Market Outlook Report – April 2016

Market Overview – The Year So Far

Markets at the beginning of 2016 broke away from the anomaly known as the ‘January effect’ – a term coined to describe the tendency of stock prices to increase during the first month of the year.

The FTSE 100 Index endured its worst start to the year on record, although the Index crept to its highest level since the end of 2015 in April.

Globally, the financial markets face great uncertainty.  The China slow down and questions about the integrity of their reporting are a regular feature in most investment managers’ reports.  Ongoing uncertainty regarding Brexit continues to impact both UK and other European markets.  The International Monetary Fund (‘IMF’) recently warned that the global economy is in danger of stagnating and that political leaders across the world should start preparing for the worst, as the global economy slips into a low-growth trap.

We therefore continue to recommend a cautious approach and a diversified investment strategy with cash remaining a strategic holding in our managed portfolios.  This defensive stance has protected our clients from much of the recent volatility and poor performance of many international markets.  Most portfolios have also been helped by positive property returns which are held at relatively high levels.  Cash and property both feature in the top ten performers of the past 12 months, with property being ranked the 4th best performing sector in that time.  Threadneedle Property is currently our largest individual holding and has led the way for our fund selection showing an 8% return – double the sector average.

For those clients wanting more market exposure, we advise a movement towards reinvestment (switching) rather than an ‘all in approach’.  In particular, and especially for our higher risk rated clients, we believe it is time to reduce our cash and UK property holdings in favour of specialist funds.  We have used technology funds ‘off and on’ for many years now and these funds remain our preferred equity sector for long term growth.

Financial companies have been struggling for some time but, taking a longer term view, we remain comfortable that these remain good funds to hold.  They are currently in the worst performing sector of the year, which we see as a buying opportunity.

Another core holding in our managed portfolios is US equities. They have performed well in recent months.  However, we believe that our exposure to this sector is too high and will move into alternative funds to diversify and mitigate risk.

Gold prices have soared in this year, driven by uncertainty in other markets which has encouraged investors to move into this sector.  There could be further gains in gold for clients that are not happy with cash as the place to be in times of uncertainty.  However, be warned that it will not be a long term hold and historically gold prices are very volatile.

A number of our ”braver” clients have invested in tracking oil prices.  Whilst the price of oil has turned around in past weeks, whether or not we have seen the lowest of oil prices remains to be seen.  However, if you are prepared to take the longer-term view, tracking oil prices remains a positive in our view.

In summary, the message we are repeating almost daily at the moment is to remember that investment returns do not go in smooth predictable lines and investing in equities does not a guarantee positive return, even in the long term. Just ask those investors that invested in 2000 (16 years ago) when the FTSE 100 Index was at around 7000 points.

Europe

It has been a poor start to the year for equity markets worldwide and the Eurozone has been no exception; the Eurozone economies grew at a modest pace of 1.6% in 2015.  Fears over global growth, lower commodity prices and weaker emerging economies led to a sharp decline in equity markets.  Encouraging European Central Bank policy announcements have, however, helped to improve market sentiment.

Whilst closely monitoring the future recovery potential of the European market, our unique perspective on investment trust companies has identified a particular European investment trust of interest, namely JPMorgan European Smaller Companies Investment Trust plc.  It is one of the few investment trusts to focus on the European smaller companies market.  The trust aims to provide capital growth from a diversified portfolio of smaller European companies (excluding the United Kingdom). As the emphasis is on capital growth rather than income, shareholders should expect the dividend to vary from year to year.  The company has the ability to use borrowing to gear the portfolio within the range of 20% net cash to 20% geared in normal market conditions.

1 Year 3 Years 5 Years Since Inception
Share Price 18.78% 62.88% 66.80% 957.82%
Benchmark 4.04% 30.24% 30.13% 592.30%

Inception: 24 Apr 1990. Benchmark: Euromoney Smaller European Companies ex UK GBP. Source: J.P. Morgan Asset Management.

If you are interested in this fund and would like it included in your portfolio, please speak with one of our team.

Gold

The price of gold has risen sharply, as nervous investors have returned to the precious metal as a safe haven.  With ongoing financial turmoil and uncertainty in recent weeks, gold has regained its status as a defensive investment. Prices have risen by around 18 percent so far this year.  Many clients have holdings in gold funds, such as BlackRock Gold & General and ETFS Physical Gold.  In many cases these holdings will have endured a lengthy period of ‘paper losses’, so the recent recovery in the price of gold provides an opportunity to consider whether to switch these holdings to a less volatile sector for the medium/long-term.

Those investors with existing exposure to gold should consider whether now would be an opportune time to exit this market and switch to a broader, more diversified investment fund holding.

Oil

The crash of nearly 75 per cent in oil prices that played out over 18 months has decimated the budgets of producer countries and led to mass job losses and investment cuts across the industry.  Continued volatility and hints of a possible sustained recovery in the price of oil mean that we are keeping a very close eye on this sector.  Investment commentators are increasingly split over the next move for oil after its rebound from a 12-year low last month, setting the market up for further sharp price changes in 2016.

Financials

The London Stock Exchange, property companies, insurers, asset managers, wealth managers and of course, banks – such are the kinds of companies which define the interestingly diverse UK financials sector of the FTSE All-Share index.

The financial landscape is shifting in favour of tailored customer solutions. Mobile banking, online lending, more sophisticated credit scoring and more flexible savings products are all evidence of this trend.  Whilst the major banks have not stood still, they have been preoccupied with the legacy of the 2008 global financial crisis and the way has been opened for lower cost more innovative operators to take advantage of newly emerging technologies.

The so-called ‘challenger’ banks such as Virgin Money and Metrobank have made their mark but remain relatively small players in the banking sector. Yet they still face the same stringent regulatory environment as the older and larger incumbents. The competitive environment is further intensified by the fact that a number of UK asset managers have recently expanded into loan provision, most notably Legal & General.

But perhaps the most innovative development has come from the growth of peer-to-peer (P2P) lending platforms, where entities are not subject to banking regulation. These platforms are in a position to offer similar products to that of banks with lower overheads. P2P lenders argue that their credit scoring technology is ‘as good as the banks’, if not more granular, while their turnaround of business is much faster. Because they do not need to hold regulatory capital or liquid assets, nor operate physical branches or deal with outdated legacy IT systems their costs of making and administering small short term loans are much lower than for banks.  Given its relative infancy, there are few means of investing directly in this area through quoted companies.

One fund manager who has identified these evolutionary developments within the UK financial sector and tailored his managed funds accordingly, is Mark Barnett, Head of UK Equities, Invesco Perpetual.  His funds include Edinburgh Investment Trust plc, Keystone Investment Trust plc, Perpetual Income & Growth Trust plc and Invesco Perpetual Select Trust plc (UK Equity Share Portfolio only).

If you would like to discuss investment opportunities within the Financials Sector, as part of your long-term investment strategy, please contact one of our team.

Investment Opportunities

We are proactively monitoring specific market sectors that have exhibited significant volatility and price falls in recent months, looking for potential recovery opportunities particularly in the oil & technology sectors, Chinese and Japanese markets and collective recovery funds generally.  The obvious challenge in trying to benefit from any recovery in these sectors is timing, given the continued uncertainty and suppressed investor sentiment which prevails.

‘Drip-Feeding’ in to a Volatile Market

Given how far stock markets have fallen, more aggressive investors may be minded to look for potential recovery opportunities.  This could prove to be beneficial in the long-term, but given continued market uncertainty, it’s impossible to know when if and when the market has ‘bottomed-out’ until after the event.  Therefore, clients may wish to consider ‘drip-feeding’ cash funds back in to the market over the coming months.  This approach offers the opportunity to make market fluctuations work in your favour. If prices increase in the short-term, the strategy will be validated.  If prices fall, investors will be buying better long-term value, reducing their average unit/share costs and benefit from ‘pound cost averaging’.

Data from Fidelity shows that an investor who put £1,000 in the FTSE All Share index 30 years ago but missed the best ten days in the market since then would have achieved an average annual return of 7.09 per cent and ended up with a total investment of £7,812.  That compares with a return of 9.38 per cent a year and an investment worth £14,734 if they had stayed in the market the whole time.

Pound-Cost Averaging

Pound cost averaging is a less risky method of investing your savings.  The effect of pound cost averaging is that you’re buying assets at different prices on a regular basis, rather than buying at just one price.  And while riding out the movements of the market, you could also end up better off than if you’d invested a single lump sum.

As a simple illustrative example, if you invested a £10,000 lump sum and bought shares valued at £10 each, you’d have 1,000 shares, each costing the same price of £10.

However, if you bought £2,500 worth of shares per month over a 4 month period (amounting to £10,000 overall), you would buy different amounts each month, depending on the prevailing market price at the time of each transaction:

Month Investment Share Price Number of Share Purchased
1 £2,500 £10 250
2 £2,500 £8.33 300
3 £2,500 £8.93 280
4 £2,500 £9.26 270
Total Investment: £10,000 Average Price Paid: £9.22* 1,100

* £10.00 + £8.33 + £8.93 + £9.26 = £36.52.  £36.52/4 transactions = £9.13 average transaction price.

The average share price paid over the 4-month period for the 4 share transactions is £9.13

However, over that period, you have acquired 1,090 shares – 90 more than if you had made a one-off lump sum investment.  And the true average cost of each share acquired is £9.09 (£10,000/ 1,100 shares); £0.13 lower than the arithmetic mean average share price and 9% cheaper per share than if you had made a one-off lump sum investment.  Meanwhile, your £10,000 investment is worth £10,186 (1,100 x £9.26) in month 4.

If you can see the benefits of drip-feed investments and feel that now is an appropriate time to increase your market exposure, please get in touch with one of our team.

If you would like to talk about your portfolio please contact us on 0191 281 9862 or e-mail dianne@reevesifa.com to arrange an appointment.

Sources:

We gain our information from a range of sources including seminars, webinars, industry publications and general media comments.

Disclaimer:

This report is not intended as advice and no investment decisions should be made solely on the back of this email. Past performance is not necessarily a guide to future performance. All investments carry the risk that you will not get back what you have put in.