INVESTMENT MARKETS COMMENTARY TO 31 MARCH 2018

Transcription

1 INVESTMENT MARKETS COMMENTARY TO 31 MARCH 2018 London Wall Partners LLP Salisbury House London Wall London EC2M 5QQ +44 (0) (Direct) +44 (0) (Mobile) +44 (0) (Fax)

2 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar Investment markets commentary to 31 March was a benign year for investors, with the ongoing expansion of the world economy providing a supportive environment for share prices. However, so far in 2018, there has been a change in tone, which has predominantly come from the rhetoric surrounding President Trump. Markets have become wary of his intentions with US trade policy, and the potential for his protectionist agenda to initiate a trade war with China, which could impact global growth. As a result, over the year to 31 March 2018, stock market gains made during the last nine months of 2017 have broadly been eroded so far in 2018, in sterling terms. The last year saw a calmer geopolitical situation, after the surprises of the Brexit and Trump votes of While concerns over the security situation in North Korea increased, markets took this in their stride, presumably reflecting a confidence that nuclear deterrence will continue to work. Parliamentary elections in the UK, France and Germany may not have produced the results anticipated, but none appear likely to alter the path of economic policy. A notable feature of 2017 was the material improvement in industrial and consumer activity and confidence in the Eurozone. The region had taken longer to recover after the Global Financial Crisis ( GFC ) of 2008 / 2009 than others, because the weaknesses of the banking system were not addressed quickly, the European Central Bank ( ECB ) was slow to introduce stimulus measures, and many Eurozone governments introduced austerity programmes to meet EU deficit targets. However, it became clear that a sustained recovery was finally in train, and this was recognised in the financial markets with a change in trend in the currency markets. The euro began to strengthen against most major currencies at the start of 2017, with a notable rise against the US dollar. The US dollar had been strong at the end of the previous year, owing to expectations that the newly-elected President Trump would engender faster growth in America, but as his legislative efforts faltered during his early months in office in 2017, the US dollar weakened in response. Chart 1 shows how the euro has gained in value versus the US dollar since the start of Chart 1 Euro / US dollar exchange rate since January EUR/USD exchange rate Source: Bloomberg London Wall Partners LLP Page 2 of 14 Authorised and regulated by the

3 Given the UK s close links to Europe, the pound also rose relative to the US dollar, albeit by less than the euro as the UK economy grew less quickly than the Eurozone during The UK s slower growth rate was likely due to uncertainty caused by Brexit negotiations, and the impact of higher import prices in Britain, caused by the decline in sterling after the 2016 EU referendum, which in turn contained UK consumer spending. While UK CPI inflation had been above the UK government s target of 2% p.a. for most of the last year, the Bank of England ( BoE ) was cautious about increasing interest rates. Recently, however, the BoE has suggested it may be inclined to raise rates in the coming months as the UK economy benefits from improved global growth. That said, ongoing lack of clarity surrounding Brexit could change this outlook, especially as inflation is expected to fall back towards its target during Despite inflation in most other countries remaining at or below target, interest rate policies in the major economies are taking different courses. It appears likely the ECB and Bank of Japan will continue with their stimulus programmes for the time being, but the US Federal Reserve has begun to increase interest rates in America; while there has not been a material upturn in inflation which would justify this, the resilience of the US economy and tightness of the labour market are enabling monetary policy to begin to normalise, removing the need for the supportive measures introduced to address the impact of the GFC nearly ten years ago. Summary of global market performance Table 1 shows that, during the year to 31 March 2018, company shares (measured by the FTSE All-World Index) returned 11.7% in local currencies, and 2.9% in sterling; over 60% of the World Index is accounted for by companies whose shares are priced in US dollars, and dollar weakness reduced local returns for UK investors. UK company shares (measured by the FTSE All-Share Index) gained 1.3%. UK Government bonds and index-linked gilts declined 0.9% and 0.7%, respectively. UK commercial property returned 10.3%. Table 1 - Six and twelve month market returns. % Total Return Six months Twelve months Index local local FTSE All-World FTSE All-Share ( ) S&P 500 ($) FTSE Europe ex-uk TOPIX (Y) FTSE All-World Asia ex-japan FTSE Emerging Markets FTSE UK Govt 5-15 years ( ) FTSE UK Govt I-L 5-15 years ( ) iboxx Corp Bonds 5-15 years ( ) IPD All Property ( ) Gold Bullion ($) London Wall Partners LLP Page 3 of 14 Authorised and regulated by the

4 Table 2 shows returns over the last three and five years, during which stock and property markets have generated the strongest returns in sterling terms; US and Japanese company shares have performed particularly well, but the UK lagged most other major stock markets. Bond markets also produced positive returns, with corporate bonds producing stronger returns than conventional UK Government bonds. Table 2 Three and five year market returns. % Total Return Three years Five years Index local local FTSE All-World FTSE All-Share ( ) S&P 500 ($) FTSE Europe ex-uk TOPIX (Y) FTSE All-World Asia ex-japan FTSE Emerging Markets FTSE UK Govt 5-15 years ( ) FTSE UK Govt I-L 5-15 years ( ) iboxx Corp Bonds 5-15 years ( ) IPD All Property ( ) Gold Bullion ($) Notes: 1. Figures as at 31 March All figures include income reinvested. 3. Local currency indicated in index name, for single country indices. 4. Investment Property Databank ( IPD ) Index may be subject to retrospective revision. 5. Source: FE Analytics. 2. Economic and stock market outlook Our investment strategy continues to be based on the belief that we are in a global economic expansion which should persist, enabling productive businesses to continue to thrive. We expect stock markets to deliver attractive returns and our recommended asset allocation still favours company shares. Our sanguine economic outlook is broadly in-line with consensus, though some commentators believe shares are over-valued and stock markets should not make further progress. Our analysis indicates that valuations are somewhat stretched in the US, as shown in Chart 2 overleaf, but valuations in most other markets are close to historic averages. With US earnings likely to benefit from the strong economy and cuts in corporate tax rates, we think even the US stock market could advance, despite its currently elevated historic price / earnings ratio. We are also focusing our US company share allocations, achieved through global funds, towards what we believe are the sectors of the US market with the most attractive long term prospects, namely technology, consumer and healthcare companies. London Wall Partners LLP Page 4 of 14 Authorised and regulated by the

5 Percentage Chart 2: Historic price / earnings ratio of the S&P 500 index since Historic PE ratio of S&P 500 Source: Bloomberg We continue to base our company share allocations on funds which build portfolios of high quality companies, with strong market positions, high financial returns and which operate in resilient industry sectors. Given our confidence in the economic cycle, we are also recommending smaller company and listed private equity funds, which should be well placed to outperform in an era of continued economic growth. We continue to have an unfavourable stance towards bonds; their low initial yields are likely to generate only very modest returns, which do not match inflation. In addition, the valuation argument against bonds appears strong. Chart 3 shows the yield on US 10-year Treasury bonds since 1953; with yields near historic lows, we believe that bond markets remain expensive. Chart 3: US 10 year Treasury bond yields since US Treasury 10 year yield Source: Bloomberg London Wall Partners LLP Page 5 of 14 Authorised and regulated by the

6 We believe other asset classes should deliver superior returns to bonds and that bonds should currently only be held within a diversified portfolio as insurance against unexpected adverse economic events, and clients should have the lowest bond allocation appropriate for their circumstances. We also recommend clients seek the highest quality insurance, i.e. government rather than corporate bonds. We continue to recommend allocations to UK commercial property and infrastructure, two asset classes which we expect to outperform cash and bonds, and which should provide portfolio diversification. With UK real estate yields in some market segments exceeding 5%, and a tight supply / demand balance outside the London office market enabling rents to grow, commercial property should continue to offer attractive real returns. Selected infrastructure investments should also outperform inflation, providing operators of such assets continue to meet customers and regulators expectations. We remain mindful of risks which could challenge our strategy. A plausible negative economic scenario would be a sustained upturn in inflation; this would most likely happen first in the US, where the economic cycle is most mature. With US unemployment low, and tax cuts potentially fuelling the expansion, it is possible that inflation rises and forces the Federal Reserve to increase interest rates in a manner which undermines market confidence. It is also plausible that President Trump starts a trade war with China; however, it may be that his threats to impose large tariffs on Chinese imports are not followed through, and are part of his negotiating tactics to get better trade terms with China. With few elections planned for 2018, political risk does not appear likely to be a near-term concern for investors, but there is always a possibility that Brexit negotiations take an unexpected course, and provoke a fresh UK General Election. Some fear that the Labour Party does not have an investor-friendly attitude and any UK political change could prove unsettling for markets. Finally, while it has been appropriate to ignore military posturing on the Korean peninsula so far, a misjudgement by one of several parties could result in an appalling conflict. London Wall Partners LLP Page 6 of 14 Authorised and regulated by the

7 Further commentary on regions and asset classes are discussed in the following sections: 2.1. UK The UK economy is participating in the global expansion, but is now being outperformed by many other developed economies. The slower growth rate in the UK is most likely being caused by Brexit related factors; some manufacturing companies are likely delaying capital investment until they get a full picture of a new trading relationship with the EU, and some financial services businesses have been moving activities to the Continent. The Brexit situation could ease if negotiations with the EU progress smoothly, and the UK stock market could regain some lost ground against global stock markets, especially if sterling strengthened, thereby both reducing inflationary pressures and increasing the attractions of UK-focused businesses US It was not until the end of President Trump s first year in office that he managed to pass some major legislation; during the rest of 2018, markets will be seeking to gain a deeper understanding of how companies and consumers will react to the tax reduction programme which was approved by Congress at the end of The reduction in the corporate tax rate from 35% to 21% should boost post-tax company profits, support corporate investment and encourage a repatriation of foreign earnings to the US. However, there is a risk that the stimulatory impact on the economy leads to higher interest rates and lower asset prices. Lastly, US trade policies could also influence growth prospects Europe ex-uk The Eurozone economic recovery gathered pace in 2017, and Eurozone Purchasing Managers Index ( PMI ) surveys, a forward-looking indicator of economic activity, are among the strongest globally despite moderating more recently. This has supported higher GDP growth forecasts; Chart 4 shows expectations for 2018 GDP growth have risen steadily since London Wall Partners LLP Page 7 of 14 Authorised and regulated by the

8 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Percentage Chart 4: expectations for 2018 GDP growth in the Eurozone, since March Source: Bloomberg We continue to recommend European funds which favour smaller companies as such stocks tend to have a domestic bias and should benefit disproportionately from the stronger local economy. The political calendar in Europe in 2018 is relatively empty compared to previous years, with the recent Italian General Election the major feature; results showed populist parties increased their share of the vote, but there was no clear winner and negotiations to broker a coalition government continue. In Germany, Angela Merkel secured another coalition deal in March after Parliamentary elections in September 2017 did not deliver a decisive result Japan The Abe government has been in power for over five years, having been re-elected in October 2017 with its large majority intact. The Government is continuing with its corporate and economic reform agenda to entrench faster growth and restore inflation to conventional levels. Our enthusiasm for investing in Japan reflects a growing corporate consensus, provoked by government policy, that Japanese companies should focus more on shareholders interests; this is supported by a valuation case, as most Japanese company shares are more attractively priced than their peers in other markets. The government s interventionist policies extend beyond seeking to change corporate behaviour amongst other measures is a desire to develop the tourism industry, and Chart 5 overleaf shows that this is proving to be a successful initiative. London Wall Partners LLP Page 8 of 14 Authorised and regulated by the

9 Number of people Chart 5 Overseas visitors to Japan since ,000,000 25,000,000 20,000,000 15,000,000 10,000,000 5,000, Number of foreign visitors to Japan Source: Japan National Tourism Organisation 2.5 Asia ex-japan and Emerging Markets Mirroring the situation in the West, economic developments in Asia ex-japan and Emerging Markets have been relatively unremarkable over the last year, with the Chinese economy remaining on a relatively steady path. India had a more momentous year; first, with the ongoing impact of 2016 s demonetisation programme (whereby large denomination bank notes were suddenly withdrawn to combat corruption), then with the introduction in July 2017 of a standardised nationwide Goods and Services Tax (like VAT), and finally in October 2017, with a major recapitalisation of the state banking system. The former two changes held back economic activity somewhat in the short term, but all three should improve the prospects of stronger growth, with fewer inflationary pressures, in the medium and long term. Asia ex-japan and Emerging Markets indices outperformed the World Index over the last year, largely reflecting the very strong share price gains of the Chinese Internet giants, Tencent (somewhat like Facebook) and Alibaba (somewhat like Amazon); their shares rose by 84% and 70% respectively in sterling terms during 2017, and are among the largest stocks in their indices. A key rationale for investing in Asia ex-japan and Emerging Markets is to benefit from the increasing spending power of consumers and a growing middle class, which tends to expand as economies develop. The fund managers we respect tend to find the most attractive opportunities to take advantage of this trend in India. London Wall Partners LLP Page 9 of 14 Authorised and regulated by the

10 Bonds and Cash 3.1. Conventional bonds We believe the two main reasons for investing in conventional bonds are the attractions of an initial yield and/or protection against an economic recession; interest rates are usually reduced in response to a downturn and this generally supports bond prices. We are currently advocating the very low allocation to conventional bonds as we believe yields are low and unattractive and there is minimal risk of a recession in the near-term. For clients for whom an allocation to conventional bonds is appropriate we are recommending US Treasury bonds; the market offers the highest yields of the G7 countries and should provide protection against a recession. We are not currently recommending an allocation to corporate bonds. While there is a modest yield premium on such securities, we do not believe it is sufficient to justify the additional risk of corporate failure. Chart 6 illustrates this, comparing the yield on our favoured US Treasury bonds (red line) with the yield on high risk high-yield Euro corporate debt (blue line), which has been a popular area for investors given the strength of the Eurozone economy. Not only does this demonstrate the current negligible opportunity to earn a higher yield, but also reminds us of how much corporate yields can rise - and prices fall - at times of stress; such junk bonds yielded nearly 30% in early Chart 6: Yields on European High-yield (blue) and US Treasury bonds (red) Euro high-yield bond yield US 10 year Treasury yield Source: Bloomberg London Wall Partners LLP Page 10 of 14 Authorised and regulated by the

11 3.2. Index-linked bonds We continue to anticipate that Index-linked gilts ( ILGs ) will offer a modest positive total return if held to redemption, based on current inflation expectations. In addition, ILGs provide protection for portfolios from unexpected increases in inflation. In the UK, ILGs track the RPI measure of inflation; this has supported performance, since RPI is typically about 1% per annum higher than the officially targeted CPI measure of inflation due to differences in the way the two inflation measures are calculated. We recommend ILGs with low coupons as these are more efficient when held in taxable accounts; they offer a larger share of the expected return in tax-free capital gains, rather than taxable income Cash While UK interest rates were increased from their record low of 0.25% to 0.50% in November 2017, returns from cash are likely to remain below inflation for the foreseeable future, and we recommend that long term investors remain fully invested. 4. Real assets 4.1. UK Commercial Real Estate The UK Commercial real estate sector has continued to deliver positive returns for investors over the last year, and most properties are now valued above levels reached after the market setback provoked by the Brexit referendum result in June This recovery likely reflects a tightness in the balance between supply and demand in many parts of the market as well as ongoing investor appetite for the attractive yields and rental growth available in the sector. Chart 7 not only illustrates the competitve returns which property has delivered compared to the UK stock market over the last 20 years, but also some of the diversifying characteristics of the asset class; for instance, UK Commercial Property continued to make gains while the stock market declined following the TMT boom in However, real estate tends to be influenced by economic factors and both property and shares declined in value during the market turmoil of the GFC in 2008 and London Wall Partners LLP Page 11 of 14 Authorised and regulated by the

12 Rebased to 100 Chart 7 UK Commercial Property (blue) and UK stock market (red) returns since UK IPD All Property Index TR FTSE All-Share Index TR Source: Bloomberg Ongoing uncertainty over the impact of Brexit may well constrain demand for office space in London in the next few years, but there is a positive outlook for some other market segments. For instance, the decline in the pound following the Brexit vote has increased the attractions of the UK as a tourist destination, boosting certain retail and leisure properties, and overseas investors have been taking advantage of lower UK real estate prices in their own currencies to acquire new investments. In addition, the relentless increase in online shopping is increasing the demand for distribution and logistics warehouses close to major conurbations, as companies such as Amazon continue to invest in their supply chains Infrastructure Infrastructure companies provide essential services and their profits tend to be unaffected by economic cycles; given this recession-resistance, infrastructure is usually regarded as a defensive asset class, albeit one whose price can be correlated with bonds in the short term. Many infrastructure investments also have index-linked revenues, thus providing portfolios with long term inflation protection. Infrastructure assets, such as utilities, airports and toll roads generally have long lives and stable cash flows, which supports their long-term value, especially as they rarely have material maintenance requirements or significant competition. Many infrastructure businesses are monopolies and subject to government regulation; we advocate taking a global approach to infrastructure investments to diversify regulatory risk across different jurisdictions. London Wall Partners LLP Page 12 of 14 Authorised and regulated by the

13 4.3. Gold The price of gold declined 10.9% in sterling terms over the last year, and by 5.5% over the last five years. While gold should be a safe-haven during times of market turbulence, we prefer government bonds for portfolio protection as they offer a guaranteed redemption value and an income, which gold does not. To discuss this note, or any other matter, please contact Nick Fletcher on , or any member of the London Wall Partners investment team on London Wall Partners LLP Page 13 of 14 Authorised and regulated by the

14 Appendix - Regulatory Information and Disclosures Table 3 Discrete twelve-month total returns in local currency. Return (%) for the 12 months to: Index FTSE All-World FTSE All-Share ( ) S&P 500 ($) FTSE Europe ex-uk TOPIX (Y) FTSE All-World Asia ex-japan FTSE Emerging Markets FTSE UK Govt 5-15 years ( ) FTSE UK Govt I-L 5-15 years ( ) iboxx Corp Bonds 5-15 years ( ) IPD All Property ( ) Gold Bullion ($) Table 4 Discrete twelve-month total returns in sterling. Return (%) for the 12 months to: Index FTSE All-World FTSE All-Share ( ) S&P 500 ($) FTSE Europe ex-uk TOPIX (Y) FTSE All-World Asia ex-japan FTSE Emerging Markets FTSE UK Govt 5-15 years ( ) FTSE UK Govt I-L 5-15 years ( ) iboxx Corp Bonds 5-15 years ( ) IPD All Property ( ) Gold Bullion ($) Notes: 1. All figures include income reinvested. 2. Local currency indicated in index name, for single country indices. The returns of non-sterling assets may increase or decrease as a result of currency fluctuations. 3. Investment Property Databank ( IPD ) Index may be subject to retrospective revision. 4. Source: FE Analytics. The information, data, analyses, and opinions contained herein are provided solely for informational purposes and may not be copied or redistributed; neither do they constitute investment advice offered by London Wall Partners and therefore are not an offer to buy or sell any security. London Wall Partners expressly disclaims any responsibility for trading decisions, damages or other losses resulting from any use of the information herein. Investments fluctuate in value and may fall as well as rise and investors may not get back the value of their original investment. Past performance of financial markets should not be used as a guide to future performance. Ref.: London Wall Partners LLP Page 14 of 14 Authorised and regulated by the