Market Outlook Report – November 2016


Inflation is back. Figures published by the Office for National Statistics revealed that Consumer Price Inflation (‘CPI’) reached 1 per cent in September. That's a fair hike from 0.6 per cent in August.

The increase is down largely to rising prices for hotel rooms, clothing and petrol. And the cost of filling up a car is almost certain to rise again after oil prices hit a year-high of $53.50 per barrel during the month. It's important to note that the data does not yet reflect the recent falls in sterling, so there are likely to be more increases around the corner. Some economists are predicting that CPI will reach 3.5 per cent by the end of 2017.

Sterling has continued its post-EU referendum bumpy ride and is still 17 per cent weaker against both the dollar and the euro than at the start of the year.

pound continues to slide

The threat of further falls in the value of Sterling is starting to threaten the UK's credit worthiness

The weaker pound and looming inflation proved lethal for UK government debt markets, pushing the value of gilts further down.

The UK's Creditworthiness is Coming into Question

International investors are concerned that rising inflation and further slumps in sterling could mean the UK’s creditworthiness is challenged. This is important because this group makes up 27 per cent of the holders of UK debt. Consequently, yields on government bonds have recently been trading at more than 1 per cent for the first time since the referendum.

This is good news for annuity rates, which have risen by 3.4 per cent in the past month.

GOOD NEWS: Annuity rates are finally on the up.

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Meanwhile, the FTSE 100 index of leading shares this week briefly exceeded (in intra-day trade) its record closing high of 7,104.

By way of explanation, the FTSE 100 index has been boosted by the weaker pound. A weaker exchange rate inflates the sterling value of British companies’ overseas earnings. And since stocks in the FTSE 100 derive 75 per cent of their earnings from abroad, the falling pound provides them with a currency windfall.

However not all companies stand to benefit from the latest ride in the currency roller coaster. Those that import substantial amounts of goods, or who have large dollar-related costs, could be hit hard.


  • In the past year, the FTSE 100 index is down 10.5% (down 5% with dividends).
  • Over three years, it is down 4.5% (up 8.9% with dividends).
  • Over five years, it is up 6.1% (up 30.1% with dividends).

The above figures underline the importance and positive impact of reinvesting dividend payments over time.

UK Inflation

UK consumer price inflation (‘CPI’) jumped to a 22-month high of 1% in the year to September 2016. That compares to 0.6% in the year to August.

This was the highest inflation rate reported since November 2014. The increase was also above market expectations of a 0.9 percent gain. The Office for National Statistics (ONS) reported the key drivers were rising prices for clothing, overnight hotel stays and motor fuels. They also said that a weaker pound has contributed to the increase.

Inflation in the United Kingdom averaged 2.59 percent from 1989 until 2016. Within that time it peaked at a high of 8.50 percent (April 1991) and slumped to -0.10 percent (April 2015). The Bank of England says it is happy to see higher inflation after it hovered near to zero for 18 months.

uk inflation rate graph nov 2016

The UK inflation rate for the year to September jumped to 0.9 per cent

Mark Carney, the Governor of the Bank of England, said that imports would soon be more expensive. He also said that the price of food would be the first to be affected. Economists anticipate that inflation will soon accelerate upwards and many foresee rates above 3 per cent within a year.

Carney has warned that millions of households are set to see their living standards squeezed as inflation outstrips wage growth. Wages have been increasing by little more than 2 per cent a year. This is much less than the predicted rise in the cost of living.

The Implications of Higher Inflation for Investors

The obvious explanation for the recent inflationary increase would be that the economy is starting to feel the effects of a weak pound. Yet according to the ONS, the rise was largely due to energy costs and restaurant prices.

Sterling’s 18 per cent decline against the dollar since the Brexit referendum has yet to filter through into the economy. Therefore, inflation looks certain to rise further over the coming months, and could easily exceed the Bank of England’s 2% target in 2017. This will not be good news for savers who are losing money in real terms.

bank of england governor

Bank of England Governor, Mark Carney, suggests that MPC will be flexible over application of inflation target

Governor Mark Carney has indicated that the Monetary Policy Committee (MPC) will ‘look through’ what should be a temporary bout of inflation and keep monetary policy loose to support the economy. How far will the committee go? Well, in the aftermath of the financial crisis the MPC was prepared to tolerate a spike in inflation to more than 5 per cent.

We're willing to tolerate a bit of an overshoot in inflation over the course of the next few years in order to avoid (rising unemployment), to cushion the blow and make sure the economy can adjust as well as possible.

Mark Carney
Governor of the Bank of England

The Bigger Picture

The bigger picture is that there are very few structural inflationary pressures. This is due in part to demographics. The ‘baby boomers’ are now starting to retire in their droves. They have already passed through their consumption phase: They've bought their houses, cars and consumer goods.

Meanwhile, the generation behind them is saddled with debt and struggling to get on the housing ladder. They don't have any money to spend.

There is also no sign of any tightness developing in the labour market. Wage growth is seemingly set to remain depressed. All this should mean less inflationary pressure, lacklustre economic growth, and little upward pressure on interest rates.

However the picture is not all negative. The very latest UK economic growth figures revealed that the economy had grown 0.5 per cent in the three months to September. This was well above consensus forecasts of 0.3 per cent. Such strong growth figures diminish the likelihood of a further cut in interest rates. Consequently, yields on government bonds (‘Gilts’) have risen, pushing up the cost of Government borrowing.


What are Gilts?

Gilts are fixed-interest loan securities issued by the UK government. They are bonds issued by the Government to raise money.

There are two different reasons given to explain their name. One is that they have been traditionally perceived as investments that are “as good as gold”. Another is that their original bond certificates had a gilt (or guilded) edge.

Gilts have been issued by the Debt Management Office on behalf of HM Treasury since April 1998. In 2002 the data collected by the ONS revealed that about two-thirds of all UK gilts were held by insurance companies and pension funds.

debt management office logo

UK Government gilts are issued by the Debt Management Office

Large quantities of gilts have been created and repurchased by the Bank of England under its quantitative easing programmes.

Overseas investors have been attracted to gilts by their "safe haven" status.

Is There More Than One Type of Gilt?

Yes. Conventional Gilts are the simplest form of government bond and make up the largest share of Government liabilities. They guarantee to pay the holder a fixed cash payment - or coupon in bond jargon - every six months until the bond matures. At that point the holder receives the final coupon payment and gets his original investment back.

For example, take an investor who holds £1,000 nominal of 4pc Treasury Gilt 2016. He will receive two coupon payments of £20 each on 7 March and 7 September until the gilt expires in 2016.

Other types of gilts include Index-Linked Gilts (IGs). These form the second largest part of the Government's gilt portfolio. With IGs, the coupon is varied in line with the Retail Prices Index (RPI). In other words, the payments are linked to inflation.

Like all bonds, gilt prices move inversely to yields — when yields are up, it’s because they’re selling at lower prices and fewer people want them.

Gilts are supposed to be the safest of investments. But the government gilt market has become extremely volatile in recent times. Below, we explain why and what it means for investors.

What Happened to Change Gilt Prices?

Investors have rushed to sell out of gilts. This has caused prices to fall and yields (the total return in relation to prices) to rise to 1.22 per cent on a ten-year gilt. That's more than double the 0.5 per cent available in the summer. And it's the highest rate since June.

International investors own 27 per cent of the government’s debt. They have sold out because a slumping pound means their holdings are now worth less. They are also worried about higher inflation. The consumer price index (CPI) rose to 1 per cent last month and experts forecast 3 per cent by the end of 2017.

Why Does Inflation Matter?

Inflation cuts the value of bonds when their yield is lower than the rate of price rises. Given that gilts run for up to 50 years before maturity (payback of the capital), it’s important to factor in inflation before deciding whether to buy or keep gilts.

What About Brexit?

International investors have been divesting sterling assets since the referendum in June because of economic uncertainty. The 20 per cent fall in the pound against the dollar this year is evidence of that. So is the dumping of gilts.

It's likely that the gilt market will be remain quite volatile over the next few years because of ongoing concerns about sterling and trade.

As part of our strategic balanced investment approach, our managed pension portfolios include exposure to gilts, via selected funds such as the Investec Cautious Managed fund.

Eurozone Grows at Fastest Pace in Nearly a Year

Business activity in the eurozone has risen its highest level in nearly a year, despite companies raising their prices at the fastest rate in five years. This is reflected in the eurozone flash purchasing managers’ index which rose to 53.7 this month, up from 52.6 in September. The index is considered one of the best indicators of the economic health of the 19-nation bloc. Any reading above 50 marks expansion, while any reading below indicates a contraction in activity.

Business activity in the eurozone has risen its highest level in nearly a year

Private Sector Stimulus

Private sector companies in the eurozone reported the highest level of new orders since January. This has prompted many employers to take on more staff. Employment numbers have shown their biggest gains in three months.

The increase in activity and prices will be welcome reading for policymakers at the European Central Bank (ECB). They've spent months trying to boost growth and inflation. The ECB left its ultra-loose stimulus measures unchanged in October. But it hinted at announcing more stimulus in December to keep inflation moving up towards its target.

Economists said the PMI flash survey points towards the eurozone economy expanding by 0.4 per cent in the third quarter of the year, up from 0.3 per cent between April and June.

Inflation is Also Awakening in the Eurozone

The pick-up in new orders for manufacturers and service sector providers in the eurozone was rapid. Backlogs of work accumulated at the fastest rate since May 2011 as many firms struggled to keep pace with demand. The improving economy meant that companies were able to charge higher rates to customers. Average prices charged for goods and services rose for first time since August 2015.

With backlogs of work accumulating at the fastest rate for over five years, business activity growth and hiring look set to accelerate further as we head towards the end of the year.

Chris Williamson
Chief Economist, IHS Markit

However, increasing demand wasn't the only reason for higher prices in the Eurozone. Costs also rose dramatically. Average input costs increased at the steepest rate for 15 months. This was linked mainly to higher commodity prices, such as the price of oil, as well as rising wage costs.

Inflation is still way off the ECB’s target of just under 2 per cent, coming in at 0.4 per cent in September. But increasing price pressures could mean the ECB chooses not to extend its huge €80 billion a month QE programme that is currently due to end in March 2017.

The German Powerhouse Continues to March Forward

Germany led growth in the eurozone with its second largest monthly increase in business activity so far this year, according to IHS Markit. Manufacturing in the eurozone’s biggest economy enjoyed one of the largest upturns in production seen over the past two-and-a-half years. Business activity in the service sector surged even higher, reviving from September’s slump of near zero growth. Growth in German employment hit a five-year high. And the increase in average selling prices was the joint-largest seen over the past four-and-a-half years.

By contrast, the pace of growth slowed in France. Factory output grew at its highest rate in two-and-a-half-years but was countered by a slower rate of service sector expansion. Even though backlogs of work jumped to the greatest extent since May 2011 selling prices grew at their weakest rate for just over a year.

france ecomony

The pace of economic growth in France slowed last month

We therefore remain committed to our European investment exposure within our managed pension portfolios, and believe that future long term prospects remain positive.

Investment Performance Summary of Reeves Managed Pension Balanced Portfolio

Name Total Ret
1 Day
Total Ret
1 Wk
Total Ret
1 Mo
Total Ret
3 Mo
Total Ret
6 Mo
Total Ret
1 Yr
Baillie Gifford Shin Nippon Ord -0.09 -0.39 4.18 11.41 26.19 57.43
Schroder US Mid Cap Acc -0.70 -0.78 4.58 5.96 22.84 35.15
iShares Core S&P 500 0.22 0.17 5.45 6.52 22.66 32.24
Jupiter North American Income Acc -0.32 -0.13 5.37 5.15 22.15 32.18
JPMorgan European Smaller Comp Ord -0.07 -1.80 2.44 7.55 22.08 31.25
Fidelity American Special Situations 0.20 -0.07 5.15 5.15 23.22 30.56
Threadneedle Eurp Sm Cos Ret Z GBP Inc -0.66 -2.51 1.55 6.28 17.22 29.10
iShares US Property Yield -2.04 -3.70 -2.82 -3.81 17.28 28.74
Legg Mason IF CB US Eq A Acc 0.00 -0.45 5.61 5.22 22.02 28.71
Schroder European Sm Cos Z Acc -0.51 -1.36 3.38 10.13 20.57 24.47
Schroder Global Cities Real Estt Z Acc -1.34 -1.51 -1.50 -1.09 14.59 21.89
Lazard European Smlr Coms Retl C Acc -0.50 -2.42 0.46 4.20 12.69 21.00
Summary -0.16 -0.78 1.13 4.42 14.69 20.27
Liontrust Special Situations I Inc 0.12 -1.61 -0.51 2.11 12.08 16.92
Tritax Big Box 0.00 0.00 2.43 4.95 8.51 16.07
Jupiter Financial Opportunities Inc -0.40 -0.81 4.53 6.91 19.83 15.64
AXA Framlington Financial Rl Acc -0.05 1.33 8.20 12.74 20.03 14.90
Investec Cautious Managed I Acc Net -0.30 -0.27 3.32 4.90 9.48 14.15
Benchmark:FTSE AllSh TR GBP 0.30 -0.75 2.33 4.39 11.36 12.73
Empiric Student Property PLC 0.87 1.98 2.62 4.62 9.55 12.33
MedicX Ord 0.02 0.12 0.45 2.59 4.87 10.00
Marlborough Special Situations P Acc 1.58 0.29 -2.02 7.27 6.08 9.27
TR Property Ord -1.33 -2.79 -4.95 -2.18 6.77 8.68
Target Healthcare REIT 0.00 0.00 -0.64 0.91 0.69 5.53
AXA Framlington Biotech GBP Z Acc 0.21 -0.87 -5.86 1.96 10.56 1.46
JPMorgan Mid Cap Ord -0.07 -2.25 0.96 4.55 0.79 -0.21
GCP Student Living Ord 0.00 0.00 -1.08 -1.38 3.70 -0.25

Funds ranked in descending order, based on 12 monthly performance figures.

Source: Morningstar as at 28 October 2016

Comment on Portfolio Performance

The above table illustrates the commendable performance of our core Balanced pension portfolio over the past 12 months, with the majority of our investments beating the performance of the FTSE All-Share Index, some by a considerable multiple.

We continue to monitor the performance of our 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.

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