Fraser Heath Market Update
The volatile start to 2016 continued to moderate in April as UK equity markets delivered a second month of positive returns.
The stock market again took its direction from global events – particularly from oil and mining prices. The oil price continued to rise, with Brent crude closing the month a price close to US $50 a barrel, compared with one touching US $30 only three months earlier. Mining prices showed a similarly strong recovery, boosted by positive trade data from China.
Corporate news flow was generally more positive, however the woes of the retail sector continued to make headlines news, with BHS filing for administration. Clothing and home sales continued to decline and the UK high street remained a tough place to do business.
The banking sector had performed poorly so far this year, but enjoyed a much better month in share price terms. Barclays’ first quarter results were well received by the market, regardless of sharply falling profits.
Full year results from BP confirmed that the company’s focus on cash control is helping offset the impact of falling oil prices. Profits from its downstream business were more than 60% ahead of forecasts while the upstream oil exploration business also performed better than forecast with unchanged losses, despite a much lower oil price during the period.
The US equity market marginally improved over the course of the month despite growing economic headwinds. The S&P 500 index returned 0.63% in April (in US $ total return terms) up 1.96% year-to-date.
Fresh gains for oil prices continued to support investor sentiment, but signs of an economic activity slowdown, coupled with anaemic wage growth (in spite of low unemployment figures) are suppressing the spark needed for a sustained pickup in economic growth, and thus dampening overall index returns.
The Fed kept interest rates on hold, reflecting concerns over weak global and US economic growth
Some of the strongest returns in April came from cyclical sectors, led by producers in the oil & gas sector, which continued to benefit from a further rise in oil prices, as well as the materials and financial sectors. At the other end of the scale, technology, telecoms and more defensive consumer staples stocks lagged. Overall, the environment proved to be conducive for value investors as value names continued to gain traction versus growth stocks.
European equity markets rose in April, advancing for the second month in a row. The FTSE World Europe (Ex UK) Index ended the month 1.7% up as the ECB released further detail of its corporate bond purchase programme. Data at the end of April showed economic growth accelerating in the euro-area and inflation dropping further.
The oil and gas sector was the standout performer, with technology being the biggest detractor.
Eurozone GDP grew by 0.6% in Q1 2016 beating expectations. This was largely driven by French and Spanish economies which grew faster than expected in the first quarter. Growth in France accelerated to 0.5% from 0.3% helped by investment and consumer spending, while Spain grew 0.8% in quarter one shrugging off a political deadlock that had potentially left it facing new elections. Unemployment in the Eurozone also continued to decline, dropping to 10.2% in March, the lowest since August 2011.
The positive GDP readings were accompanied by a drop in consumer prices, highlighting the inflation challenge. The euro-area headline inflation rate fell to -0.2% in April; worse than the -0.1% expected by economists.
ASIA & EMERGING MARKETS
Asian equity markets declined slightly in April. China’s equity market performed in line with the broader market, but not strong enough to allay lingering concerns over the sustainability of the country’s recovery.
Australia was the regions’ best performing equity market making solid gains led by strength in the mining sector as crude oil and iron ore prices rallied strongly.
Taiwan lagged the furthest largely due to the underperformance of its IT sector.
Emerging equity markets drew comfort from higher commodity prices and a weaker US dollar. Currencies appreciated in value, especially the Brazilian real, South African rand and Russian rouble.
At country level, equity performance was varied with domestic factors, particularly politics, playing a pivotal role. Egypt, Peru and Brazil came out on top with Poland, Taiwan and the Philippines being the main underachievers.
The Japanese equity market ended the month marginally lower in local currency terms due to the Yen appreciation against the US dollar, declining inflation expectations and mixed corporate results.
The strength of the Yen combined with subdued global demand, has increased concerns about the outlook for corporate earnings, at a time when central bank policy appears to be suffering from diminishing returns. Bank of Japan’s stimulus efforts which have included an expanded QE programme and a shift into negative interest rate territory, have failed to stem the yen’s rise and increase inflation expectations.
This has weakened investor confidence in the bank’s ability to reflate the economy. Weak consumption and inflation data, and the BOJ’s decisiontowards the end of the month to make no changes to its monetary policy, have dampened investor sentiment in the Japanese equity market.
The positive sentiment that began in the middle of quarter one continued through April, with generally positive returns for corporate bonds.
Government bonds, typically viewed as “safe havens” during periods of market stress, were the weakest bond sector amidst an improvement in sentiment. A recovery in commodity prices helped the US high yield market
According to data from Merrill Lynch, sterling investment grade corporate bonds returned 0.6% compared to -1.3% for Gilts.
What do we think………?
Investor attention is increasingly distracted by political issues at the moment. While the referendum result will have the biggest impact on the UK, the rest of the world is looking on with interest to see if a vote to leave might lead to wider political instability in Europe. The rise of Donald Trump as Republican Presidential candidate provides more cause for concern. It is often the uncertain and unpredictable times that make investors twitchy.
Fund managers that we listen to are increasingly reflecting the views of global economists that a vote to leave will result in a fall in valuations. As the market price already reflects nervousness around the issue, it’s worth keeping in mind that a vote to remain might be met with what’s known as a relief rally, where investor demand to buy back in to investments sees values shoot up. So expect some volatility around the 23rd June and remember that while some investors seek to make gains in the short term, we’re long term investors, and it’s the growth of the global economy over time that determines your long term returns.
When we focus too much on the day-to-day worries of the world we can often fail to see the big picture. In the words of Warren Buffett, arguably the world’s most successful investor, “In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
Date of next meeting: 23rd June 2016
The Bank of England’s decision at the start of November to raise interest rates for the first time in 10 years was widely expected and caused little initial stir in the markets. Since then the FTSE 100 has fallen a couple of percentage points at the time of writing. Perhaps the combination of negative talk around Brexit combined with the prospect of rising interest rates are starting to bring back a little fear to the market which has, for some time, felt like it has been in a state of complacency.
Most commentators expect interest rates in the UK will rise for the first time since July 2007 when the Monetary Policy Committee (MPC) of the Bank of England next gets together for its monthly meeting on 2nd November 2017. Indeed, Mark Carney said on the BBC Today programme, shortly after the minutes of last month’s meeting were released, “What we have said is that if the economy continues on the track that it has been on - and all the indications are that it is - in the relatively near term you can expect that interest rates will rise”. He went on to say, “We are talking about just easing a bit off the accelerator to keep with the speed limit of the economy”, which has been widely predicted to mean that rate rises will be gradual and measured.
Our reason for showing these graphs is to highlight that the VIX index is trading back at 2007 levels of low volatility while stock markets are at all-time highs. We can no more see the future than anyone else but we do know that when it comes to investing, the most money is often made when every sinew in your body is screaming that it is madness to invest, and that sometimes the opposite is true.
It has been a strong start to the year for investment portfolios, mostly driven by signs of continued strength in the US Economy and the promise of more to come under the Trump presidency. Markets always move ahead of the economy so to make money, investors will position portfolios to benefit from what they think is around the corner. But what if the promise does not materialise? One fund manager described this recent wave of enthusiasm as the “Trump Bump” and that this may well be followed by the “Trump Dump” if the new President is unable to deliver on his campaign promises due to lack of support from political colleagues. In this respect, it seems that the failed repeal of Obamacare has given investors pause for thought over the last week or so.
While some asset classes are looking expensive, on an individual basis, there remains optimism amongst fund managers. Those who particularly seek to invest in undervalued, unloved but robust companies can see plenty of scope for increased valuations in their investment pool.
Eight years have now passed since the FTSE 100 hit its Credit Crunch low point. In investor memory, particularly among younger investors, we are getting to the point when the slide that started in summer 2007 down to its nadir risks being forgotten. We don’t know what the future holds but the past tells us that investing needs time on your hands to ride out the tough times. We’re confident that investing remains the best long term strategy for your money but make sure that you understand the strategy you are taking and that your portfolio is right for your attitude to investment risk and your time frame.
Markets made a much better start to the year compared to this time last year. However, investors remain wary of problems that are likely to rear their heads later in the year and so, in general, markets have paused for now. Politics seems likely to dominate sentiment again this year, with a number of key general elections to be fought in Europe, most notably in France and Germany. Volatility is likely to spike during these events. However, market volatility can be the friend of the active fund manager and in recent meetings and conference calls with managers many have expressed the view that there are plenty of good opportunities and are generally cautiously optimistic about prospects for the year as a whole.
Our view is that the strong equity returns we saw in the second half of 2016 are “in the bank”, as it were, so if markets do sell off at some point in the next few months, these profits can be eroded before we are worse off than we were before the EU referendum on 23rd June 2016.