Surging US economy is bad news for FTSE stocks
At the beginning of the month, the FTSE 100 suffered its worst week since March after strong jobs figures in the United States worsened a sell-off in global equity markets. Investors are concerned that a wave of positive economic data from the US will prompt the Federal Reserve to raise rates faster than expected and increase borrowing costs, which could cool global economic growth.
Michael Pearce, senior US economist at Capital Economics, said that the employment report was “strong” and would “keep the Fed firmly on track to continue raising rates once a quarter”. The probability of a rate rise in December rose to 86.7 per cent after the report was published, CME Group said.
Expectations of sharply rising interest rates in the US and the likely push for similar tandem increases globally are not good news for share prices and therefore our fund holdings. Since hitting a record high last month, America’s main stock market index, the S&P 500, and the tech-laden Nasdaq have both fallen by more than 10 per cent.
Our cautious approach means that we have retained a significant cash holding in our Balance model portfolio, ready to take advantage once a degree of stability and composure returns to the markets.
Falling share prices particularly in emerging markets have scared many investors
The soaring value of the dollar, sparking talk of more interest-rate rises in the US, has meant more woe for emerging markets. Many of these nations have dollar-denominated debt that is expensive to repay if the cost of borrowing rises in America. These markets, whose total value has fallen 20 per cent since January, have also been hit by global trade tensions and political problems in countries such as South Africa and Brazil.
The magnitude of the recent sell-off, set against what is a broadly supportive financial background for emerging markets, suggests that there could be a swift recovery, which investors could miss. The share-price falls have left emerging markets on a significantly cheaper valuation than most other regions. While emerging markets shares trade at 14 times earnings, the UK trades at 16 times earnings, Europe at 17 times and the US at 23 times.
Adrian Lowcock of Willis Owen, an investment supermarket, says: “In the next five years 70 per cent of the world’s growth is expected to come from emerging markets. The populations of India and China account for more than a third of the global population and as they get better educated and richer they can afford more goods and services. Young Chinese consumers are among the world’s most brand-conscious.”
Although emerging markets have not delivered stellar returns in recent years, their long-term performance is considerably better than their more developed rivals. Since the turn of the century emerging markets have produced returns averaging 7.9 per cent a year, compared with 5.4 per cent on US shares and 3.5 per cent on European shares.
Despite the potential upturn in emerging markets over the long-term, we remain cautious that there may be further turbulence in global markets generally and concerned this may have a disproportionate impact on emerging markets in the short-term.
FCA: Property Funds must Shutter Immediately in future crises
Funds investing in illiquid assets such as property and infrastructure will have to close much faster if another Brexit-like event happens.
In a consultation paper on open-ended funds investing in illiquid assets, the Financial Conduct Authority (FCA) has said fund managers and independent valuers should move much quicker to suspend dealing. Funds currently close when the manager judges the market to be pricing material discounts. The proposals will remain open for consultation until the end of January 2019.
The consultation comes after billions of pounds of client assets were locked in property funds in the wake of the EU referendum result in June 2016. Property fund giants including Legal & General, Henderson, Prudential and Standard Life were forced to gate their property funds due to the high volume of redemption requests, triggered over fears of the ensuing market instability following the Brexit vote.
AJ Bell head of active portfolios Ryan Hughes said the change would lessen the incentive for investors to seek a first-mover advantage. Widespread redemptions in anticipation of a run on property is believed to have been a severe exacerbating factor in the 2016 sell-off.
With holdings in open-ended property funds (unit trusts and OEICS), we remain exposed to the risk of these funds imposing a substantial levy/exit penalty on sale requests/redemptions or suspending sale trades all together, should there be another significant market downturn, similar to the post Brexit vote result in June 2016.
We are aware, and have past experience, of these risks associated with open-ended property funds. This is why we have balanced this inherent risk by diversifying our exposure to illiquid property assets through closed-ended investment trusts/REITS, which offer continuous trading liquidity in all market conditions.
Fund managers’ gloom deepens
Fund managers are at their most pessimistic on the prospects for the global economy since the financial crash of 2008, a study suggests.
Investors are sitting on cash amid gloom over trade tensions and expectations that the US Federal Reserve will carry on its tightening policy by raising short-term interest rates, according to Bank of America Merrill Lynch’s monthly fund manager survey. The Federal Reserve has raised interest rates six times since Mr Trump came to office in January last year.
Higher interest rates mean bond yields rise (and bond prices correspondingly fall) to remain competitive. If you can get a risk-free yield on government bonds that equals or beats the yield on shares, which are riskier, you might switch money out of shares and into bonds.
Those investing in US government bonds today can obtain yields of more than 3 per cent, which is higher than the dividend yield on most US shares.
Also, higher interest rates threaten the real economy too by restraining growth, denting consumer confidence and potentially driving highly-indebted companies to the wall.
The Reeves Investment Team shares the concerns of the wider investment fund market. Our cautious approach means that we have retained a healthy cash holding in our Balance model portfolio, so we are in a position to take advantage once a degree of stability and composure returns to the markets.
Head of the FCA warns on emerging markets
Turmoil in emerging markets poses a serious risk to Britain’s financial system, the chief executive of the City watchdog has warned.
Andrew Bailey, head of the Financial Conduct Authority, said the potential for a meltdown in heavily indebted emerging economies as the post-crisis era of low interest rates draws to a close was top of a list of external threats to the UK.
MSCI’s global index, which covers the main markets in 23 developed economies, is now more than 14 per cent down from its record close in January. It has fallen for five straight weeks, the first time that has happened since 2013.
Investors are selling shares amid concerns about a cocktail of global factors. These include fears about a slowdown in global economic growth, the trade war between the US and China, a row between Italy and the EU over the country’s budget deficit and Brexit. The sell-off was sparked this month by fears of rising interest rates and an end to the era of cheap money.
The recent declines mean the global bull market for stocks is already over, some observers argue. Analysts at Bank of America Merrill Lynch said their preferred gauge of global markets, the MSCI World Equal Weighted Index, was down more than 20% since its January 29 peak — the definition of an equity bear market.
UK 2018 Budget
In his 2018 Budget, Chancellor of the Exchequer Phillip Hammond announced a series of initiatives for the UK. Key points included:
The Budget was received calmly by equity, currency and, perhaps most importantly for the Chancellor, debt markets.
However, it was delivered against a backdrop of continued anaemic UK economic growth and with considerable uncertainty around the likely implications of Brexit. In addition, with interest rates continuing to rise in the United States, with global trade tariffs rising and with volatility picking up across markets, the global backdrop is much more uncertain than when the Chancellor stood at the dispatch box a year ago. Therefore, while there were many initiatives outlined in the budget that affect the corporate sector, these broader themes are likely to have a greater impact on companies operating in the UK over the coming years.
The information in this blog or any response to comments should not be regarded as final advice. Please remember that the value of your investment can go down as well as up, and may be worth less than you paid in. Information is based on our understanding at October 2018.