In vestm ent Views. Equities Unbroken string of gains continues. Global strategy Dogma and the tax man. Fixed income Risk still skewed to higher rates

Transcription

1 Global strategy Dogma and the tax man Equities Unbroken string of gains continues Fixed income Risk still skewed to higher rates Global asset allocation In vestm ent Views October 2017

2 Global strategy Dogma and the tax man It should be ingrained in every investor s mind by now that there is little value in looking backward to inform one s investment strategy. Despite this, we constantly receive backward-looking market commentary from many sources (including other managers, analysts and Wall Street research). Here at Butterfield, we try our best not to fall into that trap. Of course it is interesting to discover some details around past investment performance and we do that, but we ll at least start with the future. We believe the overriding feature we will see in the fourth quarter of 2017 will be a display, on both sides of the Atlantic, of just how difficult it is to accomplish consensus and move in a positive direction in this political environment. Some of this has to do with the toxic environment (US), some to do with crossing unprecedented thresholds (UK), and in all cases father time is a major stumbling block. First, in the US just prior to the end of the third quarter, the socalled Big Six released the Republican blueprint for tax reform. According to a Pew Research poll the day after the release, there exists a serious enthusiasm gap among the public on this issue. Only about a quarter of Americans believe that corporations need a tax cut and nearly half would rather see them raised. The details of the plan - if one can even call a seven paragraph outline details - call for much of the same dogma for which the old Republican guard is well-known. The core message of tax relief and reform for the average American worker is pure hyperbole; there is very little simplification of the tax code and there have been zero details on how it would be paid for, except to hint that the methodology will include a dynamic scoring system that will assume much higher trend GDP growth. To be absolutely clear, we would applaud actual tax reform and simplification, but we have seen no evidence that this is what is on offer, and empirical research disagrees entirely with the notion that this kind of tax cut is able to produce a notably higher trend growth rate. Furthermore, as we said last month, there is not enough time left

3 Global strategy Dogma and the tax man (continued) in the year to get a comprehensive agreement and the legislative text. We expect something will be passed in the new year, but once again we reiterate that this is a cautionary tale on how NOT to rely on political rhetoric to construct an investment discipline. If the US tax plan is impaired by dogma, the UK is equally hampered by the prescribed doctrine of the wisdom of Brexit. We cannot state clearly enough how little progress has been made by the May Government on the subject of Brexit. Time is decidedly not on the side of the UK in this negotiation and evidence that they are very worried about time is easily evident by recent pronouncements that the UK now desires a lengthy transition period past We believe there will be no material progress on this issue in the fourth quarter and the lack of progress will continue to hurt the UK economy. It is our view that the Bank of England is in danger of looking remarkably out of step with its own rhetoric that base rate increases are needed for the UK in the near future. We expect Bank of England (BoE) Governor Carney to walk back expectations for an increase as the quarter progresses.

4 Equities Unbroken string of gains continues The third quarter saw the sixth consecutive quarterly gain for global equities with a total return of 4.84% in US dollar terms. This is a fairly long stretch of gains by historical standards, but by no means unprecedented, as the market saw eight straight quarters in , eleven in and thirteen in The synchronised nature of the current global expansion is reflected in the low dispersion of returns between regions. For example, the S&P 500 was up 4.32%, the Euro Stoxx 50 increased by 4.70%, Asia improved by 5.17%, whilst Emerging Market returns were slightly ahead at 7.89%. Emerging Markets have continued to benefit from a pickup in earnings; a welcome rebound from the period of weakness between 2011 and At the sector level, the energy and materials sectors benefitted from rising oil and base metals prices. Oil prices rose due to a combination of strong demand growth in Europe, the US and China, together with higher than expected compliance by non- OPEC countries with OPEC s production cut targets. The pickup that we have seen in global manufacturing and industrial production benefitted Metals and Mining stocks, although gains moderated in September as commodity prices consolidated. Other notable sectors include Information Technology, which returned 8.41% as strong earnings encouraged further inflows from investors. Consumer Staples stocks lagged the market as investors marked down valuations of tobacco stocks on increasing regulatory risk. Cyber security has been very topical for a number of years, but the recent hack suffered by Equifax, leading to the data theft of up to 143 million US consumers, has brought the risk into much sharper focus. Cyber risk has been rising up the boardroom agenda for years, but companies are now taking the threat much

5 Equities Unbroken string of gains continues (continued) more seriously. On top of the significant reputational risk, a deceptively mundane sounding directive called the General Data Protection Regulation (GDPR) comes into effect next year, and this will subject companies to substantial fines of up to 4% of global revenue for data protection failings. We are not direct investors in Equifax, but the 34% decline in the stock price following the news demonstrates the importance of portfolio diversification. On the earnings front, the outlook continues to look favourable, with record numbers of US companies issuing positive revenue guidance for the third quarter. Upgrades have been concentrated in the Health Care, Information Technology and Consumer Discretionary sectors, and overall the weaker US dollar should provide a tailwind for US companies with overseas revenues. We have written extensively about the lack of volatility in markets, but the picture remains one of positive underlying earnings momentum, and this is supportive of equity markets.

6 Fixed income Risk still skewed to higher rates International bond markets have posted mixed returns during the most recent quarter, with Euro and US Dollar-denominated debt posting small positive returns, while Sterling and Canadian Dollar bonds have suffered minor reversals in value. Despite different outcomes across geographies, the trends were largely the same; bonds rallied through much of the quarter in response to spikes in volatility and geopolitical fears, then suffered reversals as market attention moved back to fundamentals and the scope for interest rates to increase. The quarter has passed without a change in monetary policy from the Federal Reserve. Despite no actual movement in official policy, expectations about future policy have, unsurprisingly, followed the general trend in bond markets. At the start of the quarter, chances of a further interest rate hike before the end of the year were balanced at approximately fifty/fifty. The likelihood of action fell to approximately 35% as the quarter progressed, then increased to around 65% as the quarter closed. Whilst interesting, we tend to see the forecasting of the precise time in which interest rates may change as not entirely useful. Of greater concern to us as we move towards 2018 is the gap between the market perception of where interest rates may increase to over the coming years, versus the expectation of more aggressive policy moves as detailed by the Fed s own dot analysis. Turning to the UK, sentiment has swiftly moved from an expectation that interest rates were unlikely to move in the foreseeable future, to an expectation that within the coming months, the UK could experience its first interest rate increase since July The timing of increasingly hawkish comments from the BoE has come as a surprise to us, as underlying growth data has been slowing and remains relatively weak versus that of the US and the aggregate across the Eurozone. To this extent, we would not be surprised to see the BoE reverse tack in the coming weeks, and if they don t, a hike from the BoE should simply be seen as a reversal of the emergency measures put in place immediately following the Brexit vote in Further action

7 Fixed income Risk still skewed to higher rates (continued) would be data dependent, relying both on improving GDP data and signs that domestically generated inflationary pressures were picking up. In Europe, the German election provides additional evidence that the swing to the right within European politics has not been as pronounced as feared at the start of the year. The political backdrop in Europe is gradually becoming one less issue for markets to contend with and, when combined with improving economic conditions, does bring about questions of when emergency monetary condition in the Eurozone will start to be unwound. The disinflationary effects of a stronger Euro complicate the picture, but our expectation would be for a plan on the tapering of quantitative easing to be announced in the coming months. However, the normalisation from a negative interest rate environment is still likely to be some way in the future. During the latest quarter, we have made no change to our core fixed income strategy and hence, are maintaining an underweight interest rate risk strategy versus our benchmarks. The general disconnect between an improving global economic environment and the current level of yield suggests that risks continue to be skewed towards higher rates into 2018.

8 Global asset allocation The chart below details our 6-12 month tactical investment strategy Underweight + Overweight Inflation protection US mid-caps Non-traditional asset classes High yield debt Emerging markets Healthcare Investment grade corporate debt Asset allocation Fixed interest Equities Regional Equities Sector Fixed interest US$ interest rate risk Sterling interest rate risk Telecommunications Utilities Government debt

9 Disclaimer This document and the information contained herein has been prepared and issued by Butterfield Asset Management Limited, Butterfield Bank (Cayman) Limited and Butterfield Bank (Guernsey) Limited and is for illustrative purposes only. It neither constitutes investment advice nor is it an offer or an invitation to acquire or dispose of any securities and should not be relied upon as such. Prior to making any investment decision a financial adviser should be consulted. Products and services are available in the respective home jurisdictions and only in those other jurisdictions where they may be legally offered or obtained. The data source for this document is Bloomberg unless explicitly stated otherwise and is believed to be accurate as at the date of publication and may be subject to change without notice. Whilst every care has been taken in producing this commentary, neither the author nor Butterfield Asset Management Limited, Butterfield Bank (Cayman) Limited, nor Butterfield Bank (Guernsey) Limited shall be liable for any errors, misprints or misinterpretation of any of the matters set out in it. Past performance is not necessarily a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down. In the case of some investments, you should be aware that there is no recognised market for them and that it may therefore be difficult for you to deal in them or to obtain reliable information about their value or the extent of the risks to which they are exposed. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors. Before contemplating any transaction, you should consider whether you require financial advice. Any copying, duplication or reproduction of part or all of this commentary and/or its content in any form without the express written consent of the copyright owner is prohibited and will constitute an infringement of copyright unless expressly agreed to by Butterfield Asset Management Limited, Butterfield Bank (Cayman) Limited, or Butterfield Bank (Guernsey) Limited, or as otherwise permitted by the Copyright (Bailiwick of Guernsey) Ordinance You may not, without our express written permission, distribute or commercially exploit this work. This commentary and/or its content is copyright of Butterfield Asset Management, Butterfield Bank (Cayman) Limited and Butterfield Bank (Guernsey) Limited. All rights reserved. Butterfield Asset Management Limited is licensed to conduct investment business by the Bermuda Monetary Authority. Registered Office Address: 65 Front Street, Hamilton HM12, Bermuda. Telephone: +(441) Website: Butterfield Bank (Cayman) Limited is licensed to conduct securities investment business by the Cayman Islands Monetary Authority. Registered Office Address: Butterfield Place, 12 Albert Panton Street, George Town, Grand Cayman KY1-1107, Cayman Islands. Telephone: +(345) Website: Butterfield Bank (Guernsey) Limited is licensed by the Guernsey Financial Services Commission under the Banking Supervision (Bailiwick of Guernsey) Law, 1994, The Protection of Investors (Bailiwick of Guernsey) Law, 1987 and the Regulation of Fiduciaries, Administration Businesses and Company Directors, etc. (Bailiwick of Guernsey) Law, 2000, each as amended from time to time. Registered Office Address: Regency Court, Glategny Esplanade, St Peter Port, Guernsey, GY1 3AP. Company registered in Guernsey No Telephone: +44 (0) Fax: +44 (0) Website: Telephone calls are recorded for training, regulatory and security purposes. October 2017