Detailed Market Outlook Report – November 2017

Reeves Monthly Client Market Outlook Report

During a recent client meeting, Nigel was asked whether our monthly Client Market Outlook updates were generic ‘off-the-shelf’ reports produced by/copied from a third party. Whilst this misconception was taken modestly as a complement on the quality of our reports, we wanted to clarify that all our publications are compiled in-house over the reporting period by our Investment Team. Whilst much of our coverage will inevitably be generic, reflecting topical economic events, germane investment market news and ongoing political developments, we always endeavour to tailor our coverage to explain how these wider macro issues specifically affect our investment strategy and their impact on our clients’ investments. And so to this month’s overview.

Market Overview

The first thing to highlight is the positive performance of our in-house managed funds, compared with the FTSE All-Share Index benchmark. As the graph below illustrates, all of our funds have significantly out-performed the benchmark index. This reflects the fund choices selected by the Reeves Investment Team and their positive performance since acquisition. We are happy that our investment strategy is able to deliver such positive returns even when global stock markets generally are dragging asset values in the opposite direction. We can’t get everything right all of the time, but our informed clients understand the challenges we face and benefit from the strategic diversification and well-researched fund selection decisions we have made. We endeavour to continue delivering positive results and outperform underlying market benchmarks going forward.

The above graph illustrates our portfolio performance that was reviewed in our recent investment meeting

Following the strategic portfolio changes made last month, it was decided during the November Investment Team meeting not to make any additional changes this month. Our meeting inevitably highlighted particular areas of focus and identified specific funds which we were closely monitoring, we will wait until the New Year before making any incremental changes. We appreciate that constant portfolio changes are time consuming for our clients and there are inevitable transaction costs in implementing such changes. However, they are only ever made with the best intentions for our clients, i.e. to protect your pension funds as best we can and to optimise the potential for those funds to grow.

UK

It is less than two weeks since Philip Hammond delivered his budget. Hammond will go down as the chancellor who, against the traditions of the election cycle, loosened policy after a general election, even though there was no real room to do so, a reflection of the government’s very weak position. If it is followed by an agreement at the EU summit on December 14-15 that “sufficient progress” has been made to move on to trade, Theresa May’s administration will end the year in a stronger position than it dared hope a few weeks ago, when cabinet ministers were falling like ninepins. A government that is stable, if not strong, will help business and consumer confidence.

The chancellor has borrowed more, yet was able to point to a faster fall in public sector debt — relative to gross domestic product — than in March. That was partly because of the reclassification of housing associations to the private sector, which takes their debt off the government’s balance sheet, and also the decision to raise about £15bn by selling most of the government’s stake in Royal Bank of Scotland. Hammond is often regarded as a sober accountant-type but he and his officials are nothing if not creative.

However, the OBR has been wrong on productivity over past five years, and as far as I can see, there’s no reason to believe that they will get it right over the next five years. Indeed, productivity actually went up in the last quarter so, although one data point doesn’t necessarily point to ongoing improvements, it is entirely plausible that the OBR has made this change at precisely the wrong time. Indeed, leave supporting politicians have accused the OBR of producing excessively gloomy forecasts that cast Brexit in a bad light, although Robert Chote, chairman of the government’s fiscal watchdog, said the claims were “without any foundation whatsoever”.

Nevertheless, market momentum already seems to be waning in the UK, given the unique (Brexit & low productivity) challenges we are facing. As Paul Johnson, director of the Institute for Fiscal Studies, put it: “The forecasts for productivity, earnings and economic growth make pretty grim reading. One should never forget, of course, that these are just forecasts. But they now suggest that GDP per capita will be 3.5% smaller in 2021 than was forecast less than two years ago, in March 2016. That’s a loss of £65bn to the economy. Average earnings look like they will be nearly £1,400 a year lower than forecast back then, still below their 2008 level. We are in danger of losing not just one, but getting on for two, decades of earnings growth.”

Another key reason why the FTSE 100 has recently come under pressure is renewed confidence about Britain’s departure from the European Union. This helped sterling to complete its best month in November since April 2015. However, the FTSE, which is dominated by companies that report their earnings in dollars, often struggles when sterling rises. The pound hit a ten-week high of $1.355 last Thursday.

As November drew to a close last week, the pound finished the month ahead of any other member of the world’s group of 10 (G10) exchange rates. It rose almost 2.5 per cent as market nervousness over Brexit subsided a little, putting it marginally ahead of the euro.

Analysts urged caution, however. “This week’s sterling bounce on reports that the UK has accepted a higher financial divorce settlement with the EU seems based on the false assumption that the way is now clear for the European Council on 14-15 December to authorise moving on to the next phase of the Brexit process,” Christopher Granville, managing director at TS Lombard, said.

As the market turbulence and uncertainty continues, we remain comfortable with our strategic balanced approach to our investment portfolios. We have maintained a sizeable cash balance as a prudent measure to take advantage of a major market downturn, whilst maintaining diversified portfolio of shares with exposure to wider global markets. Meanwhile, we are beating the market

We have been particularly pleased with our recent acquisitions in the Pyrford Global Total Fund and the Threadneedle Dynamic Real Return Fund. Both were selected as relatively low-risk funds, with the Pyrford Global Total Fund investing in a combination of shares, government bonds and cash with the aim of delivering attractive long term growth with less volatility than the stock market. The Threadneedle Dynamic Real Return Fund is a research-driven multi asset portfolio targeting equity-like returns with around two-thirds the volatility, which targets an inflation +4% (gross) return, regardless of market conditions over the medium. As explained in our previous Market Outlook report, both fund managers share our risk-averse, cautionary position and the selection of these funds reflects our stated objective of finding optimum investments which provide an attractive return within a safe and liquid investment product. Both of these funds have performed modestly well in the very short period that we have included them in our investment portfolios, against a backdrop of dreary market conditions.

US

The Dow Jones industrial average broke through 24,000 for the first time last week, as President Trump’s tax cuts moved a step closer. The index, which represents the combined strength of 30 of America’s largest companies, rose by 331.67 points to reach 24,272.35 in New York last week, a gain of 1.4 per cent for the day and 3.8 per cent for the month.

The Dow broke through the 20,000 barrier for the first time in its 132-year history shortly after Mr Trump took office in January. It went on to breach 21,000 in March, 22,000 at the start of August and 23,000 in the middle of October.

Stock market analysts disagree on what has powered the Dow to repeated records this year. Some believe that it is the president’s promise of sweeping tax cuts but others point to the underlying strength of corporate America after the country’s largest companies reported better-than-expected financial results for the past three quarters.

Reeves clients are well placed to participate in the current buoyant US stock-market, with core long-term fund holdings including Fidelity American Special Situations, Jupiter North American Income Acc and iShares Core S&P 500 ETF USD Acc.

Oil/Energy

Our model balanced investment portfolio maintains a proportionate exposure to the oil market, via the ETFS Brent Oil 1 month ETC fund. We were therefore pleased to see hear hat the world’s biggest oil producers have agreed to continue limiting their output throughout 2018 in an effort to reduce a global glut of crude and support prices. The deal between Opec, the 14-nation cartel whose members pump a third of the world’s oil, and ten other producers led by Russia, the world’s biggest producer, will be subject to a review in June in case it sends prices too high. The price of Brent crude oil, the global benchmark, rose by 0.73 per cent to $63.57 a barrel after the widely expected agreement at a meeting in Vienna last week, extending a deal first secured a year ago when oil was trading at less than $50 a barrel. Although brimming global inventories have started to fall as a result of the agreement, which withholds about 2 per cent of world supplies, stocks remain well above long-term averages. Oil was trading at less than $50 a barrel before the production curbs were agreed a year ago. Saudi Arabia has been particularly keen to maintain higher oil prices to improve the prospects for its planned initial public offering of Aramco, the state oil major.

Fund in Focus

Scottish Mortgage Investment Trust PLC

One of our core portfolio holdings is the Scottish Mortgage Investment Trust PLC, which we selected for our clients some months ago. With assets under management of £4.5 billion, Baillie Gifford's Scottish Mortgage Investment Trust is the largest global generalist investment trust in the UK. It won Money Observer's Best Global Trust award in 2015 and 2016.

It has been managed for the past 17 years by James Anderson, and Tom Slater became his co-manager in 2014. Anderson is fiercely committed to a long-term, high-conviction approach and the trust's portfolio contains only around 70 holdings, with the top 10 accounting for more than 50 per cent by value. Companies are bought on a minimum five-year view. The trust reiterated its strategy in last week’s half-year figures. “Scottish Mortgage is best suited to those who share its long-term approach to investing.”

With only 75 holdings, the top 30 accounting for 85 per cent of all assets and the top ten for more than half. The net asset value per share rose by 17.5 per cent over the first half, while its share price rose by 15.4 per cent. It is not easy to find a comparator for a trust of this nature, but world equity markets did little over that period in sterling terms.

Over the five years to the end of September the total return was 222.8 per cent. Net assets per share were ahead by 193.1 per cent. A passive investor would have seen about half that total return.

Over the five years the total return was 213.4 per cent.  A passive investor would have seen about half that total return.

After strong share price growth over the past couple of years, Scottish Mortgage is the biggest quoted investment trust. Its stable of mainly high-tech investments have been selected because they can be expected to at least double sales over a five-year period. The trust’s performance has tended to track that of Nasdaq though it has outperformed the high-tech US market of late.

The trust sold out of Apple, for example, the world’s biggest company, because the managers do not expect that sort of sales progress in future. Instead they are focused on disruptors such as Amazon, Tesla, the electric vehicle maker, and three Chinese internet companies: Tencent, Alibaba and Baidu.com. The share prices in these businesses have been especially strong over the first half to the end of September.About 13 per cent of the fund is invested in private companies, while there is the authority to take this to 25 per cent. Among these are Spotify, the digital music service with more than 60 million subscribers, and Airbnb, the online provider of accommodation. This gives access to early-stage investments that are not easily available elsewhere. This is a significant advantage, offering the sort of returns that would generally only be available to private equity.Scottish Mortgage believes the next growth area could be healthcare, through the development of personalised treatments and diagnosis. This explains the investment in Illumina, a San Diego-based business that develops products for gene sequencing.Only 4 per cent of Scottish Mortgage is in the UK, so its geographic diversification is another advantage. Twice-yearly dividend payments have generally increased over the past three decades although this year’s payment is expected to be merely maintained, and the managers have indicated a willingness to make any future payments out of capital if necessary.

Scottish Mortgage will inevitably suffer if markets are in turmoil, but as a long-term holding in a well-managed, diversified international investment portfolio with a consistently strong performance record, the trust is difficult to beat. That is why it is a core, long term investment holding within our model portfolios, delivering positive returns for our clients.

Closing Comments

November has proved to be a painful month for equity investors. Battered as the pound has risen on hopes of a Brexit “deal” the FTSE 100 ended the month down 2.1 per cent yesterday. Will December prove any more profitable? It is historically the best month of the year for the markets, prompting talk of a “Santa Claus rally”. According to The Harriman Stock Market Almanac the index has fallen only three times in December since 1995, although two of those times were in 2014 and 2015. Whatever happens in the markets generally, we believe that our diverse investment portfolios will continue to maintain their respectable performances against the market indices benchmarks and protect our clients from the worst affects of any potential market downturn. That’s our job and to date we have been pleased with the strategic decisions we have made during 2017. We hope to continue achieving the same results in 2018.

In the meantime, the entire Reeves team would like to wish each and every one of our clients a very happy Christmas and a peaceful and prosperous New Year.