Market Commentary – 22nd November 2017
Are the markets… still…positive?
Since our last writing, not much has changed within the global financial markets. With the equity rally continuing to reach record highs, our investment thesis is the same and we aim to keep relatively cautious through this economic cycle and entering into 2018.
We would like to however suggest that we shouldn’t focus on the political noise out there, but focus on the economic data. To put this into perspective, the week before last, we saw markets fall 1% based on investors thinking that the end is near and reducing their exposure, however since then, markets have come back up on themselves and are continuing to reach record highs, because the data is strong. Earnings and earnings growth, is the most important dynamic for markets and this shows that investors can panic, and we shouldn’t pay attention to short term volatility, but focus on the economics.
Where are we in the global economic cycle?
Boom? Recovery? It’s fair to say that no one knows, however, if we consider what we said above, if we look at the economic data, we are zooming towards a global economic boom and this is true for the US, Europe and Emerging Markets (which is dependent on the Developed Markets). Economic cycles look young based on measures such as output gaps, inflation and real interest rates. Valuations of risk assets such as equities and credit are historically at late-cycle levels, so what does this mean? We can usually look at where we are in the cycle by assessing the barometers, which will give us an indication, but in terms of when the next correction will happen, we are conscious that while business cycles may not look especially advanced, and we maintain supportive of growth acceleration, the developed markets risk asset valuations are already quite expensive, and they are only getting more expensive.
We can’t really correlate the global markets to the UK as the dynamics have changed following Brexit, which is a shame based on the resilience and prospects it’s showing. With the negotiations continuing to erode the economy, we are keeping our distance from the risks in the bloc which is further substantiated with other investment houses that share our view.
A combination of a mature financial cycle and a young economic cycle raises the risk that asset price declines can become a trigger for an economic downturn, however from the publications we read, economists don’t think that this is imminent, even though asset valuations are expensive. From a historical point of view, they aren’t as extreme, especially from a Relative Strength Index (RSI), credit spreads and Price-to-earnings (P/E) ratios which have reached more extreme levels in the past, such as before the 2007/8 financial crisis. In the initial stages of a tightening cycle, credit spreads decline rather than rise.
Where are the risks moving forward?
From the perspective of the next four quarters, the good news is that while valuations of equities are high and credit risks are elevated, they are by no means at extreme levels. There are some areas of concern in the markets, such as the US high-yield and commercial property assets. There are fears that these could cause a systematic crisis, like that seen by the US subprime debt seen in 2007.
Even with the data being strong, investors remain in a sceptical mood, and some are simply downright bearish, such as ourselves. Despite this backdrop, the stock markets are continuing to perform well. Each upward move is moving closer and closer towards a market correction.
Following on from the Brexit referendum, the surprise election result has exacerbated the political uncertainty. Investors response has been to reduce UK weightings in favour of overseas investments. Domestically focused UK stocks are especially unloved, and some fund managers are now telling us they look undervalued as a result. A contrarian strategy of investing in unfashionable areas always feels incredibly uncomfortable at the time. But it can also be very successful. These are also the sectors where much of the downside risk is already accounted for in the price. Elsewhere we think the US market looks pricey. Europe has performed well after being deeply unpopular for much of the post-crisis period. Japan is still the cheapest of the large developed markets – earnings are growing strongly but this isn’t yet fully reflected in share prices. Based on this, we are diversifying the model portfolios across a variety of sectors and geographical regions, and are not trying to beat the markets by spending time trying to forecast which will perform best.
The budget has been released today, and we will be reporting on this shortly.
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Model Portfolios & Indices
Over the last week we have seen most of the indices that we track improve with strong gains, following positive global political and economic news. Markets now are mostly higher as oil prices rise (please see attached for the reason as to why oil is on the rise). The focus early this week was on Europe after reports on Monday suggested that Angela Merkel’s bid to form a new coalition government had collapsed. Now, like we’ve said in the past, we don’t like political noise and if you were to follow the crowd, we would have sold our German exposure and incurred losses as Investors did the opposite and invested into the area. This is brought from the economic data out of Germany which is strong and shows the economy is resilient, despite a collapse in the political framework.
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 1990, Margaret Thatcher resigned as the Prime Minister of Britain, after serving 11 years in office. Her resignation came after losing the support of her cabinet in a run-off election for the leadership of the Conservative Party. The ‘Iron Lady,’ so nicknamed for her tough demeanour, was Britain’s first female prime minister.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager