2018.
Rate rises for businesses losing their small-business rate relief will be capped at £50 a month. There will also be a £1,000 discount this year on business rates for pubs with a rateable value of less than £100,000.National living wage
This will rise from £7.20 to £7.50 an hour next month. For a full-time worker it equates to a pay rise of more than £500 a year.Duty on tobacco
A minimum excise duty on cigarettes will be introduced in May. On Wednesday the cost of tobacco rose 2 per cent above the retail prices index (RPI), adding 35p to a packet of 20 cigarettes and 42p to a pack of rolling tobacco.Duty on alcoholThe cost of beer, cider, wine and spirits will increase from Monday in line with RPI inflation: 2p on a pint of beer, 1p on a pint of cider, 36p on a bottle of whisky and 32p on gin.
From April 2018 soft drinks containing 5g of sugar per 100ml will be subject to an 18p levy per litre, rising to 24p for drinks with 8g or more of sugar per 100ml.
Impact of Budget on Investments
The FTSE 100 slipped 31 points to close the week ending 10 March at 7,343, as investors gave a lukewarm reaction to Philip Hammond’s spring budget.
- Over a year, the index is up 20.3% (up 25.1% with dividends).
- Over three years, it is up 9.9% (up 23.4% with dividends).
- Over five years, it is up 24.8% (up 50.6% with dividends).
- Over 10 years, it is up 20.6% (up 75.9% with dividends).
As many as 2.3 million savers and entrepreneurs will be hit by a cut in the tax-free dividend allowance announced in the budget. The concession, which was introduced only this tax year, is to be reduced from £5,000 to £2,000 from April 2018. The chancellor, Philip Hammond, wants to discourage small-company owners from the practice of drawing dividends rather than salaries to reduce their tax bills. However, the reform will also hit savers who have an investment portfolio worth £50,000 or more — at least 400,000 of these are retirees.
Its withdrawal will enhance the appeal of individual savings accounts (Isas), which offer tax-free income and growth.
Older workers hit by a move to penalise ‘double-dippers’
A loophole giving over-55s extra tax relief on pension savings will be narrowed from next month. Under changes confirmed in the government’s budget, savers who have already taken an income from their pension pots will have the amount they can continue putting away tax efficiently for retirement cut to £4,000. The change is designed to stop abuse of the system by so-called doubledippers, who withdraw money from a pension after reaching 55, the age that investors can access their pensions, only to put it straight back in for a second-helping of tax relief. The practice is called “recycling” and a higher-rate taxpayer can qualify for £1,125 a year of free money by doing this.
Most people under retirement age are eligible for tax relief on up to £40,000 saved into a pension each year, although different rules apply for high-fliers earning more than £150,000. The much lower limit of £4,000 will affect pension savers who have triggered the money purchase annual allowance (MPAA), a complicated clause that kicks in when someone takes an income from their pension. The MPAA was introduced in 2015 at £10,000.
The eurozone economy is growing at an annualised rate of more than 2 per cent, its fastest for more than six years and faster than the US. Every country in the eurozone economy is growing and the growth is across all sectors. The latest surveys show sharp increases in manufacturing and services activity, order books and business optimism, with French output stronger than Germany for the first time since 2012. Meanwhile job creation is at its strongest in almost a decade and unemployment is down to 9.6 per cent, down a percentage point in a year and its lowest since 2009.
European stock markets face an especially challenging time in 2017. In addition to the continuing turmoil over Britain’s exit from the European Union, there are elections in three European countries where the far right has a chance of winning and creating further disruption, as electors in the Netherlands, France and Germany collectively decide the political fate of Europe.
The other headwinds
The rising tide of protectionism threatens to disrupt world trade and hit some of the successful multinational companies that are based in Europe. Mr Dowling says pharmaceuticals have come under fire for ratcheting up their prices to customers, and many European funds have substantial holdings in the sector.
Martin Todd, the manager of Hermes European Alpha Equity Strategy, says there are plenty of other flashpoints. “In Turkey, President Erdogan’s authoritarian grip on society is strengthening, while on the Russia-Ukraine border conflict smoulders.”
Despite the gloomy news, the European economy is steadily picking up. Unemployment continues to fall while the latest figures show growth in manufacturing and services. Tim Stevenson, the manager of Henderson EuroTrust, says: “Europe’s gross domestic product is expected to grow by about 1.5 per cent in 2017 and an improving economic climate is leading to more relaxed government spending.” Mr Todd says: “While the risks posed by far-right parties and instability in eastern Europe are myriad, we believe that investors focused on large-scale political events may be missing out on opportunities at the company level. Companies are not the economy or politics of any nation. It is important to step back from the endless stream of depressing headlines to recognise the strength of balance sheets within many European companies.”
Although Europe is home to many of the world’s most successful and innovative companies, European stocks are significantly cheaper than US stocks, with valuations averaging only 15.8 times earnings compared with 18.2 times for US stocks. Mr Dowling says the political uncertainties that led investors to pull large amounts of money from European markets after the Brexit vote have made European shares attractive to bargain hunters. He says the average discount to the real, or net asset, value at which European investment trusts trade almost doubled in the month after the referendum. Yet, as his company’s research shows, many of the trusts were “European funds” only in the sense that they invest in companies that are domiciled in Europe. He adds: “While the sector was seeing its share prices battered by fears about the health of the EU in the wake of Brexit, many funds it contained were drawing revenue streams from all over the world.”
Our selected European funds have performed very well over the past month (Schroder European Smaller Companies Z Acc up 4.86%, Threadneedle European Smaller Companies Z Inc up 3.53% and the JPMorgan European Smaller Companies Investment Trust up 6.57%. Our clients have benefitted from these pleasing returns.
The US economy has surged since the presidential election in November, with stock markets hitting repeated highs. As markets have soared, so too has inflation. The US Federal Reserve’s preferred measure of inflation, the personal consumption expenditures index, has risen to within touching distance of the central bank’s 2 per cent target. Consequently, America’s central bank signalled the end of an era of ultra-low borrowing costs this week, as it raised interest rates for the second time in three months and forecast two further increases this year. The federal open market committee (FOMC), the central bank’s policymaking body, voted nine to one to lift the federal funds rate range by a quarter of a percentage point, to between 0.75 per cent and 1 per cent. The committee’s decision to raise rates, which was widely expected, came after several positive economic reports in recent weeks, including stronger than expected jobs figures in March. The federal funds rate stood at 5.25 per cent when the financial crisis struck. The Fed embarked on a series of cuts in September 2007, reducing the rate to a range of 0 per cent to 0.25 per cent by the end of 2008. The next rise would come seven years later, and the one after that in December last year.
The committee noted yesterday that inflation had “increased in recent quarters” and was “moving close” to its 2% target. Two recent reports suggest that inflationary pressure was building further. The consumer price index rose to a five-year high of 2.7 per cent in February, up from 2.5 per cent the month before. Retail spending rose by 0.1 per cent in February, in line with expectations, a separate report showed. Spending in January was revised upwards to growth of 0.6 per cent.
Meanwhile, American employers added 235,000 new jobs in February, the first full month of Donald Trump’s presidency, blasting through economists’ expectations. The unemployment rate, which is calculated from a different survey by the US Department of Labor, fell from 4.8 per cent to 4.7 per cent.
US job growth - monthly change in workers, excluding farm employees:
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. Consequently, during our latest Monthly Investment Meeting, we decided to reduce our exposure to the U.S. in our model investment portfolios, following recent US market jitters which have started to have an impact on the value of U.S. funds.
The performance of the default/benchmark Reeves IWM Balanced portfolio is summarised below.
Reeves Version 17C Balanced Portfolio - 27/03/2017
The above table reflects the strong performance of our selected European funds over recent months (as commented on above) and illustrates the reasoning behind our recent decisions to reduce our exposure to the U.S. in our model investment portfolios (following recent US market jitters which have started to have an impact on the value of U.S. funds).
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