Market Commentary 3rd October 2018
Bull markets don’t die of old age
One of the most amazing features of the global equity markets is just how calm they seem to be, despite the last few weeks and history shows this tends to be a good thing, especially when we are in mid-late cycle. As the markets remain on this juncture and the bull market continues to get extended, we are pleased with the economic cycle and the growth projections of the global economy, but very wary that we are as I keep saying, near to the end of this cycle. One thing to say though is that bull market cycles don’t die of old age and this particular cycle is proving just that. The volatility we are seeing in the markets is mainly politically created with Trade wars, Brexit and European issues coupled with issues in emerging countries due to the strength of the US$.
The good news today is that data is still positive, volatility is unnervingly low as that has tended to be good for equity returns. But low volatility could at this end of the cycle is often bad news too. Unusual calm leads to unusual risk-taking which leads to over-exuberance, poor capital allocation and eventually volatility’s return with a vengeance as poor, or simply over-valued investments falter and confidence finally cracks, even if we all know the past is no guarantee for the future. We have seen this cycle being repeated over and over as investors sentiment gets high, investments strengthen and take stock higher, however when risks present themselves, investors panic and take all the risk-off the table. If it was not for the politicking the global indices would be higher that they are in the Non-US areas and that would benefit the portfolios.
We are not pessimists just eyes wide open worried optimists (owls); however it is interesting to note how the US economy just reaches record highs after record highs despite all the risks, but if you look at the rest of the world they in some areas reach four year lows and other areas have gone nowhere now for 12 months so it is getting harder and harder to generate positive returns. If we also look at where the returns are coming from as we have highlighted in the past commentaries, technology and oil stocks are currently driving most of the growth in the major indices. Perhaps its these very risks that explain why more developed Western markets are holding up, as money retreats from the edge to the core and to a narrowing selection of assets, geographies, sectors and stocks that are perceived to be ‘safer.’
What we are now closely looking at and talking to our fund managers about is over the outlook of 2019, as the Europe starts to remove Quantitative Easing (QE) and adapt Quantitative Tightening (QT) as the US already has done. These are all limitations of economics and monetary policy because its very difficult to get the amount of stimulus correct, so central bankers tend to always over shoot or under shoot over the macro climate at the time based on the stimulus being a delay to the economy. It is easy to see why, looking at how the balance sheets of the US Federal Reserve, European Central Bank, Swiss National Bank, Bank of England and Bank of Japan have swollen since 2008 thanks to the QE, asset-buying schemes. What we are now closely looking at is how the big five central banks’ balance sheets are about to start shrinking. Every time they have tried to ease back on the stimulus, stocks and even economies have shaken, and central banks have turned the taps back on, providing the liquidity in which asset valuations could really do well.
UK economy expands, but Brexit dominates
I think it’s only fair to attribute the UK Economy over its resilience. The individual constituents monitored by Markit (Construction, Manufacturing and Composite) all show that each sector of the economy is still growing, despite a fall in the pace of growth from a month to month basis. This morning, we received the growth figures that showed the economy grew by 0.5% in the third quarter, which was slightly up from 0.4% in the second quarter. Despite this, it is anticipated that the UK economy will remain on track to grow by 1.3% this year. Bearing this in mind, imagine what these figures would be if we didn’t vote to leave the European Union? As highlighted in the attached economics document, it is apparent that the economy is remaining strong, but is influenced largely by Brexit and the direct relationship to sterling and Brexit worries continue to dominate the outlook. The way the UK economy is going with the decision over Brexit, we could be left with no choice but a no-deal Brexit if the EU tries to lock us in to a customs union.
With the fundamentals of the economy, we could continue to see the resilience with the economy, however don’t expect any more interest rate hikes by the Bank of England over the uncertainty over the outlook. With the manufacturing sector, which is by far the most resilient sector, an increase in the PMI figure this month is great news for a sector dealing with an ongoing lack of clarity about the UK’s future trading relationship with the EU, escalating trade wars and rising commodity prices. Manufacturers across different sub-sectors are starting to react to the ever-increasing likelihood of a no-deal Brexit with a degree of nervousness. The announcements from major UK automotive firms in response to ongoing economic uncertainty and suppressed demand are signs it is creating unease based on how strong they are.
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 except the US all fall. The important one to note is that the US again continues to strengthen and the US 10-year yield is below 3.2%, which further justifies the reasons over remaining fully invested. Despite this, Italy has fallen over the concerns with the new government and the uncertainty around the economy which seems to be abating today so we would expect that to come through in the portfolios next week. Europe as a whole has been lower based on this as the bloc is closely watching Italy. Asian markets strengthen with most of the gains being brought into the Japanese economy as the economy has shown strong economic growth. The weaker Yen has given exporters a boost.
With the model portfolios, these have remained relatively flat over the past week based on the backdrop of high risks in the markets, over fears over Italy, the trade wars and the restructuring over NAFTA. We will continue to watch the markets closely and speak directly to the fund manager to ascertain the strategies they are adopting to ensure its in line with the macro-economic landscape. We will continue to hold a strong balance with the equity and non-equity split in the model portfolios which will benefit from the risk-on environment in the financial markets. The non-equity element will act as a hedge for when markets see a correction in this nervous phase of the cycle and the equity element will provide the growth. We don’t expect the markets to maintain this nervous stage for too long, however by monitoring the core economic fundamentals, we are able to rotate the assets for when the markets are providing growth and for when they are falling.
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
With the 10-year anniversary since the 2008 global financial crisis, on this day in 2008, George W. Bush signed the infamous $700 billion bailout bill for the US financial system. This was referred to the Emergency Economic Stabilisation Act and is the law enacted subsequently to the subprime mortgage crisis. We are still feeling the effects of this crisis…
As always have a wonderful week and stay safe.