Market Outlook Report – December 2016

Overview

You would have to say it has been a bracing few months, particularly for the pound. The wind has blown sterling in one direction and that's sharply down. That has brought clear consequences for the economy, notably higher inflation. The governor of the Bank of England, Mark Carney, has recently warned that higher inflation is “going to come” as retailers are forced to pass the higher costs of their imported goods onto consumers.

However, manufacturers are benefiting from weaker sterling. The latest purchasing managers’ survey for the sector from Markit shows that export orders are driving a mini-revival in our factories.

graph of UK manuacturing pmi  to october 2016

Manufacturing PMI has shown a resurgence in months as companies benefit from the weaker pound

A further, positive consequence of weaker sterling is the current account deficit. That's the amount that this country is in the red in its transactions with the rest of the world. The deficit used to be regarded as the one of the best measures of the nation’s economic health.

A benefit of weaker sterling is that net UK trade (exports minus imports), having made a negative contribution to growth in recent years, is forecast to make a significant positive contribution next year and beyond. The trade deficit in goods and services, standing at £39bn last year, is now predicted to disappear before the end of the decade.

Finally, weaker sterling also has an impact on investment income. Foreigners previously enjoyed better returns on the investments they made in Britain than British people and institutions achieved on their overseas investments. However, the lower pound has boosted the sterling value of foreign assets meaning that Britain’s net international investment position has now improved. It also leaves the sterling value of foreign-owned assets here unchanged which boosts the value of foreign income for UK investors.

As a prudent wealth manager, we invest our managed pension portfolios in diversified international collective investments. We anticipate these will benefit from the recent relative decline in sterling’s value.

US Presidential Election Result

First political pundits were wrong-footed, then it was the turn of the world’s market-watchers. Donald Trump’s victory in the American presidential election had everybody flummoxed.

After Donald Trump’s recent surprise victory, the markets reacted relatively calmly overall. His triumph was supposed to be the trigger for a global sell-off in equities but, in fact, indices soared. The Dow Jones industrial average hit an all-time high as finance professionals quickly boned up on Mr Trump’s economic policy, something that few had thought they would need to do. Reassured by his focus on an infrastructure spending blitz, investors pushed shares higher.

Nevertheless, the aftershocks of Mr Trump’s election continue to be felt. This has resulted in fresh highs for sterling, the dollar and equities. Much of these gains have been fuelled by investors celebrating the end of election uncertainty and by Mr Trump’s promise of greater spending and reduced taxes.

Traders are also pricing in an 83 per cent chance that the Federal Reserve will raise interest rates next month after its chairwoman, Janet Yellen, said that rates would rise “relatively soon”.

Donald Trump’s election victory has put economists in a bit of a quandary. Many are critical of substantial aspects of his agenda, particularly his protectionist policies. Most did not favour a Trump victory. Could it be that Mr Trump’s domestic agenda, including tax cuts and a huge infrastructure programme — a boost that his advisers say will be worth at least $1 trillion (£800 billion) — is exactly what many economists, particularly those on the left, have been calling for over many years?

Trump's election has given the markets a quandary

Since the financial crisis in 2007-09, growth in the west has disappointed. Growth rates have been lower than in the pre-crisis period despite loose monetary policy. Years of near-zero interest rates and the use of unconventional tools such as quantitative easing (QE) have helped economies grow but have not restored the kind of performance that was the norm in the past.

lower EU GP growth chart

Annual GDP growth in Europe, like much of the western world, has been lower since the 2008 financial crisis

So is Mr Trump now the toast of economists hungry for an aggressive fiscal expansion and salivating over his promise to make America’s infrastructure the envy of the world? Has he come up with a policy prescription that might have been expected from a left-winger?

Not exactly, though economists think that something important is stirring. Markets have begun to pick up on this shift, selling government bonds on the basis that a lot more of them may be issued and that all this spending could have an inflationary impact.

We have exposure to the American market in our recommended model portfolio and will be maintaining these positions for the foreseeable future. Performance from our selected funds over the past year has been strong:

PERFORMANCE OF OUR US FUNDS

Fidelity American Special Situations

iShares Core S&P 500 USD Acc​

Jupiter North American Income Acc​

Schroder US Mid Cap Acc​

up 31.79%

up 32.93%

up 32.55%

up 37.67%​

Fund performance statistics sourced from Morningstar.co.uk as at 18 November 2016.

At present, our US fund positions are a firm ‘Hold’.

The Post-Brexit Journey

It’s now more than four months since the plunge in sterling that followed the vote to leave the European Union in June. Mark Carney, governor of the Bank of England, has said that he expects the weaker pound to improve the trade deficit, but that it “takes time”.

However, the competitive advantage to British companies conferred by the drop in sterling should be significant. According to the Office for National Statistics, the pound in October was 20 per cent lower than a year earlier. We have already seen clear evidence of the positive impact of the steep plunge in the pound, with the export of branded British food and non-alcoholic drinks increasing by almost 14% in the third quarter of this year.

UK food and drink industry

UK food and drink industry exports have benefited from weaker pound

The latest export figures from the Food and Drink Federation represented the biggest quarterly export sales it had recorded and built on the second quarter, “which was in turn the largest [increase] up to that point”. The overall value of all exports, including food and drink commodities, rose to £3.4 billion in the third quarter, up 12.1 per cent on last year.

Meanwhile, British retail sales grew by 1.9 per cent, pushing annual growth up to 7.4 per cent in October, its fastest pace in 14 years. Tesco recently reported that in the three months to November had risen by their fastest rate in three years.

Figures from the Office for National Statistics brought more good news in the form of a fall in unemployment to an 11-year low in the first full quarter after June’s referendum result.

UK Inflation

uk inflation graph to november 2016

Monthly inflation rate figures for the United Kingdom are reported by the Office for National Statistics

Inflation dipped unexpectedly last month but economists have warned that a huge build-up in the cost of raw materials for manufacturers and producers will soon start to eat into household incomes. The consumer prices index fell from 1 per cent in September to 0.9 per cent in October, defying expectations from economists that it would reach a two-year high of 1.2 per cent.

One of the main reasons for the dip was that clothes prices and university tuition fees rose by less than they did a year ago.

The sharp fall in the pound since the EU referendum, which is down 15 per cent against the dollar and 11 per cent against the euro, has led to an increase in the cost of imports. The cost of raw materials and oil for producers in the UK jumped 4.6 per cent in October, which was a record monthly jump. This, in turn, has led to manufacturers increasing the prices of goods leaving the factories. Factory gate, or output, prices rose by 2.1 per cent, faster than expected and the biggest increase since April 2012.

On the basis of all the information I have received, I am inclined to consider that CPIH should become the ONS preferred measure of consumer inflation and the focal point of ONS commentary in due course. I consider that it is important that a measure of owner occupiers’ housing costs is included in the measure we make the focal point of our commentary.

John Pullinger
National Statistician

Britain’s national statistician has urged the authorities to switch to a measure of inflation that includes housing costs and council tax to provide a more comprehensive picture of the way that prices are changing. John Pullinger, Head of the Office for National Statistics, has decided to make CPIH “the preferred measure” from March 2017, in a move that may affect pensions, benefits and rail fares.

CPIH is an augmented measure of the Consumer Prices Index (‘CPI’) which the Bank of England is mandated to follow for its 2 per cent inflation target. Pensions, benefits and income-tax thresholds are linked to CPI, and increases in train fares, water bills and £500 billion of inflation-linked government debt are indexed to the retail prices index (RPI). Because the CPIH tends to be higher than CPI and lower than RPI, the move could put more money in the pockets of workers, commuters, pensioners and benefit claimants. Although the ONS does not have the power to force policymakers to change the measures they use, the decision will put pressure on them to make the switch.

The Bond Market

Putting your money into bonds — government gilt-edged stocks and corporate bonds — should be a reassuring option. However, this has not been the case this year. The Brexit vote in June and Donald Trump’s election victory have dealt a double blow to investors. These IOUs issued by governments and companies, usually seen as a safe haven, have given their holders a rollercoaster ride in recent months.

UK Government 10-year bond prices have fallen substantially since the referendum result as yields have risen

First, after the Brexit vote, investors rushed to buy gilts, which pushed up prices and depressed yields. Then they sold out of them en masse when the outlook became more uncertain.

Now investors have sold $1.14 trillion (£915 billion) worth of US government bonds in the wake of Trump’s election. They are concerned that Trump policies, such as big spending on infrastructure projects, will mean issuing more bonds, hitting the value of existing bonds. These infrastructure projects could also create inflation, which is bad for bonds.

Will my pension be affected?

If you are in a defined contribution company pension scheme, the size of your pension pot at retirement will be determined by how your investments, including bonds, have done. So a rise in bond prices will boost your retirement pot, and a fall will reduce its value.

The recent falls in bond prices will be bad news.

If you are in a final-salary company scheme, where payouts are linked to final salary and years of service, your money is likely to be heavily invested in bonds. Since the financial crash of 2008, bonds’ popularity has driven up their prices and correspondingly driven down their yields. As bond yields have fallen, the size of pension-scheme deficits has grown bigger because lower yields mean less money to pay pension liabilities. Now that bond prices have been falling, bond yields have been rising, thus shrinking the deficits in final-salary schemes. It sounds counterintuitive, but defined-benefit schemes want bond prices to fall because it makes yields rise.

What lies ahead?

In the past 30 years bonds have been through an exceptional period of good returns and seemed almost risk free, but lately things have changed. As a result of the rise in bond prices, yields have sunk so low that many bonds have been giving investors zero or even negative returns, but Mr Trump’s election victory may have marked the turn of the tide. There has certainly been an assumption in the past ten years that these things are risk free. They are not.”

Election victory for #Trump in the US may have marked the turn of the tide in falling bond prices

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Cap on pension early-exit fees

The Financial Conduct Authority has recently announced a cap of 1% on exit charges for savers aged 55 and over who wish to cash in their pensions will come into effect on March 31 2017. Many pension customers face fees of 5% or more of their pots if they switch to a new provider or withdraw money before their “selected” retirement date, according to the FCA. The cap will apply to personal, workplace personal, stakeholder and self-invested personal pensions. A separate 1% cap on exit fees for occupational pensions is expected to come into effect next October.​

Investment Performance Summary of Reeves Managed Pension Balanced Portfolio

Name Total Ret
1 Day
(Daily)
Total Ret
1 Wk
(Daily)
Total Ret
1 Mo
(Daily)
Total Ret
3 Mo
(Daily)
Total Ret
6 Mo
(Daily)
Total Ret
1 Yr
(Daily)
Summary
Benchmark:FTSE AllSh TR GBP 0.20 0.51 -1.69 0.31 10.55 12.09
Aberdeen UK Property I Acc 0.00 0.02 0.18 3.57 -4.57 -6.54
AXA Framlington Biotech GBP Z Acc 0.37 -0.73 2.91 0.47 21.01 -1.69
AXA Framlington Financial Rl Acc -0.41 1.38 2.91 11.99 27.61 19.35
AXA Framlington Global Technology Z Acc -0.78 1.36 -1.96 8.53 33.97 31.83
Baillie Gifford Shin Nippon Ord -0.12 -0.96 -8.75 4.59 10.75 30.25
Empiric Student Property PLC 0.87 1.98 2.62 4.62 9.55 12.33
F&C UK Property 2 inc 0.00 0.09 0.37 2.85 -0.59 1.86
Fidelity American Special Situations -0.07 1.59 2.81 8.62 28.62 32.16
Fidelity Special Situations W Acc -0.64 -0.32 -0.77 3.06 10.22 12.73
GCP Student Living Ord 0.00 0.00 1.05 -0.65 6.24 4.00
Henderson Global Technology I Acc -0.94 1.11 -3.45 5.95 29.34 26.59
Investec Cautious Managed I Acc Net -0.53 -0.13 -0.27 3.21 11.09 16.64
iShares Core S&P 500 USD Acc 0.29 1.49 1.49 7.72 26.71 31.32
JPMorgan European Smaller Comp Ord 0.06 -0.22 -9.67 -4.11 10.62 19.63
JPMorgan Mid Cap Ord 0.14 1.33 0.43 1.57 -0.71 1.72
Jupiter Financial Opportunities Inc -0.63 1.09 -4.06 3.28 15.44 12.27
Jupiter North American Income Acc -0.13 0.74 2.16 7.34 25.98 31.38
Lazard European Smlr Coms Retl C Acc -0.79 -0.04 -6.32 -3.35 7.44 16.03
Liontrust Special Situations I Inc -0.43 0.18 -3.63 -3.08 8.69 13.34
Marlborough Special Situations P Acc -0.21 0.61 -1.14 0.08 4.56 9.09
MedicX Ord -0.06 0.01 2.35 2.72 4.95 10.10
Schroder European Sm Cos Z Acc -0.81 0.00 -6.29 -1.69 14.04 21.37
Schroder US Mid Cap Acc 0.00 2.22 3.33 10.99 30.30 36.68
Target Healthcare REIT 0.00 0.00 1.60 0.95 0.75 5.57
Threadneedle Eurp Sm Cos Ret Z GBP Inc -1.02 -0.50 -9.74 -6.09 8.20 19.18
Threadneedle UK Prpty Authrsd Invmt IGA 0.00 0.09 0.34 1.38 -1.51
TR Property Ord -0.13 -0.88 -10.31 -12.23 -1.58 5.86
Tritax Big Box 0.00 0.00 0.00 2.43 8.51 16.07

Source: Morningstar as at 25 November 2016

Access a PDF of this table here.

The above table illustrates the continued overall strong performance of our core Balanced pension portfolio, with the majority beating the performance of the FTSE All-Share Index. We continue to monitor the performance of out portfolio investments and adjust the composition accordingly, as appropriate. We are pleased with the performance to date and we constantly strive to achieve optimum investment outcomes for our clients in the future.​