Detailed Market Overview
Recent Global Market Turmoil
Britain’s blue-chip shares have suffered their worst quarterly fall in nearly seven years as fears of an international trade war with the United States and a tech market sell-off battered stocks. After enduring intense volatility this year, the FTSE 100 closed up 11.87 points at 7,056.61 last night. While it marked a gain of 0.17 per cent on the day, shares on the index have lost 8.2 per cent of their value this year. That is the worst performance since the third quarter of 2011 and came despite the FTSE 100 hitting a record high of 7,778.64 in mid-January, since when it has fallen by 9.3 per cent.
The decline has mainly been attributed to fears that steel and aluminium import tariffs of 25 per cent and 10 per cent respectively, introduced by President Trump, will spark a damaging trade war with China that could also ensnare the European Union. Also, after four years of strong gains, fears of a sharp drop in tech stocks on Wall Street have been exacerbated in recent weeks by a data privacy scandal that has gripped Facebook and Google.
US markets have also endured a torrid first quarter. The Dow Jones industrial average, is down around 2.3 per cent this year. The S&P 500 is 1.2 per cent lower over the first quarter, whilst the technology-heavy Nasdaq index is 2.9 per cent off this year.
Things weren’t helped when, in mid-March, President Trump threatened to impose $60 billion tariffs on Chinese imports to counter Beijing’s alleged theft of American trade secrets and to rebalance a $375 billion deficit in goods traded. China responded with a threat to impose $3 billion tariffs on imports of US farm produce and metals, leading to fears that the world’s largest economies were on the brink of a trade war. As a result, US stock markets suffered their worst week since January 2016 as investors pulled money from American shares and put it into safe-haven assets.
Yet, at the beginning of last week, stock markets in the United States achieved their best daily percentage gains in 29 months, as fears of a global trade war receded. After American and Chinese officials softened their rhetoric after threatening each other with billions of dollars of import levies last week, Wall Street reacted with little-disguised delight.
The Dow Jones industrial average climbed by 669.40 points in one day, its largest points gain since 2008 and third best ever, to close up by 2.8 per cent at 24,202.60. The broader-based S&P 500 rose by 2.7 per cent and the technology-focused Nasdaq index added 227.88 points, its biggest points gain in a day since 2001.
In Asia stocks markets bounced with Japan’s Nikkei 225 rising 2.65 per cent. Europe followed with Britain’s FTSE 100, Germany’s DAX and France’s CAC indexes all gaining more more than 1 per cent.
Steven Mnuchin, the US Treasury secretary, said he was “cautiously hopeful” that the countries would come to an agreement on trade imbalances. China pledged to ease restrictions on American businesses operating in the country and to buy more microchips from US manufacturers.
After the rollercoaster ride we have experienced so far this year, some investors who have grown used to stock markets’ positive returns may be feeling queasy. That does not mean we should rush for the exit, however. “Markets do not rise in straight lines”, says Nancy Curtin, Chief Investment Officer of Close Brothers Asset Management. Our view is that 2018 will be a year in which world markets deliver more modest returns and we also expect the volatility to continue – but it’s important to recognise that ups and downs are absolutely normal, even in [an overall] rising market”. The Reeves Investment Team share this view, subject to some minor tweaks to our model investment portfolios, which are explained later in this Market Outlook report.
There are two main reasons why investors should hold tight. The first is that the global economic outlook remains remarkably benign. While markets have been spooked by the fear that US inflation will prompt a more aggressive rise in interest rates than expected, economists at groups such as the International Monetary Fund still predict that the global economy will grow at its fastest pace since 2010.
Moreover, while political risk is also a concern (for example Brexit in Europe and President Trump’s protectionist policies in the US), volatility can create opportunities for investment managers, says Robert Alster, Close Brothers’ Head of Research. “When investors are nervous, even good companies get marked down, which means they may offer more vale”, he says.
The second reason to hold our nerve is that investment should always be viewed as a long-term pursuit. If you cannot accept that the value of investments may fall as well as rise, especially in the short term, you should avoid equity-based assets. Rather than worrying about short-term volatility, you focus on long-term goals. If you are investing over 20 years to build a pension, a few months of ups and downs is largely irrelevant. This is not to suggest that we should ignore risk altogether. Instead, we aim for a diversified portfolio, with savings spread over shares, bonds, and alternative investments including property and gold. Such a strategy offers a degree of protection from volatility in any one market/sector/asset class.
Also, consider regular savings through which to invest a fixed sum each month. Such arrangements help smooth out market ups and downs, as your cash investment buys more shares in month when prices have fallen, which lowers your average cost and helps you recover more quickly when the market recovers.
With further turbulence likely, we remain focussed on the long-term objective of growing the value of our clients’ pension funds, whilst mitigating the impact of market downturns. The cost of trying to second-guess the market is likely to be much higher than staying in the market. This has been repeatedly illustrated/proven in many empirical studies.
International investors have shunned UK markets since the Brexit vote, but some fund managers say that now is the time to buy undervalued stocks.
Pessimism towards UK stock markets is entrenched among global fund managers, according to a survey by Bank of America Merrill Lynch. The research found a consensus among professional investors that Britain’s stock markets were to be avoided and that sentiment hadn’t been this bad since the financial crisis. Even among British investors, our stock markets were the ones that people felt least confident about, according to research from Hargreaves Lansdown, the wealth manager.
This gloomy mood has been reflected in stock market performance. While global markets soared through 2017, the UK markets were weak in comparison. Michael Clark, the portfolio manager of the Fidelity Moneybuilder Dividend fund, says it is political uncertainty that has kept investors away, while the amount of money US fund managers have allocated to the UK is at a historically low level.
“The FTSE 100 and the FTSE All-Share have underperformed versus the US and European markets. People are worried about the political direction, or lack of it. It isn’t clear what will happen. It has a lot of people ruling out the UK [for investment], particularly Americans. They don’t want to allocate here because they fear there is going to be a disaster,” he says.
Yet Mr Clark says that shunning British companies doesn’t make sense, given that in many respects, the economy is fine. “The fundamentals of the UK are reasonably sound. We are still expecting GDP growth. It has been revised down, but we are still expecting it. The economy is strong enough to take higher interest rates, and the consumer economy, based on full employment, is doing well,” Mr Clark says.
Richard Buxton, the manager of the Old Mutual UK Alpha fund, says: “The UK market has underperformed and some of it is understandable and justified. But pessimism in some of the consumer-facing stocks is unjustified, because investors are pricing in a very tough economic backdrop. I think it may not be that bad.”
With global investors having such negative sentiment towards the UK, the million-dollar question is when will their outlook change? Mr Clark says: “At some point there will be more positivity, but this is very hard to call. I suspect we will have to wait until the first quarter of 2019, when Brexit has happened. But when valuations appear like this, it is always important, in my view, to get in early and buy.”
We are maintaining our investment exposure to UK markets, but are tweaking the composition of our special situations funds, as detailed further down in this report.
Economic growth in Europe hit a ten-year high of 2.5 per cent in 2017, eclipsing the UK’s 1.8 per cent. Despite Dutch, French and German voters being lured towards the far right, Europe chose a more stable course politically. However, the inconclusive result of the recent Italian elections threatens to throw a cloud of uncertainty over the continent once again. We examine the arguments for and against Europe.
The biggest fear for investors was that the Italian elections would produce a government of populist parties that would carry out their threat to hold a referendum on leaving the eurozone. Yet despite the political stalemate that has emerged after the strong showing of two anti-establishment parties — the Five Star Movement and the eurosceptic Northern League — Adrian Hilton of Columbia Threadneedle Investments, an asset management company, doesn’t think the chances of Italy leaving the eurozone have gone up substantially. “Both parties have toned down their Euroscepticism in recent months and surveys continue to show a popular majority in favour of membership of the single currency. The constitutional obstacles to a Brexit-style referendum in Italy are also considerable.”
While stock markets appear to be shrugging off any immediate concerns about the election result, it does reinforce a more worrying long-term trend, says Ian Ormiston, the manager of Old Mutual Europe Smaller Companies fund. He says that in Italy, just as in France and Germany, parties at the fringe have gained at the expense of those in the centre. “Centrist parties are not offering the answers that electorates across the world want to hear,” he says. “Across Europe the mood continues to deteriorate among voters, even as the economy creates jobs and incomes continue to rise.”
Dean Tenerelli, the manager of the T Rowe Price Continental European Equity fund, says most investors are looking past the short-term political worries in Europe and focusing on the stronger economic fundamentals, such as the recovery in corporate earnings.
The eurozone’s manufacturing Purchasing Manager Index, a key measure of business confidence, reached its highest level in December, says Stuart Mitchell, the manager of the SW Mitchell Capital European fund. He says: “Our company visits tell of a corporate sector recovery continuing to outpace more cautious market expectations. European markets remain good value, trading at a 36 per cent discount to the US.”
Yet headwinds remain, according to Hartwig Kos of SYZ Asset Management. He says: “Inflationary pressures in Europe have remained muted, but question marks about European Central Bank policy are undoubtedly rising. Further euro currency strength has the potential to undermine the case for European equities, particularly exporters in northern Europe.”
Our Investment Approach to Europe
Smaller companies tend to outperform their larger counterparts in every large region of the world. Last year European smaller companies returned 20.3 per cent against 12.3 per cent for mainstream European stocks.
Although some sectors are not as cheap as they were, Nick Leung, a research analyst at Wisdom Tree in Europe, a provider of exchange traded funds (which track an index), sees opportunities in the industrials, consumer and financials sectors. Also, with its prestigious universities and skilled workforce, Europe is a hub for innovative technology.
Maike Currie, the investment director at Fidelity International, a fund manager, says: “Europe is no longer the bargain it was a year ago, but it still looks attractive. Political fears have receded, although not disappeared, and while the European Central Bank may be slowly turning off the liquidity tap, it is not raising interest rates any time soon, which should be good news for shares.”
We have established a long-term core exposure to European markets in our model investment portfolios, via a diversified selection of collective investment funds, including JP Morgan European Smaller Companies investment trust, Lazard European Smaller Companies, Schroder European Smaller Companies and Threadneedle European Smaller Companies. Clearly, our focus is on smaller European companies. This diverse and constantly changing area of the European market offers investors exposure to some niche growth areas that, often, cannot be accessed through large companies. They also tend to grow more rapidly than larger firms.
The JP Morgan European Smaller Companies Investment Trust PLC has an emphasis on capital growth, is well diversified and is one of the few investment trusts to focus on the European smaller companies market. The Company aims to provide capital growth from a diversified portfolio of selected undervalued high quality smaller companies from across developed European markets (excluding the United Kingdom).
Lazard European Smaller Companies (OEIC) fund seeks to generate strong relative returns compared to the MSCI Europe Small Cap Index over a market cycle by investing in the smallest 10 per cent of European-listed companies by market capitalisation. It is rather different from many of its peers in that it invests in the UK as well as continental Europe.
The Schroder European Smaller Companies (unit trust) fund invests at least 80% of its assets in equities of small-sized European companies, excluding the UK. These are companies that, at the time of purchase, are similar in size to those comprising the bottom 30% by market capitalisation of the European equity market, excluding the UK. The fund may also invest in European companies headquartered or quoted outside the Europe which derive a significant proportion of their revenues or profits from Europe.
Threadneedle European Smaller Companies (OEIC) invests at least two-thirds of its assets in shares of smaller companies in Continental Europe or companies that have significant operations there. In doing so, the Fund focuses on businesses that are smaller in size than the top 225 companies in the FTSE World Europe (ex-UK) Index. The fund may also invest in asset classes and instruments other than ordinary shares. The fund permanently invests a minimum of 75% of its assets in European Economic Area equities, and is therefore PEA (Plan d’Epargne en Actions) eligible in France. The PEA status allows the fund manager to manage a portfolio of European securities whilst benefiting from preferential tax conditions.
Our four European smaller companies funds we have selected have produced annual returns of between 13%-15% over the past 12 months. We believe there is potential and reasonable likelihood for further capital growth in these strategic investments
Whilst there is understandable concern about the ongoing threat of an escalating trade war lead by the US, the underlying fundamentals of the US economy appear to be strengthening. During March, Americans filed fewer new claims for unemployment benefits last week than in any week since 1969. Unemployment claims is an important indicator of the health of the US labour market, and in turn, the health of the American economy, which is the world’s largest.
A separate report showed that consumer prices increased moderately in February. The core personal consumption expenditures price index, which is the Federal Reserve’s preferred measure of consumer price inflation, rose by 0.3 per cent month on month in January, with the annual rate staying at 1.5 per cent. The Fed’s annual inflation target is 2 per cent. Personal incomes climbed by 0.4 per cent month on month in January and consumer spending increased by 0.2 per cent, the personal incomes and outlays report showed. Paul Ashworth, chief North American economist at Capital Economics, said: “With consumer confidence elevated and disposable incomes rising, we don’t expect the softness in spending to last long. Assuming it rebounds, rising inflationary pressures will keep the Fed hiking interest rates.” Manufacturing output increased unexpectedly in February, another report showed. The Institute for Supply Management’s manufacturing index climbed to 60.8 from 59.1 in January, maintaining a 13-year high. Construction spending was flat in February, although there is much anticipation about future prospects resulting from President Trump’s national infrastructure rebuilding programme.
Whilst we are maintaining a core long-term exposure to the US markets through a diversified range of US-sector funds, we are changing the composition of our selected funds to strengthen and consolidate our ongoing position, as outlined later on in this report.
Early Retirement put on hold
Those looking forward to early retirement should prepare for disappointment. One of Britain’s biggest insurance and pension providers has said that the days of people retiring early will have disappeared within 20 years. Aviva said that higher life expectancy, the decline in final salary pensions, a rise in the state pension age for women and financial pressures mean that most people can expect to have to work into their 70s.
The number of people retiring before the age of 65 peaked in June 2011 at 1.6 million, after years of continued increases since records began in 1993. After seven years of declines, that number has since fallen by a quarter to 1.15 million people.
Aviva said that if this trend continued it would mean the “death of early retirement” by 2035. That would mean nearly everyone born after 1970 working beyond their 65th birthday. Alistair McQueen, head of savings and retirement at Aviva, said that a significant number of people used to retire at 55 thanks to final salary pensions. With those disappearing, “it is a necessity for many to keep working”.
Reeves Model Investment Portfolios
Once again, all of our model investment portfolios have performed better than our FTSE All Share Index benchmark during March. 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 a 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 Cautions model portfolio to show more resistance/resilience, and perform better than our Balanced and Adventurus portfolios. This is exactly what happened in March, as reflected in the graph below.
As the market (as measured by the FTSE All-Share Index) has fallen by approximately 11% since its peak in January, we remain cautious about near-term prospects. That’s why we have maintained a 32.59% cash balance, which has been a bold position to take but it has certainly mitigated our clients’ exposure to market risk and the significantly reduced the impact of the recent market downturn.
Whilst maintaining a sizeable cash-flow has limited our measured exposure market risk & volatility, around 23% of our selected collective investment funds have produced positive returns over the past month, despite the overall decline in global market values. This is particularly pleasing and noteworthy.
A number of our clients have benefitted further, by electing to reduce their market risk exposure by switching model investment portfolios in recent months have benefitted from such a cautious tactical move.
During our monthly Investment Team meeting, the Reeves Investment Team met with Regional Representatives from Coram Asset Management, who manage three open-ended investment companies (OEICs), managed by MitonOptimal UK Limited, namely the Coram Global Defensive fund, Coram Global Balanced fund & the Coram Global Opportunities fund. The uninspiring performance of all three funds didn’t impress the Reeves Investment Team, nor ignite the desire to incorporate any of them within our model investment portfolios.
The Reeves Investment Team also met with representatives from First Trust. The meeting was useful and informative, and whilst their funds were of more interest, again the Investment Team was not minded to make any changes to our model investment portfolios based on this meeting.
The changes that have been made following last month’s Reeve’s Investment Team meeting include:
Email communications will be going out shortly to those clients whose investment portfolios are affected by these latest strategic changes.
Aberdeen Emerging Markets Investment Company Ltd (AEMC) Corporate Action
We recently selected Aberdeen Emerging Markets Investment Company Ltd for inclusion in our model investment portfolios. It was selected to provide clients with exposure to the ongoing growth potential of emerging markets, via a fund which is being turned around by a new management regime and offers good future prospects for future growth.
The £320 million fund-of-funds gets its exposure to emerging markets by investing in other funds and investment companies, which results in a highly diversified portfolio. However, prior to our acquisition in the fund, it had not been matching the MSCI Emerging Markets index. For the year to 31 October the company reported a total return on net assets of 14.9%, falling short of the 16.6% from the MSCI index. The managers blamed a number of their Asian fund investments for failing to match their benchmarks, including Fidelity China Special Situations (FCSS), Weiss Korea Opportunity, and Schroder International Selection Taiwanese Equity.
Ahead of a shareholder continuation vote on 12 April it has sought to keep investors happy by scrapping its performance fee and launching a tender offer to enable shareholders to sell back some of their shares at a higher price. The tender offer will allow shareholders to sell 10% of their stakes at a discount of 3.5% to NAV. This is designed to appeal to value investors such as City of London Investment Group which have built up large stakes in the fund.
AEMC has performed better since managers Bernard Moody and Andrew Lister took over in 2014. Moody and Lister added to funds investing in ‘favoured’ parts of the world, including Findlay Park Latin American fund, Avaron Emerging Europe fund, and Neuberger Berman China Equity fund, the latter of which closed to new investors at the end of last year. Since emerging markets’ low point in February 2016 to end of 2017, the fund has delivered a share price total return of 74.9%, which Moody and Lister said marked ‘improvement in the fundamental outlook for emerging markets’.
As this is a relatively new holding within our model investment portfolio, we have not advised clients to sell a proportion of their shares back to the Company so soon after acquisition. The investment trust appears to have turned a corner under its new management regime and the outlook/prospects for the emerging markets sector remain positive. Therefore, we have recommended no action on this tender offer to sell shares back to the company.