General Economic Overview
The summer months passed without any major events for markets, with perhaps one of the standout features being the strength of the euro versus the US dollar. The long bull market, which started in 2009 following the nancial crisis, has continued – one of the remarkable things about this economic recovery is the lack of inflationary pressure both in goods and in wages, which has meant that markets have remained quite sanguine despite some souring of political relations between North Korea and the rest of the world. Economic growth has continued to move ahead at a moderate pace, led by the US but increasingly supported by other regions. GDP growth has been below par, relative to previous recovery phases, but continues to benefit from the growth in consumer demand which has been resilient, despite political uncertainty and little wage in ation. The only worrying factor is that much of this has been based on consumer credit growth, which, in the UK, grew by 10% in the year to April 2017, the fastest annual growth rate since 2005. A specific concern is the new car market, which is heavily supported by personal contract purchases (80% of new car sales) and is responsible for half of the growth in consumer credit this year.
Equity Markets Overview
The market appreciation in the quarter has continued to benefit from investors’ ability to ignore any bad news on a macro basis but be more discerning on a stock by stock basis. Many investors believe this is a good sign for active managers, given the recent investor preference for passive investments but, more broadly, we can see both over the quarter and, year-to-date, there have been some very strong performances from equity markets, particularly in the Far East and in Europe.
The UK market has also seen positive returns but the threat of Brexit and the unexpected strength in sterling has weakened investors’ confidence in the markets’ ability to overcome these factors. The trend in markets has been to support focused areas and companies – for example the US has been led by the technology sector whilst the energy sector has performed poorly and in Japan and the UK, currency weakness has supported the global exporting companies. Another clear trend has been the general support for growth stocks and the gap between the world growth and value indices has widened again in 2017 after the value rally in late 2016. There are a number of theories as to why this is the case, but we tend to believe that it is the more defensive nature of investors, who still want to be exposed to equities in this period of continued momentum, but recognise the length of the bull market and the fragility of growth levels. This leads them to pick more predictable, less cyclical stocks. We would anticipate that this situation should normalise but it could persist for some time yet.
For much of the year, the headlines regarding the UK economy have been dominated by the current and likely effect of leaving the European Union. The robust levels of growth we have seen since the EU vote have been driven by the weakness in sterling, which has helped exporters and a further easing of monetary policy which has boosted consumer confidence. That said, household consumption has been financed by credit, with the household savings ratio at its lowest level since 1960 and the continued global growth, which has helped to support the UK economy, may not be relied upon in the future. The inflation figure is, therefore, worrying many investors as it moves towards 3%, meaning that real household income has turned sharply negative over 2017, particularly if we recognise that, at the same time, wage rises year-on-year are at just 1.8%. The rate of retail spending has been reducing with GDP figures this year indicating a much lower growth rate of around 1.2%, well below forecasts at the beginning of the year of 1.7%.
Whilst recognising these issues, many investors have still benefitted from holding equities this year and, in the third quarter, the main market benchmarks have all been up around 2%, and over 6% year to date. This has been led by the larger, more internationally diverse companies with more predictable dividend streams, which has resulted in a growth bias in the UK market year to date.
Not all the news is negative, however, as data is still supportive of continued growth of the economy with unemployment less than 5% and UK PMI data still positive after the election blip.
The US market has continued to lead global stock markets upwards in 2017, with all-time market highs, which have caused some valuation concerns amounts investors. The main players in this growth have been in the technology sector with companies like Facebook, Amazon, Netflix and Google. Returns have been limited for sterling investors by a resurgence in the strength of the pound against the dollar.
Europe has also been a very strong market this year thanks to an improvement in both economic conditions and market sentiment. For sterling investors there has been the additional bonus of a stronger Euro which has added to returns.
Inflation figures are weaker in Europe than in the UK and the US and overall employment numbers do not suggest more than weak recovery so makes are likely to be more sensitive to any uncertainty or weak economic data. If PMI data continues to offer encouraging signs then investors will support European equity markets.
Asian markets have been the beneficiaries of a stable economic regime over the last 10 months, particularly the reaction of the US dollar, which has been weaker than expected given the lack of fiscal expansion in the US. The Chinese market has risen substantially over 2017 year-to-date and the majority of the upturn, as in the US, has been due to technology stocks.
Fixed Interest Markets Overview
The overall view on this sector has been negative for some time, with many managers calling time on the so-called bond bull market. Rising rates in the US have generally lifted expectations across the globe for yields to rise and recent statements by the Bank of England and the European Central bank have reinforced this sentiment. The current levels of yield available on government bonds have left many investors with little choice but to seek higher risk investments to satisfy income requirements. So far, this has not reduced demand as the bond buying programs of many central banks and pension funds have been maintained along with loose monetary policy.
Most investment managers are avoiding government debt and investing selectively in credit. Spreads have tightened in the last few months, with little opportunity to make gains for investment-grade bondholders. High yield has been well supported but, even here, the risk premium for holding such assets offers less reward. Consensus suggests that rates are likely to rise from here, but many investors have been wrong for the last 18 months with short duration strategies dragging down many mixed asset portfolios. Those with a more balanced duration strategy have benefited with small gains being made in 2017.
A secondary threat is liquidity in bond markets, which have been much less liquid since the new banking rules came into place following the financial crisis. Concerns have been raised for some time, by investors, that the new regime has not really been tested in a stressed environment but that little can be done about this at the moment other than holding fewer non-investment-grade assets.
Fixed interest continues to provide diversification for an investor portfolio, at a time when many asset classes are increasingly correlated. It would be extremely risky to move to a portfolio holding just equities, as unexpected events could happen and, in an era of heightened geopolitical tensions, shocks are always possible. Fixed interest holdings should be maintained in a diversified balanced portfolio, strategic bond funds continuing to offer investors a spread of fixed interest assets with the ability to react quickly to any changes in macro economic conditions. We believe that this will be where the skills of the managers will come into force as we transition to a higher interest rate regime.
The position for investors today is as intriguing as ever with global stock markets close to all- time highs after a long period of improving valuations. Fixed interest assets are under pressure from a tightening of monetary policy and a reduction in bond buying programmes although the likelihood of rates rising to the levels seen in previous cycles is limited.
There is a growing confidence that global growth can be maintained at current levels as economies continue to recover from the financial crisis some nine years ago. Markets can continue to benefit from the synchronised global recovery for a while yet, especially in an environment where monetary policy overall looks likely to remain accommodative. The end of dollar dominance has proved supportive to emerging markets, and particularly Asia, which is likely to provide the engine to global growth over the next decade.
If you are concerned about your investments, their performance, where you are invested or would simply like to discuss the above then please feel free to contact us. White Oak Financial Planning offer independent financial advice for individuals and business. With specialisms in retirement, pension and investment planning we are happy to help. White Oak Financial Planning, Chester's leading independent financial planners.
Source RSMR Quarterly Investment Bulletin October 2017
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