All in the mix now with the confidence vote the Brexiters have played there hand and are trying to see if there is a majority of parliamentarians who want rid of her. We don’t have a sense of the specific numbers, but my view is that she survives tonight and as she is not Maggie Thatcher we also think she is tenacious enough not to resign. If therefore she survives tonight, and does not resolve the issue over the backstop and open the door to losing the support of the DUP, she will soon have to face the Parliamentary no confidence vote. Success of this hangs on the DUP. Hence the significance of Labour DUP talks. However, Corbyn Sinn Fein links makes this an unnatural alliance. So ..
- If the PM loses tonight I think there is a real risk of Brexiteer (hopefully David Davis but definitely not Rees Mogg and his Nanny or Boris) winning and pushing for hard Brexit, which will be bad for sterling as it will fall and positive for government debt – cash will be neutral.
- If she loses a parliament vote of no confidence in coming week this will result in early elections, chances of Brexit delayed (revoke A50 and renegotiate) increases, but possibility of Labour government increases which will be same for markets as above.
If she survives both there is still a chance that Brexit is delayed but the reduced chance of hard Brexit and Labour government should be positive for sterling and negative for government debt and cash will be neutral. In summary therefore I am glad we have lots of cash as no one has any idea what is happening next and our ships are safest in harbour………..
As regards to the normal content of the weekly market commentary please read on.
Economic icebergs lie ahead, time to plot an alternative course
Last week, following a wave of increasingly negative economic data, the decision was made to take a more defensive stance in portfolios. As part of this defensive strategy, equity exposure was reduced, and high cash levels were implemented as the data now suggests that a structural sell off in equities in Q1 2019 is a distinct possibility. Over the last week, markets have been mixed as we expected, with political events dominating market movements. Equity markets continue to demonstrate high levels of volatility, with key events over the coming weeks being the ongoing Brexit chaos, updates on the Xi and Trump trade truce situation, and a possible US rate rise next week.
The decision to implement a more defensive strategy was made after an in-depth analysis of the risks, taking into account both current economic data and expectations for future economic data. It is important to highlight that while a number of economists continue to highlight the strength of the economy with reference to backward-looking data, when we consult expectations for future growth, the picture becomes much more negative. By consulting the forward-looking data, we are able to provide a more complete assessment of the risks which has resulted in us choosing to move away from the herd.
Beware of the backward-looking data
Most economic analysis tends to be backward looking, looking at changes in the trends in lagging economic indicators such as retail sales, employment, and earnings data to provide an insight into the overall health of the economy. While this approach can be useful in looking for minor changes in trends over recent months, it involves looking backwards to determine the future health of economy. For this reason, economic analysis focusing solely on backward looking data always misses major turning points in economic history. IT is therefore not a reliable information source for identifying the turning points in the economic cycle. A great analogy for this is the sinking of the Titanic: The Captain was so busy building up speed that he ignored ice warnings and failed to see the iceberg ahead of him. There are a number of economic icebergs out there that are not seen and if they are, they are ignored by many, prominently in most economic minds as they are too busy going fast to look ahead and take action through fear of being wrong.
What is the forward-looking data telling us?
The current economic outlook suggests that there is further volatility and risk on the horizon in 2019, with a number of key developments leading expectations for a slowing of global growth and a structural sell off in equities in Q1 2019. This evaluation of the global economy is based on an analysis of the risks in the below key regions. It is our view that significant weaknesses and uncertainties exist in each area which are likely to result in lower equity valuations in the near-term.
Recent developments in Europe are beginning to raise concerns of a potential recession in the area following social unrest in France, a contraction of German GDP in Q3, and a budget stalemate in Italy. On Monday, following a period of social unrest in France, President Macron announced major measures to support households’ purchasing power. The costs of the new measures are expected to widen the fiscal deficit in 2019 to 3.4% of GDP, well above the initial target of 2.8%. As a result, the measures are likely to support growth through higher consumption, however could force the European Commission (EC) to open an Excessive Deficit Procedure against France for breeching its 3% deficit threshold. Considering Macron’s criticism of fiscal slippage in Italy, the EC will have a hard time avoiding opening the procedure for France due to one-offs.
The German economy is also experiencing weakness, with GDP contracting 0.2% in Q3. This came largely as a result of temporary production cuts in the automotive sector, however with inflation eroding real incomes, and political uncertainty following Merkel’s decision not to continue as Chancellor, the German economy is expected to experience weakness in the coming months. As the powerhouse economy in Europe, a slowing of the German economy is likely to reduce growth across the bloc. In Italy, tensions persist after the EC rejected the Italian budget after no significant changes were made to the first spending proposal under the new government. More recently, discussions have become more constructive, suggesting the possibility of a compromise, however if no compromise is made, the Italian government could also face an Excessive Deficit Procedure which could result in economic sanctions being placed on the state. Considering the underlying weaknesses in the Eurozone economy and the existing risks, slowing global growth is likely to further exacerbate weakness, leading expectations for a brief recession in Europe over the next year. For this reason, we have reduced European exposure in our model portfolios and continue to monitor developments going into the new year.
With the issues detailed today with a vote of no confidence in Theresa May no one has any idea the direction of the UK Economy and the wild gyrations will continue until clarity is given as noted at the beginning. My best bet today is that to be honest I have not get any idea and if she loses I will write another market commentary that details what next. For today though I am just ignoring trying to second guess what next because it is a shambles. In the UK, the economy is showing signs of slowing amidst chaotic Brexit negotiations which are creating negative sentiment and reducing levels of investment in the UK economy. After weaker growth over the last two months, Q4 GDP growth is expected to slow to 0.3%, following weakness in both Manufacturing and Services. This weakness is expected to feed into corporate earnings this quarter, resulting in lower equity valuations.
In the US, while backward looking data continues to suggest that the US is in strong health, growing headwinds from higher input and borrowing costs, increased trade protectionism and slower global activity are creating weakness in the economy. This weakness is expected to bring GDP growth down from 3% currently to around 2% in 2019, feeding through to lower corporate earnings and widening corporate bond spreads. In recent weeks, weaker data is beginning to come through, with recent labour data reflecting a maturing labour market and lower small business optimism. Slower global growth and a strong dollar are expected to cool business investment in 2019, with further rate hikes next year putting further pressures on a slowing US economy.
China’s domestic economy is already cooling, and is expected to ease further in 2019 due to slow credit growth, weaker real estate activity and the impacts of its trade conflict with the US feeding through into corporate profits. Despite the recent truce with the US, tensions remain after the arrest of Huawei’s CFO in Canada, creating uncertainty over the future of a truce agreement. A simultaneous slowdown of the two largest economies in the world is likely to present a strong headwind for the rest of the world.
Overall, it appears that when looking at the data, the picture is one of slower growth based on political uncertainty and lack of momentum in equity markets, alongside existing evidence of slowing growth in US and Chinese economies. In 2019, this is expected to flow through into earnings, bringing about our expectations for a selloff in equities in 2019. Despite this outlook, all is not doom and gloom. Due to our defensive strategy, we are now well positioned to benefit from a drop back in equity markets, and have high cash levels in preparation for the emergence of opportunities when markets reach their lowest points. Based on the forward-looking data, we are not expecting a global recession, but more an equity sell off and a potential recession in Europe which we will be poised to benefit from in the long term.
For anyone who wants further data to substantiate the global economy is not falling off a cliff and is still in relatively good shape looking at what has happened not what is happening, please review the attached Global Economic News Document. Also we have added a section on US government bond rates and the inversion that is about to happen which is always a signal of an impending recession.
Model Portfolios & Indices
Over the last week, global indices have fallen on the back of more negative economic data, continued political uncertainty and growing scepticism over the US-China trade truce. As we have referenced we went defensive on Tuesday so we have still tracked the market down on Tuesday but not suffered the continued losses later in the week. Despite the market rallying today that decision to go into capital preservation mode, on a forward looking basis for Q1 2019, is still correct because for as much as the news reel is positive today it will again turn negative as the focus stops being on politics and returns back to the data.
If we compare the indices to the OBI portfolios then in comparison, the OBI portfolios have also fallen over the period but to a lesser extent, with the recent defensive repositioning resulting in outperformance of all portfolios in comparison to the benchmark over the 1 month, 3 month and 6 month views. Active 7 is stilt e best performing portfolio TD and in direct comparison to the FTSE 100 this portfolio is down 3.44% and the FTSE 100 is down 11.46%. Although not something to shout about as it is still a loss, compared t the indices and our peers we are doing positively. Looking forward to 2019 we are confident that if we get the entry point correct and tactically trade the portfolio in Q1, leaving the day to day up to the fund managers, we will have a very positive 2019 that will follow though into 2020 and beyond. We have as I said completed step 1 which is remove the threat and as long as the threat becomes a reality and we reinvest at the right time the threat will become an opportunity.
The attachment titled “OCM OBI Active 7 Portfolio returns from May 2018 to Nov 2009” details what we did in 2018 when the market capitulated by going defensive at the end of the cycle and having a high cash portfolio. As you can see from the chart the disparity in returns when we took risk off the table was large accepting it did not happen immediately and there were a few periods when it looked like we should have stayed invested. We did though stay in cash and held our nerve and when the markets capitulated in Sept 2008 we sold the remaining part of our equity portfolios and went very defensive buying UK government debt and global government debt. We then reconnected in June 2009 and tracked the market up with direct correlation. All in it was fantastically successful period and one that we are trying to repeat accepting 2008 was an extreme and we are not expecting to repeat what happened then.
However, upon reflection of 2008 and 2009 what we have identified is that we could have done even better, for the clients that can accept the volatility, gone risk on earlier in 2009 once the market had capitulated, and this is something we are looking at carefully and have already built the portfolio that we would invest into if the economic indicators and movement ins assets plays out as expected. Obviously, we do not want to give too much of what we will do and when away in a public document but rest assured, we have numerous plans and numerous items that we are observing. We also for many expect to have fully reinvested by end of Q1 2019 if the direction of markets is the same as in Q1 2016, which was our last risk off period and the data looks like it is bottoming out, we have a resolution to Brexit and the trade wars have ceased. Exciting times ahead and I am not going on any holidays that are longer than a day!!!!
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the days movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 1964, Kenya became a republic on the first anniversary of its independence from Britain.
As always have a wonderful week and stay safe. If May loses tonight, I will send more tomorrow afternoon once we have an idea as to what is happening next. If she wins then no need as we will just have more of the same unless she can get the European leaders to agree to remove the backstop. If she cannot then well if the Tories lose the support of the DUP, we will have to defer leaving the EU have an election and Corbyn and god knows what will happen then!!!!!