Fund Management Diary Meeting held on 6 October 2015 The Fed s put is off While the Fed has been continually forecasting rate rises with monetary tightening in 2015, following the jobs data with only 142,000 new jobs against a forecast of over 200,000, the judgement from the market was swift with 10 year treasury yields falling back through 2% and once again creating a reverse yield gap against the dividend yield on the S&P 500, as shown in our chart at Appendix 1. This has particular significance for markets as set out in our comments and could, in our opinion, mark an important inflexion point. The initial reaction to the poor jobs data was for markets to fall, but as the implications became clearer, this provided no room for monetary policy to be tightened and indeed external factors were creating even further uncertainty, thereby calling into question the FOMC s credibility. As we have set out in previous diaries, it was our opinion that the Fed had fallen behind the curve and should have looked to normalise monetary and fiscal policy far earlier, perhaps as long as two years ago, which would have provided the necessary toolkit so that they could deal with unexpected shocks and ensure that they were in the driving seat. As it is, they now have precious few levers and face the outcomes of external fears of a global slowdown, together with political risk, particularly with regard to Emerging, which weigh heavily on market sentiment. At the end of September, the IMF issued strong warning to the Fed on the risk of rate rises due to Emerging having been caught up in a credit bubble, which was principally created by the readiness of China and other participants to take up the baton of global growth due to the banking crisis in developed markets. Countries throughout SE Asia, Latin America, the Middle East and Africa were all too prepared to borrow dollars at the ultra-cheap rates being offered to finance their expansion. However, as any UK citizen who was persuaded to borrow in Swiss Francs in the 1980s when they could match rates of around 2-4% against the double digits in the UK, has found to their cost, as devaluation struck they were actually left with paying far higher interest and an exponential increase in their mortgage. Effectively, developed markets sold Emerging a pup as they rushed to push the QE button which effectively devalued their currency, while inflating their own financial assets. At the same time, QE was creating financial repression for the working population and removing income through interest from the savings classes and pensioners. The result was to reduce consumption and aggregate demand as workers had less disposable income and savers followed the well-known path of increasing their savings and also cutting out spending producing a double whammy. Gillian Tett of the FT quoted from the IMF s Stability Report that Emerging Market corporate debt had increased from $4000bn in 2004 to $14000bn in 2014, the majority of which has been recycled from central banks. It appears from research by Citi Bank that 75% of this was placed into developing markets, generating some $5000bn of private emerging market credit each year!
Gillian Tett goes on to state that a critical question is what happens if the process of Emerging Market private money creation slows or goes into reverse? Some policymakers hope that the shock can be contained by more monetary creation by Western banks, but the simple fact is that the world is reaching a point of credit exhaustion. The real problem as is now being expressed by a majority of economists is that it is not solvency that is the problem, but one of liquidity, which has been made all too clear by the extraordinary movement in the share price of Glencore, the mining giant hit by the commodity crisis. Many people believe this had been a massive put on China by mainly hedge funds and high frequency traders and in our opinion, the behind the scenes stabilisation seen this week will eventually tell its own story. are now losing confidence in the ability of the Fed and other major central banks to bolster higher rates of inflation and based on five year swap rates, it would appear that it would take five years for the Fed to reach its 2% inflation target. An open criticism is, how did the doves of the FOMC have the arrogance to brush aside market inflation expectations? The crisis now is one of deflation, which is being exported from China, as developed markets are seeing all too clearly, such as steel being dumped in world markets creating shutdowns and short working, while also exporting cheap goods reducing competitiveness and directly challenging workers in developed markets. It is all too clear that at a stroke China could, by devaluation or QE, cause major eruptions in the developed world stock markets. This is not in their interests and there is little doubt that they are now looking for accommodation by the Fed to supply liquidity to the market via means other than QE and provide a lead to the developing world to increase consumption and aggregate demand, creating the necessary stimulus to global growth. In our opinion, Glencore, just as the failure of retail banks in 2008, was too big to fail and the consequences of a shutdown of the major player in the commodity markets would have created a similar scenario. Next week, the IMF will be meeting in Peru with the major participants from the financial markets and the outcome should set the course for world stock markets. The Fed in particular and other financial participants readiness to consider normalisation of monetary and fiscal policy by providing conventional stimuli would be important. Simple analysis of the 10 year treasury charts, as shown at Appendix 1, is already showing an upward trend in interest rates. It is to be hoped that this theme will be maintained as a result of the deliberations at the IMF, which will be supported by a final joint communique by the participants. Strategy As set out in our diary, we believe that an important inflexion point is approaching in which a marketled upward trend in interest rates should be established, with central banks supporting the need for global growth, without a continual devaluation of currencies racing to the bottom. The most important aspect will be seeing a weakening of the dollar which could need injections of liquidity and fiscal policy originating from the Fed. In the meantime, the Margetts team remain committed to equities from worldwide assets where earnings and dividend growth are paramount. We believe that bond yields will now slowly increase which will be market driven and we therefore remain cautious of bonds and retain our weightings particularly in special situations.
Providence The UK allocation is mostly positive over 12 weeks with the Premier Income and the Royal London UK Equity Income funds being the strongest contributors to overall returns. The IFDS Brown Shipley Sterling Bond fund has lagged the sector over recent weeks as a result of exposure to the energy sector and a higher allocation to BBB rated bonds. These areas have been hit during recent market falls and the continued weakness in the oil price; however the manager feels that valuations remain attractive and is maintaining these positions. The team will monitor the holding going forward but do not expect to make any changes to the holding in the short term. The manager of the L&G Asian Income fund, Paul Hilsley, states that the relatively weaker performance of the strategy can be attributed to stockspecific issues, which he feels are as a result of overreactions to uncertainty driven by wider negative sentiment in the market. The investment committee will continue to monitor the holding. 5% UK Equity Income 39% Bonds 30% Other Europe 14% Select The UK Equity Income selection continues to outperform the comparable sector with the UK All Companies and European allocations also being positive. The JPM Emerging Income fund continues to slightly lag the sector which the manager attributes to the value/quality style of the fund. No changes are being considered at present as high levels of volatility continue to prevail in these markets. Small sells have been made to maintain the equity weighting within the strategy after market rises. UK Equity Income 21% UK 20% USA 11% 10% Bonds 13% Emerging 8% Europe 5% 12%
International The Baillie Gifford holding has been strong over the short term after a period of relatively weaker performance. Further to the comments made last week with regard to the Majedie UK Equity fund, the manager has stated that the recent weaker returns have been driven by the fund s lower allocation to bond proxies and stock specific issues within the supermarket sector. The fund will be monitored over the coming weeks but given the long term track record of the management team, we expect this shorter term weakness to recover. The manager of the L&G Asian Income fund, Paul Hilsley, states that the relatively weaker performance of the strategy can be attributed to stock-specific issues, which he feels are as a result of overreactions to uncertainty driven by wider negative sentiment in the market. No changes are being considered at present and the team will monitor the fund closely going forward. USA 33% 12% 3% Emerging 8% UK 15% Japan Europe 23% Venture The Old Mutual UK Alpha holding has improved over the short term which is encouraging. The JPM Emerging Income fund continues to slightly lag the sector which the manager attributes to the value/quality style of the fund. No changes are being considered at present as high levels of volatility continue to prevail in these markets. The Fundsmith Equity holding has been a strong performer over the medium term, contributing positively to overall returns. Specialist 8% Other 7% UK USA 7% 35% Europe 12% Emerging 25% 0%
Appendix 1 Reverse Yield Gap Source: Bloomberg The above chart shows periods when the dividend yields on the S&P 500 exceed the yield from 10 year treasury bonds. It should be particularly noted that this has occurred three times since the collapse in the market in 2008 and each occasion has been associated with high volatility. On this last occasion, the continual fall in bond yields is now showing a position of potential reversal in the overall trend. In our opinion, this could be an important inflexion point.
Important Information Please note that the contents are based on the author s opinion and are not intended as investment advice. This information is aimed at professional advisers and should not be relied upon by any other persons. Any research is for information only, does not constitute financial advice or necessarily reflect the views of the author and is subject to change. It remains the responsibility of the financial adviser to verify the accuracy of the information and assess whether the fund is suitable and appropriate for their customer. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested. Important information about the funds can be found in the Supplementary Information Document and NURS-KII Document which are available on our website or on request. Issued by Margetts Fund Management Ltd Margetts Fund Management Limited is authorised and regulated by the Financial Conduct Authority For any information about the company or for a copy of the company's Terms of Business, please contact the company on 0121 236 2380 or at 1 Sovereign Court, Graham Street, Birmingham B1 3JR You can e-mail us at admin@margetts.com