Fraser Heath Market Update
The UK equity market was broadly flat in November, with the FTSE All Share index rising by 0.6% as the oil price revisited its August low point.
Chancellor George Osborne delivered his autumn statement signalling further austerity ahead.
Negative UK inflation persisted as food and fuel prices fall.
The Bank of England voted 8-1 to keep interest rates on hold and said that inflation was only expected to pick up slowly, staying below 1% until the second half of 2016. This should limit upward pressure on UK interest rates in the short term and is potentially positive for UK consumer spending if wage growth continues to exceed inflation.
In company news, Rolls Royce issued a downbeat trading update forecasting that 2015 profits would be at the lower end of expectations and that they expected “sharply weaker” demand in 2016 as pricing weakness is expected to weigh on margins.
BHP Billiton saw its share price slide, not only as a result of falling commodity prices, but also when one of its joint ventures in Brazil was in the news regarding a toxic mine spill.
Imperial Tobacco confirmed the strength of the cash flow in tobacco companies with a 10% dividend increase.
The US equity market endured a challenging November amid renewed concerns about global economic growth and rising US interest rates to finish the month flat when the S&P 500 index returned 0.30% in US $ total return terms.
Financial stocks posted the strongest gains benefitting from rising expectations that banks stand to gain if the Fed raises interest rates for the first time in almost a decade at its December meeting.
The unemployment rate, which was expected to remain steady, dropped to 5%. Another bright spot in the job numbers was the news that US wage growth was starting to accelerate.
Against this backdrop, the US economy grew faster than initially thought in the third quarter, with the strong momentum likely to further bolster the Fed’s case for an interest rate rise in December.
Although third-quarter growth remains well below the 3.9% rate recorded for the second quarter, the solid numbers fuelled by improved customer spending is likely to reinforce the view among US policymakers that the economy is on a steady growth trajectory.
European equity markets increased in November as the Euro zone economy showed resilience in the face of slowing emerging markets.
All market sectors, bar utilities, recorded gains in November. The oil and gas sector was the leading outperformer, despite a further drop in the oil price, followed by the technology and industrials sector. Greek banks were among the biggest detractors as they raised new capital to reinforce their balance sheets.
Unemployment continued to fall gradually and the European Commission’s Economic Confidence index rose to its strongest level in 5 years.
While the euro macro backdrop continued to improve, inflation remained subdued, fuelling the debate for additional monetary stimulus by the ECB. Aiming to raise inflation expectations, ECB President Mario Draghi restated his willingness to consider further measures if need be to tackle low inflation and spur growth in the Euro zone.
ASIA & EMERGING MARKETS
November was a tough month for Asian equity markets given some negative news flow from China and the increased likelihood of an US interest rate hike in December.
Economic data from China was mixed as industrial production growth slowed and the contraction in exports deepened, although property and retail sales growth remained robust.
India’s quarterly earnings figures were disappointing and growth indicators remained mixed.
Better news for the Australian equity market which performed relatively well, benefitting from signs of improvement in its economy.
The prospect of higher US interest rates dented the appeal of emerging equity markets. This coupled with concerns over emerging Asia’s growth prospects and disappointing corporate earnings results for the Q3 2015
The Japanese equity market ended November marginally higher.
In macro-economic terms, preliminary estimates suggested Q3 GDP fell at an annualised rate of 0.8% quarter-on-quarter, worse than the expected decline of 0.2% and resulted in the economy slipping back into technical recession. However, the contraction was largely attributable to an inventory adjustment, which helped investor sentiment.
The Bank of Japan held back from expanding its quantitative easing program, as a weak yen continued to support economic growth.
November was positive for most major bond markets with corporate bonds outperforming government bonds
The Bank of England’s forecast of inflation was lowered and as a result the market pushed out its expectations of an interest rate rise until 2017. This helped both Gilts and high quality sterling dominated corporate bonds to rally.
According to data from Merrill Lynch, Gilts returned 1.0%. This compared to a return of 1.8% for sterling investment grade corporate bonds.
WHAT DO WE THINK?
Equity markets have started to “wobble” in recent times, through a general nervousness in the lead up to the US interest rate decision, concerns about the impact of the falling oil price and also due to issues in the high yield bond sector. As a result, markets have returned to a “risk off” environment, with negative sentiment the dominant force in the last few weeks.
Concerns over the outcome of the US interest rate decision will have a short-term impact but the impact of lower oil prices is likely to be a more long term problem for certain parts of the global economy and markets need to adjust to this.
Given our above comments, we expect a period of weak global economic growth and high volatility in what are challenging market conditions. Obviously investors are looking for good long term “real returns”, ie net of inflation, and even though the headline investment returns may have been lower in 2015 and are likely to remain so into 2016, we need to bear in mind that inflation remains low and so “real returns” remain positive.
Date of next meeting: 20th January 2016
The UK equity market retreated in November, only the second month in 2017 where we saw a meaningful fall in the key FTSE 100 Index. Comments made by Mark Carney, following the November Base rate rise, highlighted the Bank’s view that inflation will be a problem for some time to come and how business and consumers react to this will determine the path for the UK economy over the coming months. The Bank said in a statement: “The decision to leave the European Union is having a noticeable impact on the economic outlook.
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.