Brexit and Central Bank developments dominated headlines and market movements this week, as downside risks to equity markets intensified. Over the week, despite the plethora of negative economic data releases, most global indices continued their recent rally and ended higher, further inflating equity valuations in the context of weakness in global growth and lower corporate earnings. Over the week, bond yields declined, reflecting a flight to safety effect and high demand for safer assets considering the weaker growth backdrop. The overall picture depicts a fragile equity rally which is becoming increasingly out of sync with economic conditions.
Despite continued uncertainty concerning Brexit negotiations over the week, it is becoming increasingly likely as we approach the 29th March Article 50 deadline that the UK’s exit from theEuropean Union will be an orderly one, with MPs likely to vote for the existing withdrawal deal over an economically damaging no-deal Brexit. At this stage of negotiations, it appears that the options onthe table are an orderly Brexit via Theresa May’s deal, or no-Brexit via a second referendum. As a result, currency risk is becoming an increasingly important consideration for investors, with an appreciation in sterling having the potential to erode all returns made to this point in the year for those investors with exposure to FTSE 100 equities and non-sterling investments (as is the case in the benchmark). It is estimated that the impact of an appreciation in sterling against the dollar of 1.40- 1.50 would create a 4-7% drag on portfolio returns for a non-hedged, UK based portfolio. For this reason, alongside the evident fragility of the recent equity market rally, we are not concerned about missed performance up to this point for portfolios in comparison to the benchmarks.
For more information on the impact of sterling on returns, please see the attached briefing note.
It is important to highlight as we await a turning point in equity markets, that we are not stuck in a stable position, but rather we are waiting for opportunities to redeploy cash as the economic data and risks change. As it stands, high cash levels enable us to demonstrate a high degree of agility. A potential opportunity would involve adding gold exposure to the portfolio, however we are awaiting greater clarity on the Brexit outcome prior to adding due to the exposure to currency risk should sterling rapidly appreciate following a positive outcome.
As we look ahead, potential catalysts which could derail equity markets and confirm our thesis are Q1 declining corporate earnings (expected in mid-May) and movements in sterling as explained in the attachment. In the meantime, we remain confident in our current positioning, and portfolio performance remains relatively flat (as expected) due to the well-diversified asset allocation underpinning our defensive portfolio construction. In the unlikely case that economic conditions start to improve without a drop back, markets typically experience three 5% pull backs each year, with significantly more during periods of high volatility. We are therefore confident that the market would give us an appropriate buy in point which would realign performance with the benchmark, leaving clients no worse off as a result of the strategy. In the meantime, downside risk has been limited by our defensive positioning, and we remain in a strong position going forward.
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Model Portfolios & Indices
Following the defensive repositioning of portfolios in December, our OBI portfolios have a low equity allocation, with exposure predominantly coming from the FTSE 100 and S&P 500 shorts as well as the Odey Long/Short European fund. For this reason, the equity exposure within portfolios is inversely correlated to markets ahead of the expected decline this half. Overall, global indices rallied over the week due to favourable currency movements. The exception to this were Australian markets, which declined on the back of weaker Q4 GDP data. US markets declined on Wednesday on the back of a move dovish stance from the Fed and weaker GDP growth expectations. Markets are beginning to pause, with a number of key economists now questioning the sustainability of equity valuations given global economic conditions. Following a challenging week, the OBI portfolios performed consistently, remaining relatively flat owing to the defensive, well-diversified positioning.
Overall, while we know missing out on the gains in comparison to the benchmark is painful, we continue to see significant risks ahead in equity markets, with investor sentiment tilting towards the downside and risk off sentiment spreading as risks intensify. The economic data continues to support our expectation for a drop back in markets in H1, therefore we remain defensively positioned going forward. It takes time for the data to feed through structurally, therefore as we wait for the data to feed through into markets, we are expecting volatile market conditions to continue, however it is key to bear in mind that the scenario will take time to play out. We must view intra week market fluctuations in the context of longer-term market trends and stay content in the knowledge that portfolios are protected from the excessive risks in markets.
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 2006, Twitter cofounder Jack Dorsey sent the first public tweet, which read “just setting up my twttr”.
Have a great week, VBW
Gina & Jason