Market Commentary – 15th November 2017
What’s been happening over the past week?
This week we have seen volatility returning to the markets as we edge closer to the end of the year, following an equity rally throughout most of last month and the beginning of this month. On Thursday last week, the markets dropped down after concerns were raised over Trump’s ability to pass his tax cuts proposals, which has brought down the US Dollar, bond yields and equities. Volatility isn’t necessarily a bad thing, more a cause of concern, especially in this late phase of the economic cycle.
With global equities reaching record highs in previous months, it is apparent that investors are now slowly taking risks off the table. There isn’t just one compelling argument for the risk-off stance, more so a cautious approach which is in line with our investment thesis and our portfolio positioning. On the contrary, global macroeconomics looks strong with high consumer demand, high investment and high government spending. The macroeconomics is driving the microeconomics that is fuelling the equity boom, creating strong Earnings Per Share (EPS) growth.
Still too soon to sound the alarm?
Although the valuations of most risky assets have risen further above their long-run averages, it is not expected to come crashing down any time soon. Higher-than-average valuations appear to be justified by a structural decline in real interest rates, which has reduced required rates of return. Admittedly, it is expected that the Fed’s rate hikes, as they are expected to come, will push Treasury yields and the dollar up a bit. But if the global economy remains healthy, risky asset markets should continue to shrug off this tightening, with emerging market equities in particular likely to make further gains. In short, the music is unlikely to stop as we enter 2018, as the US economy starts to falter.
So, what are the current risks to the boom?
With the strong macroeconomics driving the microeconomics, we are starting to realise the potential risks of the free market global economy. Since the 2007/8 financial crisis, Central Bankers have intervened and implemented stimulus demand and supply side policies to rejuvenate the economy. Since then we have progressed through the economic cycle, however the stimulus policies implemented (Monetary and Fiscal Policy) have overheated the economy in terms of inflation. Globally, inflation is high with interest rates at record lows. Ideally inflation should equal interest rates which shows sustainable growth. Now we are in the boom phase of the global economic cycle, central bankers are reducing their asset purchasing programs (Quantitative Easing) and hiking up interest rates to match inflation.
All eyes are on the US and congress passing Trump’s Tax reform bill. With the possibility of an optimistic stance, markets are doing well and will continue to do well until the US shows weakness on passing this bill. Today we heard that congress could vote by Thursday over Tax Reform. We will continue to look into this moving forward. With regards to the geopolitical tensions between North Korea and the US, the threats seem to have dispersed for now and North Korea hasn’t conducted a missile test in exactly two months (15th September was the last).
Brexit is now becoming more of an issue as comments by the Prime Minister Theresa May and Brexit Secretary, David Davis this week have put into focus the tight timeframe in which the terms of the UK’s exit from the EU must be negotiated, and places a significant weight on the December European Council meeting for a turning point to be reached. Despite the lingering uncertainty about the negotiations as a whole though, it was reported this week that Swiss bank UBS thinks that there has been enough clarification on regulatory issues, that the risk that 1,000 of its 5,000 London staff would be moved as a result of Brexit was becoming a “more and more unlikely” scenario. If this is true for other banks too, then the 20% or so of UK bank staff that have previously been reported to be at risk of moving could be scaled back. Meanwhile, there was some reasonably encouraging news on the economy, with Q3’s GDP figures revealing a slight pick-up in growth from 0.3% in Q2 to 0.4%, above the consensus expectation. Overall, uncertainty is likely to linger for a while longer, although it doesn’t appear to be de-railing the economy, showing the overall microeconomics resilience. Assuming that there is a positive step forwards at the key European Council meeting in December, then that could help to diminish uncertainty and pave the way for a pick-up in growth next year.
The Barometers below look at some of the data we review on a day by day basis and by having these detailed, it gives you some insight into what is happening.
US Earnings are important because if the US starts to slow down, then so does the rest of the world.
For Q3 2017 (with 91% of the companies in the S&P 500 reporting actual results for the quarter), 74%
of S&P 500 companies have reported positive EPS surprises and 66% have reported positive sales surprises. For Q3 2017, the blended earnings growth rate for the S&P 500 is 6.1%. Seven sectors are reporting or have reported earnings growth for the quarter, led by the Energy sector. The forward 12-month P/E ratio for the S&P 500 is 18.0. This P/E ratio is above the 5-year average (15.7) and above the 10-year average (14.1).
By calculating money flows, we can analyse investors’ perceptions on the markets and quantify whether they were positive or negative. A positive money flow is when a stock is purchased at a higher price, or an uptick and vice versa. This indication will give us a sign as to where we are on the economic cycle and the current sensitivity as we edge closer to the top. To be able to quantify this, we have looked at the Money Flow Index (MFI) which is a momentum indicator that measures the strength of money entering or leaving a market. The MFI adds volume to the Relative Strength Index (RSI) and is also commonly referred to as the volume-weighted RSI. An MFI of over 80 suggests that the security in question is overbought and under 20 indicates that it is oversold (over the past week).
Given where global stock indices currently are, most are trading at record highs which would indicate that net money flows are positive at this current juncture and investors are willing to pay a premium for the stocks.
MFI.FTSE FTSE 100 = 50.514
MFI.INX S&P 500 = 70.094
MFI.STOXX Euro STOXX 600 = 52.440
UK & Non-UK Gilt Yields;
UK and Non-UK Government Debt are a good measure, as they indicate whether we expect the economy to improve or worsen, with rising yields reflecting positive environment and reflecting positive interest rate movements as we look out. The opposite with lowering yields as the expectation is worsening economic conditions.
Over the last week, bond yields have been quite volatile globally. We have seen yields increase with corresponding valuations dropping sharply for the UK and Europe. The same can be said for the US, however valuations return following the sharp drop. The sharp drop is largely attributed to the equity sell-off seen late last week, as investors reduced their risk appetite after various risks returned to the markets, such as Trumps administration’s incapability of passing tax reform. As we’ve mentioned in our previous commentaries, markets are on the course for a correction at some point as equities are reaching record highs indicating growth, and this became evident when investors took risk off the table on Thursday. Volatility remains high in these assets which should not be functioning like this. This is a further example of why we are still not directionally investing into these assets.
GBP to USD/Euro/JPY;
We monitor the GBP rate to see how much of the returns are coming from underlying equity valuation increases and movements in the currency, to see if we should be locking in the gains and hedging the risks. The 12-month expected range we have set below for sterling across the US Dollar, Euro and Japanese Yen is given the current economic climate and it is to reflect a more positive stance on Sterling in the near short term. Despite Brexit, the UK economy is quite resilient in showing optimism. It is inevitable that over the long term, as Brexit matures, Sterling will be more volatile and unpredictable, therefore it could potentially weaken further as the negotiations mature.
As we’ve highlighted in the past, sterling is under a lot of political and economic pressure, and is now in a territory of indecisiveness and has been since mid-September. Political tensions are driving the currency down and the economic numbers, which highlight the economy’s resilience, is pushing the currency up. Despite the Brexit negotiations currently taking place (poorly), is has been around the 1.32 – 1.30 space against the US Dollar. This week alone, sterling has dropped further against both the Euro and the US Dollar as worries escalate over Prime Minister Theresa May’s future, after a report over the weekend showed that as many as 40 of her lawmakers would support a no-confidence motion against her. The US Dollar is another topic of discussion, however Spot US Dollar (DXY) has been consistent at the end of last month and this month at 94.5 averaged.
GBP / USD – Range 1.32 – 1.20 – Today at 1.3090
GBP / EUR – Range 1.15 – 1.04 – Today at 1.1171
GBP / JPY – Range 150 – 130 – Today at 148.854
DXY (Spot USD) – Today at 94.47
We monitor the oil price as it is a strong indicator of global consumption when balancing the output and inventory data. Strong supply and usage denotes a strong global economy. Opposite reflects underlying weaknesses.
The price of oil over the past week has remained flat from the sharp gains it made the week before. WTI Crude is currently trading at $56.52 and $62.88 for Brent, down approx. 0.9% for WTI and Brent. The sharp gains previously were driven by the rising political tensions in the Middle East, however as this subsided, this has caused the price of oil to remain constant, however to sustain demand, the price will need to go higher. The reason it is still low is that there is a lot of optimism around US shale, which has delivered nearly two thirds of all the incremental volume growth we’ve seen in the last two or three years. Economists and other people familiar with the matter think that optimism is misplaced. We are already seeing tremendous cost inflation inside oil companies as the rigs are becoming more expensive to run. Drilling for oil is becoming harder and harder and oil companies are required to drill a lot of sand and water, so oil analysts think the markets, particularly in the US, have been slightly exuberant about the power that can come out of US shale.
Gold is a safe haven and a spike in price can be an indicator of increasing underlying economic concerns and as always, the opposite.
Over the past week, we have seen the price of gold drop slightly and approximately by $6 an ounce to $1,273.78 a troy ounce. Not much has changed since the last commentary we published last week and so it’s fair to suggest that investors are cautious, but still looking at the safe haven asset as a refuge, if and when markets will tumble.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track drop, with gains being made only in Asia following strong economic data coming out of the region. With the risks highlighted above, we saw a selloff in the markets last week which has brought down the indices. As our OBI portfolios are well diversified from an equity and non-equity perspective, we saw marginal losses across all our portfolios, however the losses were slightly more skewed towards our higher risk portfolios (OBI 5, OBI 6, OBI 7 and OBI 8) as they have a higher equity allocation. In terms of hedging our risk when we see another market sell off, following our last rebalance we have the inclusion of absolute return and low risk funds which benefit in a sell off. It’s moments like this we are most cautious of and will continue to look at the risks present in the markets to highlight the next market sell off.
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 1777, the Articles of Confederation was an agreement among the 13 original states of the United States of America that served as its first constitution. Its drafting by a committee appointed by the Second Continental Congress began on 12th July, 1776, and an approved version was sent to the states for ratification on 15th November 151777. The Articles of Confederation came into force on 01st March, 1781, after being ratified by all 13 states. A guiding principle of the Articles was to preserve the independence and sovereignty of the states. The federal government received only those powers which the colonies had recognised as belonging to King and Parliament.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager