Market Commentary – 4th January 2017
2017 – It is all about the Trump!
If we start our analysis of where we expect 2017 to go, from what we know about the world economy, we can say that most of the data is positive and improving, subject to the huge caveat that debt remains a big issue in many regions and Trump, is as yet still an unknown politically and what he does next once he is actually the President of the USA on the 20th January 2017 will shape 2017. We are though today, seeing further evidence that inflation is rising and is expected to rise further as we progress through 2017, particularly given the moves we have seen in commodity prices, and the relative tightness of labour markets. Labour markets in the US though and in other parts of the developed world are a bit of an enigma though as we have low unemployment but also low participation, which means that the amount of people prepared to work is at a low, and there is a perception therefore that many people may decide to re-enter the labour market and that it is not as tight as we think.
In this environment, we would expect to see growth increase and short / longer term interest rates continue to rise. Despite this we expect to see Japan and Europe determined to hold down interest rates and intervene in markets, and it seems unlikely we will see US and UK interest rates at the levels we might otherwise expect at this stage in the economic cycle. Therefore, continued falls in bond markets, particularly for longer dated bonds, are a fair prospect, but not to a dramatic degree as intervention is likely to take place if rises in yields become difficult for borrowers. The long-term impact of the ability of central banks to buy outstanding debt is yet to be known, but in the near term we are likely to see the continued pattern of intervention whenever stress appears. As a consequence, we count ourselves as fearful of government bond markets, and we expect to receive our 5% contribution from non-equity assets to be returned by either property, bond proxies or high yield.
If we look at the indices and the economic cycle the current equity market bull run may be long in the tooth (started in 2009) but it certainly is not frothy by any means in all parts of the world, with many investors remaining on the side-lines and the characteristics of the end of bull market phase not evident today. What we do expect is that the rotation out of government debt and multi asset strategies that did not work in 2016 and into more cyclical industries, will continue and that volume will at least drive equities up in Q1, for as long as US earnings support the optimism. The extended recovery / expansion phase since 2009 has been driven primarily by the revaluation and leveraging of otherwise benign industries, such as consumer staples and tobacco. We now expect to enter a period of stronger economic growth and, hence, sales and profit growth from all those equity sectors which have been left behind will become the focus, and therefore valuations will rise.
In equities, expectations are again high for risk to be rewarded having been subdued in 2016 despite leading indices in the UK and the US reaching all-time highs. Valuations, assuming forecasters have it reasonably right, do not look significantly stretched given the stage of the cycle we are in, which is the subject of significant debate. Accepting therefore any external shock to the economy we think the outlook for equity markets is positive for 2017, with political risks again being the potential problems, with either a hard or soft Brexit impacting on the UK, Trump’s geo political trade war sabre rattling and European elections being the main issues. With a Trump presidency, it is fair to assume a positive backdrop for the US corporate sector. It is therefore an easy call to be bullish on the US where most of the pieces are already in place and we are happy to be invested there via our exposure to global growth funds and not directionally, so the fund manager has more flexibility to diversify and cyclically rotate the portfolio as valuations rise and fall regionally.
In addition to this we are bullish on UK Mid Cap in Q1 as we still see value here as its performance was flat in 2016, and we expect UK economic data to continue to outperform expectations and for that to continue, if we progress with a soft Brexit. Either way, we feel there is an opportunity in Q1 to continue with our exposure here. UK Large Cap looks expensive, based on historical valuations, accepting with most of the revenue in FTSE 100 companies comes from overseas revenue and with the devaluation in sterling there is potentially a further 5% – 8% upside before it becomes expensive so again directionally we gain exposure here via global equity funds. More courageous calls are our position in Europe where we see value as the indices in 2016 were negative or underperforming and valuations remained much lower, and the strong dollar / weak Euro is a clear benefit. We potentially have the same potential in Japan and we are reviewing our exposure there and will report on this next week as we may decide to put back a directional play but hedge out the currency risk. As far as the Emerging Markets are concerned we have positives and negatives here in that a strong dollar is bad, but with rising commodity prices there is a balancing positive. We are again therefore looking to gain our exposure here via a global position so that the fund manager can make the underlying call and switch it out, without cost if they see or feel a further rotation is required.
We will revert to reviewing the Barometers next week but as I review all is good in the world and economic data continues to surprise positively, so as we start 2017 all is good in the investment world and risk should be rewarded, but it is all about the Trump in Q1 with Brexit dominating the news reel at the end of Q1 and the start of Q2. Beyond this immediate line of sight let us not today make any predictions accepting it would be hard for the far right to win in the French elections as it stands today, but strange things happened in 2016, so as always, we watch.
Indices and Portfolios
As we have now closed 2016 it is worth looking again at what the indices and portfolios did as detailed below. On first glance, 2016 looks good for UK and US large cap with double digit rises, noting everywhere else was relatively poor. The year itself was fraught with volatility traps and geo political issues that caused problems and it was a year of four different quarters, each one having its own headlines and risks. The first six weeks were dominated by the collapse in the Oil price and sovereign wealth funds indiscriminately taking capital out of markets which saw global indices sell off 10% plus by the 11th February and then, rallying gain from those lows as fear abated. We rode the markets back up towards the end of Q1 as we saw no economic reasons for the sell off, bar earnings were bad, and as we moved through Q2 we gradually increased our cash weighting due to the referendum, being an event that had significant economic consequences either way. Our house view was that we would vote to stay in but it would be close, therefore we planned for both eventualities and we ended Q2 fully invested with US Treasuries and Gold dominating the portfolios. Early Q3 was dominated with a rotation back into equities and out of treasuries and market neutral positions as distressed assets emerged. Finally Q4 has been dominated with doing nothing bar making a few tweaks and adding risk assets back into the portfolio as we are happy with our positioning in Q3, accepting we sold a few cautious funds and bought ones more aggressive and globally focussed. Overall it was a very busy year and one that I am glad to see the back off.
As we had a period of high volatility in the first six weeks of 2016 and then capital preservation in Q2 this meant over this 12-month period, we fell behind benchmarks noting we expect that to change as we continue over January and February, but over 1, 3 and 6 months we have consistently outperformed benchmarks and objectives and we are delighted with that and see no reason why that will not continue. As we look forward do not be surprised if we take profits on assets as we see some get ahead of themselves in Q1 and we are looking at that today so we can take profits, rotate into other assets and then rotate back when markets fall. There is no doubt that we will have periods of worry in 2017 with Article 50, Trump and elections in France to name a few and no bull run is a straight run up, there are always periods of increased volatility and we hope to be able to continue delivering sold returns with low levels of volatility in 2017 with a watchful eye on our barometers and valuations to stay ahead of the pack.
Fact of the Day / Week
It has returned at the request of many, in that we are again delivering a fact of the week, with some being funny and others not depending on how the mood takes me. I am therefore going to search the archives every week and deliver a fact that happened that day /week historically and add it to the market commentary as a bit of light relief.
As a first and noting not many think it was funny, on this day in 1999, for the first time since Charlemagne’s reign in the ninth century, Europe is united with a common currency when the “euro” debuts as a financial unit in corporate and investment markets. Eleven European Union (EU) nations (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain), representing some 290 million people, launched the currency in the hopes of increasing European integration and economic growth. Closing at a robust 1.17 U.S. dollars on its first day, the euro promised to give the dollar a run for its money in the new global economy. There is some humour in those expectations!
As always have a great week and let’s hope 2017 is far calmer than 2016, as always, we watch and observe and if risks change we will act in your best interests.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager