Market Commentary – 20th December 2017
Please note this will be our last commentary for the year and our next publication will be on the 03rd January 2018.
With the festive spirit settling in, market volumes around this time of the year usually taper off and the markets start to become a boring place, however with the outlook for 2018, is still positive and we end the year on a better note than where we started, with various indices hitting record highs after record highs, mostly driven by the US.
Markets in 2018 are likely to be more exciting next year as we will see higher volatility based on the developments over various macro and ecopolitical risks become clearer uncertainties. In 2018, volatility is likely to pick up and corrections are probable. With the risks to look out for, we are closely watching: (1) a bear market in US stocks; (2) a materially strong US Dollar; (3) Large rises in core yields and (4) a sharp slowdown in China. None of these are a high probability event for 2018, however given the nature of market surprises, we are still concerned of them.
With a bear market in the US, we see a large US equity bear market as unlikely yet and the current equity boom should continue to grow into 2018. Given the strong EPS momentum and solid growth in world trade, which a soft US dollar should facilitate. Any sharp rises in the dollar will be tamed by the global nature of the current expansion, and despite less marginal policy accommodation, large rises in core yields are unlikely to occur. Economists anticipate that a 30bp-50bp repricing higher in core yields, which will not be enough to upset the constructive view of the world which we have been documenting in our weekly commentaries.
Q4 Investment Committee Meeting
Yesterday, the Investment Committee convened for our 4th quarter meeting. Reflecting on our positive view on global momentum, we are forecasting above-consensus growth in 2018 for two major economies: the Eurozone and the US. An exception is made for the UK as we believe that there isn’t any upside whilst a Brexit deal is still being negotiated.
We started 2017 with strong sentiment and confidence in the markets, mostly from strong investor confidence brought forward from 2016 and bolstered by Trump’s Administration, leading the global equity rally, which is still persistent. By focusing on the economic data throughout the year, which points to a global expansion, we don’t see any immediate signs of an imminent slowing down, however we do see signs of a slower pace of an expansion, which can be further seen in the economics section attached. 2017 has sent out mixed messages which point to fears of an immediate drop as equity valuations and price/earnings ratios are extended to new record highs. Even though there were signs that data slowed during the summer, the opposite is happening (except in the UK) in that global data is again improving, and will continue to improve, leading to global growth reaching 3%. We’ve had periods of short-term volatility in 2017 sparked up from various economic and political risks. With most at the start of 2017, Trump brought optimism, as well as fear, into the markets with allegations accusing China as a “Grand Champion” of currency manipulation, various key elections in Europe, and fears of a Nuclear war over the geopolitical tensions between the US and North Korea which has currently subsided, but is still a lingering concern. However, if we focus on the economic data, data is still strong and earnings growth expectations for 2018 have in recent weeks picked up again. Although it is arguable that we are at the end of the cycle as we have low inflation and still strong global earnings growth, we will continue at the party for a while longer, and enjoy the ongoing celebrations.
If we look at the current position of where we are in the global economic cycle, earnings and expected earnings are healthy, given that the US grew by 3% in September on an annualised basis, bearing in mind that this could have missed expectations of 3.1% by the set back of the hurricanes. This solid growth has helped fuel growth in Asia, which is heavily dependent on the US Dollar and consumer confidence in the US. This month, we received data out of the US to further suggest that the strong consumer confidence remains buoyant working its way into the year end, which adds to our conviction that the party could still continue. The same could be said for European equities which are also heading upwards with earnings and expected earnings data, stronger than expected. We remain directionally invested in the bloc.
Risks are there at the moment, but they are balanced and with non-equity positions struggling to give any return we have to remain invested until we have a reason to not be. Our OBI strategy has worked and has delivered our targeted returns throughout the year. Based on the mandate of OBI, by cyclically adjusting the portfolios asset allocation, we are able to remove investments we no longer have strong conviction in, and skew the proceeds into areas where we do hold strong conviction by accessing the macroeconomic climate and re-gauging our asset allocation in each investment committee meeting. By tactfully rotating the asset allocation, we are able to remove funds which are hurting our portfolio performance, as not all conviction calls are guaranteed, with expectations of sudden changes in the markets. Despite this, we have outperformed the benchmarks for each portfolio throughout 2017. As we hold conviction that we are nearing the end of the cycle, our portfolios are more defensively managed and will be below the normal equity levels until we get a further insight to the current economic and political risks.
As equity valuations remain expensive from the view point of the current position of the economic cycle, we will remain in normal mode with a high level of multi asset and global positions in the portfolios. With our directional EM equity fund, it is estimated that EM growth will rise from 4.4% in 2017 to 4.7% in 2018 on the back of the pick-up in global trade, commodity prices and supportive domestic conditions. The EM-DM growth differential will be the widest since the financial crisis. We are confident about risks as policy enters a tightening cycle. In advanced economies, we are below consensus on inflation in 2018, based on our view that global inflationary forces will be in check, including low public-sector wages keeping private-sector wage growth weak. We take a benign view of the impact of QE withdrawal on the global economy and EMs, with the policy tightening cycle being very gradual, as seen in case of the ECB, and global bond yields will remain historically low. Despite this level of positivity, we still believe we are at the end of the cycle and expect the US to get to the peak of its tightening cycle in 2018, which will result in the US consumer spending less, and that has historically driven global recessions. We have to be wary of this as we progress through 2018. One concern we have relates to the currency and if there is a good trade deal, this will obviously result in Sterling strengthening significantly from where we are today. As it stands, as we have very little UK directional exposure that would hurt us because if sterling rises and we have overseas exposure that will be a drag on portfolios. We need to start reviewing and finding European and Global equity hedged positions and be in a position to start using them, if the currency moves against us before we go defensive towards the end of the cycle. This time last year, we were fairly optimistic about the markets as the economic data was positive on a global basis. We remain confident in that the data into 2018 is strong and expect to see a strong start to the year.
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 perform reasonably well with most of the gains being made in the US. With the normalised approach of our portfolios, following the December rebalance, they are now more skewed towards the equity rally and our strong conviction calls performing well into the new year.
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 day’s 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 1919, the Canadian National (CN) Railways was established, becoming North America’s longest railway of over 50,000km. CN was government-owned, having been a Canadian Crown corporation from its founding to its privatisation in 1995. Bill Gates was, in 2011, the largest single shareholder of CN stock.
As always have a wonderful week and stay safe.
Jason Stather-Lodge CFP, MCSI, APFS
CEO & Founder
Chartered & Certified Financial Planner
Chartered Wealth Manager