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Fund Management with Ken Baksh

 May 2019 Market Report

During one-month period to 30th April 2019, major equity markets registered reasonable gains, the FTSE ALL-World Index rose by 3.79% overall and has now risen by 15.67% since the beginning of the year. The VIX index fell 2.81% to end the period at 13.48. Fixed interest products displayed a mixed performance, with UK gilt prices and US Treasury prices declining, while several more speculative grades rose in price terms. Sterling showed little movement over the month but remains ahead of most major currencies since the year-end. Precious metals had a mixed month while oil rose, largely on supply related issues.


The European Central Bank responded to slowing economic growth by maintaining interest rates at current low levels and announcing a new round of bank loans. Political events were not in short supply as Macron, in France, continued to face civil unrest and other governments faced growing nationalist pressures. The recent Spanish election returned Pedro Sanchez, but his Socialist Party failed to obtain an overall majority. It should also be remembered that The EU faces important elections in May. US market watchers continued to grapple with ongoing tariff discussions (China,and prospectively Europe), Federal Budget concerns, Iranian sanctions,Venezuela, North Korean meeting stalemate and Trump’s personal issues(Mueller, etc). US economic data has indicated a solid trend although corporate results/forward looking statements have taken on a more cautious tone. Official interest rates were increased in December to a range of 2.25%-2.50% much as expected, but recent Fed minutes and statements, point to a much more dovish stance.  In the Far East, China flexed its muscles in response to Trump’s trade and other demands while relaxing some bank reserve requirements and contemplating other measures to help the slowing economy. Japanese economic data reflected a recent bout of natural disasters while Shinzo Abe consolidated his political position. At the Bank of Japan meeting, the current easier fiscal stance was reconfirmed. 


The UK reported mixed economic data with satisfactory developments on the government borrowing side, inflation as expected, but poor relative GDP figures (just 0.3% growth 3 months to end February) and deteriorating property sentiment, both residential (esp London) and commercial (especially retail).Business and market attention, both domestic and international, is clearly focussed on ongoing BREXIT developments and their strong influence on politics. Both the Chancellor and Bank of England Governor have made frequent references to the unsettling effects of any unsatisfactory Brexit outcome. The actual situation remains very fluid, and although the “decision time” has been lengthened, this itself brings further political issues (e.g. MEP elections) and distorted, economic /corporate indicators. On the positive side, the threat of an imminent” no deal” has receded.


Aggregate world hard economic data continues to show 2019 expansion of around 3.0%, although forecasts of future growth have been reduced in recent months by all the leading independent international organizations. Very recent European and Chinese data MIGHT alleviate fears of a sharp slowdown. Fluctuating currencies continued to play an important part in asset allocation decisions, volatile sterling being a recent example, while some emerging market currencies have been exceptionally volatile e.g. Turkey.


Equities

Global Equities rose 3.79% over April, the FTSE ALL World Index gaining an impressive 15.67% since the year end, albeit following a very weak quarter. The UK broad and narrow market indices, both rose by about 2% over the period, but lag world equities, in local currency, since the beginning of 2019. Japan and Germany both posted relatively strong performances, ahead of the UK but behind the USA since the year end. The VIX index, which has declined 46.97% since 31st December, now stands at a level of 13.48.   


UK Sectors

Sector moves over April 2019 featured strength in the areas of Industrials, Banks and Life Assurance, while Pharmaceuticals and Mining showed negative absolute returns Over the four-month period, Mining, Consumer, Industrials and Life Assurance now lead the UK sectors. First indications show that “average” UK All Company unit trusts (+13.92%) are out- performing the major indices so far this year Source (Trustnet). Balanced funds, however, are showing four month returns of between 5% and 10%, so far, before expenses, depending on risk attitude, largely reflecting the weight of Fixed Interest.


 Fixed Interest

Gilt prices fell over the month, the 10-year UK yield standing at 1.12% currently.  Other ten-year yields closed the month at US, 2.53%, Japan, -0.07%, and Germany -0.1% respectively.  UK corporate bonds, by contrast, rose   0.21 % in price terms ending April on a yield of approximately 2.59%. Amongst the more speculative grades, there were gains for US High Yield and Emerging Market bonds. Floating rate bonds and convertible bonds also rose in price terms.  See my recommendations in preference shares, convertibles, corporate bonds, floating rate bonds etc. A list of my top thirty income ideas (many yielding around 6%) from over 10 different asset classes is available.


Foreign Exchange

A quieter month for the major currencies, despite the political and economic “noise”. Sterling still remains one of the major performers year to date. Currency adjusted, the FTSE World Equity Index ended the four-month period up 13.01%, some 3% ahead of the FTSE 100. 


Commodities

A generally mixed period for commodities with oil showing supply related gains, renewed firmness in platinum and palladium but declines in the gold price, now virtually unchanged over the four-month period. Since the beginning of this year, oil and iron ore still show significant double-figure price gains.


Looking Forward 

Over the coming months, geo-political events and Central Bank actions/statements will be accompanied by the ongoing first quarter reporting season, where forward looking statements will be scrutinised even more than the historic figures, at this advanced stage in the cycle. To some extent, the, slower economic growth forecasts that are appearing, will inevitably lead to some scale-back in corporate profit projections, although there may be offsetting fiscal and monetary effects. It will also be interesting to see if recent bond yield declines and yield curve inversions are accentuated.   


 US watchers will continue to speculate on the timing and number of interest rate moves during the 2019/2020 period while longer term Federal debt dynamics, election debate and trade” war” winners/losers will affect sentiment. Corporate earnings growth will be subject to even greater analysis after a buoyant 2018, amidst a growing list of obstacles. Additional discussions pertaining to North Korea, Russia, Ukraine, Iran, and Trump’s own position could precipitate volatility in equities, commodities and currencies. In Japan market sentiment may be calmer after recent political and economic events although international events e.g. exchange rates and tariff developments, will affect equity direction. On a technical note it should be noted that The Japanese equity market will be closed until 7th May, which could lead to erratic FX trading.  There is increasing speculation that China may announce more stimulative measures. European investment mood will be tested by economic figures, EU Budget discussions, Italian bond spreads, German, French and Spanish politics, and reaction to the migrant discussions. It should also be remembered that EU elections and change of ECB Chairman are expected this year.


Hard economic data and various sentiment/residential property indicators are expected to show that UK economic growth continues to be lack-lustre and any economic upgrade over current quarters appear extremely unlikely. The UK Treasury and the MPC have both produced rather negative economic medium-term projections, whatever the Brexit outcome!  It is highly likely that near term quarterly figures (economic and corporate) will be distorted (both ways), and general asset price moves will be confused, in my view, by a mixture of currency development, political machinations, international perception and interest rate expectations. Mark Carney has a dilemma!


On a valuation basis, most, but not all, conventional government fixed interest products appear expensive against current economic forecasts and supply factors and renewed selective bond price declines and further flat performance should be expected in the medium term, in my view.However,sharper than expected economic slowdown forecasts, and any equity volatility could support bond prices from time to time. 

Equities appear more fully valued after the recent rally, but there are wide variations. Equity investors will be looking to see if slowing earnings growth and growing global headwinds are compensated for by a more dovish interest rate environment. 



In terms of current recommendations, 

Depending on benchmark, and risk attitude, first considerations should be appropriate cash/hedging stance and the degree of asset diversification (asset class, individual investment and currency).

An increased weighting in absolute return, alternative income and other vehicles may be warranted as equity returns will become increasingly lower and more volatile and holding greater than usual cash balances may also be appropriate, including some outside sterling. Among major equity markets, the USA is one of the few areas where the ten-year bond yields more than the benchmark equity index. The equity selection should be very focussed. Certain equity valuations are still rather high. Ongoing and fluid tariff discussions, as well as growing regulation could additionally unsettle selected countries, sectors and individual stocks Harley Davidson, German car producers, American and Brazilian soy producers, Chinese exporters, selected US tech shares etc etc.


  • I have kept the UK at an overweight position. Full details are available in the recent quarterly review. However, extra due diligence in stock/fund selection is strongly advised, due to ongoing macro-economic and political uncertainty. 
  • Within UK sectors, some of the higher yielding defensive plays e.g.  Pharma, telco’s and utilities have attractions relative to certain cyclicals, though watch regulatory concerns, and many financials are showing confidence by dividend hikes and buy-backs etc. Oil and gas majors may be worth holding despite the outperformance to date. Remember that the larger cap names such as Royal Dutch and BP will be better placed than some of the purer exploration plays in the event of a softer oil price. Mining stocks remain a strong hold, in my view (see my recent note for favoured large cap pooled play). Corporate activity, already apparent in the engineering (GKN), property (Hammerson,Intu), pharmaceutical (Glaxo, Shire?), packaging (Smurfit), retail (Sainsbury/Asda), leisure (Whitbread), media (Sky), mining (Randgold) is likely to increase in my view, although the Government has recently been expressing concern about overseas take-overs in certain strategic areas.
  • Continental European equities are preferred to those of USA, for reasons of valuation, and Central bank policy, although political developments and slowing economic growth need to be monitored closely. I suggest moving the European exposure to “neutral “from overweight. European investors may be advised to focus more on domestic, rather than export related themes.  Look at underlying exposure of your funds carefully and remember that certain European and Japanese companies provide US exposure, without paying US prices. I have recently written on Japan, and I would continue to overweight this market, despite the 2017 and 2018 outperformance relative to world equities. Smaller cap/ domestic focussed funds may outperform broader index averages e.g. JP Morgan Japanese Smaller Companies and Legg Mason.FX will play an increasing role in the Japanese equity decision.
  • Alternative fixed interest vehicles, which continue to perform relatively well, in total return terms, against conventional government bonds, have attractions e.g. preference shares, convertibles, for balanced, cautious accounts and energy/ emerging/speculative grade for higher risk e.g. EnQuest. These remain my favoured plays within the fixed interest space. See recent note
  • UK bank preference shares still look particularly attractive and could be considered as alternatives to the ordinary shares in some cases. Bank balance sheets are in much better shape and yields of 6%-7% are currently available.
  • Alternative income and private equity names exhibited their defensive characteristics during 2018 and are still favoured as part of a balanced portfolio. Reference could also be made to the renewable funds (see my recent solar and wind power recommendations). Both stocks registered positive capital returns over 2018 on top of income payments of approx 5%. And are still strongly recommended. Selected infrastructure funds are also recommended for purchase but be aware of the political risk. The take-over of JLIF highlights the value in the sector!
  • Any new commitments to the commercial property sector should be more focussed on direct equities and investment trusts than unit trusts (see my recent note comparing open ended and closed ended funds), thus exploiting the discount and double discount features respectively as well as having liquidity and trading advantages. However, in general I would not overweight the sector, as along with residential property, I expect further price stagnation especially in London offices and retail developments e.g. (Hammerson, Intu). Subscribers may read more on this subject in my latest quarterly review.   The outlook for some specialist sub sectors e.g. health (PHP equity and bond still strongly recommended), logistics, student, multi-let etc and property outside London/South-East, however, is currently more favourable. Investors should also consider some continental European property plays e.g SERE. 
  • I suggest a very selective approach to emerging equities and would continue to avoid bonds. Although the overall valuation for emerging market equities is relatively modest, there are large differences between individual countries. A mixture of high growth/high valuation e.g. India, Vietnam and value e.g. Russia could yield rewards and there are signs of funds moving back to South Africa on political change. Turkish assets seem likely to remain highly volatile in the short term and much of South America is either in a crisis mode   e.g. Venezuela or embarking on new political era e.g. Mexico and Brazil. As highlighted in the quarterly, Chinese index weightings are expected to increase quite significantly over coming years, and there are currently large inflows into this area following the price weakness of 2018. One additional factor to consider when benchmarking emerging markets is the large percentage now attributable to technology. A longer-term index argument is also being made in favour of Gulf States, although governance issues remain a concern.
  • The current relatively low level of the VIX (too low in my view!) presents various option and other derivative strategies, either used “defensively” against fully invested equity positions or “aggressively” by way of taking naked positions to exploit any fall in index or stock prices.I would be very wary of selling VIX or related derivatives at this level.

Full quarter report available to clients/subscribers and suggested portfolio strategy/individual recommendations will be available soon. Ideas for a ten stock FTSE portfolio, model pooled fund portfolios (cautious, balanced adventurous, income), 30 stock income lists, defensive list, hedging ideas, and a list of shorter-term low risk/ high risk ideas can also be purchased, as well as bespoke portfolio construction/restructuring. 

Feel free to contact    regarding any investment project.


Good luck with performance! 


Ken Baksh Bsc,Fellow (UK Society of Investment Professionals)

kenbaksh@btopenworld.com

1st May 2019