Market Outlook Report – September 2017

Market Overview

Supposedly a quiet month, August was dominated by rockets and sabre-rattling in the Far East as the rhetoric between North Korea and America escalated. Ten-year interest rates edged down in response, close to 1% in London, 2.1% in America and 0.4% in Germany. Despite some wobbles, stocks were little changed, London was marginally ahead while New York was close to unchanged (concealing a much better month for NASDAQ). Japanese stocks did slip but not Chinese, which were buoyed by better economic stats.

In the UK, consumers have had their spending power squeezed by higher inflation, caused by the fall in sterling after last year’s Brexit vote and the rising cost of commodities and energy. The headline rate of inflation reached 2.9 per cent in August, and the Bank expects it to exceed 3 per cent next month. The main inflation impetus is coming from sterling’s post-referendum fall, and its further weakness in recent weeks will add to the upward pressure on inflation via higher import prices. The Bank of England expects wage growth to keep pace with inflation, but salaries adjusted for inflation fell by 0.4 per cent in the three months to July.

UK Inflation

The UK inflation rate is expected to exceed 3 per cent next month.

And just as Mark Carney, the governor of the Bank of England, gave his clearest indication yet that he is minded to increase interest rates soon, for the first time in a decade, figures released the same day show that the UK economy is expanding more slowly than previously thought while the dominant services sector shrank in July, suggesting a further loss of momentum. Official data showed that Britain’s economy grew by 1.5 per cent in the three months to the end of June, compared with the same period last year. This was down from the 1.8 per cent annual growth in the first quarter. This is slower than the 1.7 per cent increase that the Office for National Statistics had estimated and is the weakest pace of annual growth since the beginning of 2013. The ONS added that growth in the last three quarters of 2016 had also all been slower than expected. Growth on a quarterly basis remained the same at 0.3 per cent, and while the first quarter was revised up from 0.2 per cent to 0.3 per cent, this still confirmed the slowest first half of any year since 2012. Output in the dominant services sector, which makes up 80 per cent of the economy, shrank on a monthly basis by 0.2 per cent between June and July, pointing to a weaker outlook than expected for the rest of the year, separate figures from the ONS showed.

The revised figures prompted some to cast doubt over the Bank of England’s aspiration to raise interest rates for the first time in a decade when its monetary policy committee meets in November, as markets and economists have been expecting. Publication of the economic data led to a fresh plunge in the value of sterling, which gave up three quarters of a cent against the dollar, to $1.34, while the FTSE 100 advanced 49.94 points, to close at 7,372.76 last Friday

US

The American economy expanded faster than previously thought in the second quarter to mark its best showing since the start of 2015. In its third and final estimate, the commerce department upgraded its evaluation of gross domestic product growth to 3.1 per cent annualised from the 3 per cent reading it gave last month. Last week, Republicans fleshed out plans for deep tax cuts to fire up the US economy and help GDP growth to reach President Trump’s ambitious target of 3 per cent a year. In the first quarter, the economy grew by 1.2 per cent.

Meanwhile, Donald Trump’s slanging match with the North Korean regime last week spooked the US and global markets, but it was his domestic announcements that sent them on a rollercoaster ride. Mr Trump’s plans for cutting taxes, including the corporate tax rate from 35 per cent to 20 per cent, helped US stocks to rally on Wednesday, with bond yields rising along with the dollar to herald the currency’s best weekly gain of the year. However, the US president’s unpredictability, and his fraught relationship with Congress, tempered expectations and equities drifted.

Reeves Model Investment Portfolios

Over the past month, our model investment portfolios have inevitably suffered from the recent downturn in the markets. Whilst we predicted, and took measures to mitigate, this downturn, it is nevertheless disappointing to experience an unavoidable fall in portfolio values. Many of our clients have lessened the impact of the market downturn by moderating their level of investment risk, e.g. moving from an adventurous to a balanced investment portfolio or from a balanced to a cautious investment portfolio.

As the graph below illustrates, our model investment portfolios reflect the inherent risk profiles associated with a market downturn, with less impact on less risky portfolios and higher-risk portfolios suffering the most.

The above graph displays the performance of our portfolios from the 1st of the month until our recent investment meeting. 

As the above graph shows, despite unavoidable losses in our model investment portfolios, the extent of these losses has been less than the benchmark FTSE ALL Share index. This reflects the strategic judgments taken by the Reeves Investment Team, both in terms of recommended portfolio composition and risk-realignment where appropriate.

Prudent measures we have taken in recent months have proven to have been judicious. These include:

  • Reducing exposure to the UK & major oversea markets;
  • Encouraging clients to transfer pension portfolios to lower risk investments;
  • Reducing clients exposure to investment trust companies, whose market performance is typically magnified by their ability to gear (borrow). Having enjoyed strong returns earlier in the year, we have reduced our investment trust holdings by 25% in our adventurous model portfolio, 50% in our balanced portfolio and 75% in our cautious portfolio. However, we are retaining a core investment trust exposure within selected well-managed investment companies, due to their consistently strong long-term performance.

The timing of our decision to reduce clients’ exposure to overseas markets earlier this year has also benefitted from the gradual recovery in the value of the pound. Unless an investment fund has hedged its overseas currency exposure (which most don’t), a strengthening of the value of the pound is bad for overseas investments. If we have a depreciating pound, this has a positive impact for an overseas investment fund that does not have any currency hedging in place. Last Friday, there was a fresh plunge in the value of sterling, which gave up three quarters of a cent against the dollar, to $1.34. This followed the release of figures by the Office for National Statistics, which indicated that in the second quarter of 2017 the UK economy grew at its weakest rate since 2013. This coincided with remarks from Mark Carney, the Bank of England governor, advising that an interest rate rise in imminent. Whilst the value of the pound fell, the FTSE 100 advanced 49.94 points, to close last week at 7,372.76.

We are conscious of our sizable cash proportions with our model portfolios and continue to struggle to find optimum investments which provide an attractive return within a safe and liquid investment product. In the longer term, our current intention is to drip-feed cash reserves back in to the market, in order to mitigate short-term price fluctuations and uncertainty, whilst also reaping the benefits of ‘pound-cost-averaging’. We will embark on this reinvestment initiative when we feel the time is right, i.e. when we feel that any impending market correction has manifested itself and that we are near the bottom of the current market cycle. This is not an easy judgment to make, but we certainly don’t think that now is the right time.