Quarterly investment outlook. Five key issues shaping current investment strategy Third quarter 2017

Transcription

1 Quarterly investment outlook Five key issues shaping current investment strategy Third quarter 2017

2 Five key issues shaping current investment strategy Third quarter 2017 Page 2 Five key issues shaping current investment strategy 1. Investing in technology Great tech-spectations 3 2. Looking up Europe: from problem child to investors favourite? 4 3. Measuring Abenomics Are Shinzo Abe s arrows flying true? 5 4. Brexit uncertainty Still lots of heat but little light 6 5. Active vs passive The unintended consequences of passive investing 7

3 Five key issues shaping current investment strategy Third quarter 2017 Page 3 1. Investing in technology Great tech-spectations The tech sector represented just under a quarter of the entire S&P 500 at its recent peak, with the five biggest US companies Apple, Alphabet, Microsoft, Amazon and Facebook all being technology stocks and making up 13% of the index (figure 1). Diversity in the sector means the overall valuation is not excessive. The S&P 500 IT subsector trades at much lower prices relative to earnings (PE) than it did at the peak of the technology boom in But it s expensive relative to the index (figure 2). These big five have built up significant cash piles. For example, Apple s cash represents nearly 22% of its market value. Cash allows them to acquire other companies to gain expertise, technology or market positioning to accelerate their growth. But after such strong performance, the sector may be due a pause or correction as investors take profits and reassess the upside. The famous five Technology in focus Apple 3.9% Alphabet 2.8% Microsoft 2. 7% Amazon 1.9% Facebo ok 1.7% Other tech 10.4% Rest of S&P % PE ratio of the tech sector relative to the S&P Figure 1 The five largest US technology stocks make up 13% of the S&P 500 Index., as at May 2017 Figure 2 Technology companies are getting more expensive relative to the S&P 500 Index as a whole, with some valuations in the sector looking stretched. The value of investments and the income from them could go down as well as up, and you could get back less than you invested.

4 Five key issues shaping current investment strategy Third quarter 2017 Page 4 2. Looking up Europe: from problem child to investors favourite? Europe is experiencing new-found popularity. Emmanuel Macron s victory has staved off investor fears about populism, while fundamentals are improving. In 2016, the region expanded faster than the US for the first time since the financial crisis. Investors have been turning away from expensive US equities in favour of their European counterparts (figure 3). European exchange-traded funds (ETFs) netted a record $6.1 billion in inflows in the first week of May (figure 4). However, Europe is no longer cheap with the headline PE ratio for the MSCI Europe index now 24.3 times compared with 21.7 times for the S&P 500. We believe investors should be wary at the top end of the market-cap spectrum where ETF flows tend to be concentrated. Headwinds remain in Europe, including political uncertainty in Italy, with the possibility of an early election before the end of this year. We remain cautious and continue to favour quality companies and fund managers with a proven track record. Global passive flows in May ($ billion) Broad Europe equity EAFE equity Investment grade corporate debt Broad emerging market equity Global excluding US equity High yield corporate debt US mid-cap equity Treasury inflation protected securities Gold miners US small-cap equity European passive flows by year ($ billion) Figure 3 Out of total flows of $45 billion into exchange-traded products in May 2017, passive investors favoured European equities out of all other asset classes and regions. Source: BlackRock Global ETP Landscape, Industry Highlights, May Figure 4 In the year to the end of May, investors have already allocated nearly $44.7 billion into European exchange-traded products. Source: BlackRock Global ETP Landscape, Industry Highlights, May 2017.

5 Five key issues shaping current investment strategy Third quarter 2017 Page 5 3. Measuring Abenomics Are Shinzo Abe s arrows flying true? Prime Minister Shinzo Abe s Abenomics strategy comprises three arrows: monetary stimulus and currency devaluation to achieve a 2% inflation target; a flexible, stimulatory fiscal policy; and a growth strategy focusing on structural reform to increase capital and productivity. During Abe s time in office, return on equity has risen by more than 3.5 percentage points (figure 5). Although Japan still has catching up to do, many companies are committing to return on equity targets for the first time. Meanwhile, household inflation expectations are rising (figure 6). Japan s workforce is rising despite an ageing population. The current government has revised regulations to permit foreigners to work in certain roles and expanded training programmes for workers from developing nations. Other areas targeted by Abe include increasing female participation in the workforce and lowering corporate taxes. In addition, inbound tourism has almost tripled in Japan since his election partly due to his government s visa deregulation measures. Return on equity Household inflation expectations Japan Asia ex Japan Expecting prices to increase Expecting prices to decrease Expecting price to remain the same Figure 5 Since Shinzo Abe s election in 2012, return on equity in Japan has risen by more than 3.5 percentage points. Figure 6 Household inflation expectations reveal signs of life in the Japanese economy. Past performance should not be seen as an indication of future performance.

6 Five key issues shaping current investment strategy Third quarter 2017 Page 6 4. Brexit uncertainty Still lots of heat but little light Household consumption has had a strong tailwind in recent quarters, partly due to lower commodity prices. However, inflation is now more than offsetting wage growth as sterling weakness drives up import costs (figure 7). With most revenues for the FTSE 100 Index generated abroad, the weaker pound has increased the value of earnings for sterling investors. The FTSE 100 continues to outperform the more domestically focused mid-cap FTSE 250 Index, but still trades on a lower price relative to earnings, or PE (figure 8). There has been a divergence in sector performance mainly due to domestic economic conditions and the pound. For example, results from UK retailers have been poor as customers real wages are being squeezed and many end-products are made overseas. Consensus UK growth forecasts for 2017 and 2018 have been revised upwards, but changing expectations for Brexit negotiations could increase the risk of downward revisions. If this occurs, investors may demand lower prices for stocks exposed to the UK economic cycle. Wages and inflation UK nominal wage growth UK consumer price inflation 6% 5% 4% 3% 2% 1% 0% -1% FTSE 250 vs FTSE 100 PE ratios FTSE 100 FTSE Jan 2016 Apr 2016 Jul 2016 Oct 2016 Jan 2017 Apr 2017 Figure 7 Wage growth has been slipping behind the pace of inflation recently. Figure 8 The more internationally focused FTSE 100 Index has benefited from sterling s fall in value following the vote for Brexit. Source: Factset, Rathbones Past performance should not be seen as an indication of future performance.

7 Five key issues shaping current investment strategy Third quarter 2017 Page 7 5. Active vs passive The unintended consequences of passive investing The exposure provided by tracking an index can be surprising. For example, five major tech companies make up 13% of the S&P 500. Investors concerned about the valuations of these companies should be wary of passive investing. In Asian and emerging markets, where there is significant divergence between countries, active managers may be able to add value by choosing regions with the fastest growth. Global equity markets have been unusually calm, a benign environment for passive investing. However, index trackers would experience the full downside if volatility were to pick up from its current historically low levels (figure 9). UK equities have the most diversified revenue streams in regional terms (figure 10). Out of the four major developed markets, the UK is most exposed to emerging markets. Calm conditions in global equity markets 3-month volatility of the MSCI World index Today's level Equity markets and geographic revenue exposures UK North America Japan Europe ex UK Latin America Asia ex Japan % Figure 9 We have rarely seen volatility this low in global equity markets. Figure 10 UK equities have the most geographically diversified revenue streams. 0 UK North America Japan Europe ex UK Asia ex Japan Latin America ; as at May 2017 Past performance should not be seen as an indication of future performance.

8 Five key issues shaping current investment strategy Third quarter 2017 Page 8 Important information The value of investments and the income from them may go down as well as up and you may not get back your original investment. Past performance should not be seen as an indication of future performance. Changes in rates of exchange between currencies may cause the value of investments to decrease or increase. Information valid at 30 June Tax regimes, bases and reliefs may change in the future. Rathbone Brothers Plc is independently owned, is the sole shareholder in each of its subsidiary businesses and is listed on the London Stock Exchange. Issued and approved by Rathbone Investment Management Limited, which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered office: Port of Liverpool Building, Pier Head, Liverpool, L3 1NW, Registered in England No Rathbones and Rathbone Greenbank Investments are trading names of Rathbone Investment Management Limited. Rathbone Unit Trust Management Limited is authorised and regulated by the Financial Conduct Authority. Registered office: 8 Finsbury Circus, London EC2M 7AZ. Registered in England No Rathbone Trust Company Limited is authorised and regulated by the Solicitors Regulation Authority. Rathbone Investment Management International is the registered business name of Rathbone Investment Management International Limited which is regulated by the Jersey Financial Services Commission. Registered Office: 26 Esplanade, St Helier, Jersey JE1 2RB. Company Registration No Rathbone Investment Management International Limited is not authorised or regulated by the Financial Conduct Authority or the Prudential Regulation Authority in the UK. Rathbone Investment Management International Limited is not subject to the provisions of the UK Financial Services and Markets Act 2000 and the Financial Services Act 2012; and, investors entering into investment agreements with Rathbone Investment Management International Limited will not have the protections afforded by those Acts or the rules and regulations made under them, including the UK Financial Services Compensation Scheme. This document is not intended as an offer or solicitation for the purchase or sale of any financial instrument by Rathbone Investment Management International Limited. No part of this document may be reproduced in any manner without prior permission Rathbone Brothers Plc. All rights reserved.