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Fund Management with Ken Baksh

 June  2019 Market Report

During one-month period to 31st May 2019, major equity markets registered falls, especially late in the month. The FTSE ALL-World Index fell by 5.33% over the last month although still up nearly 10% since the beginning of the year. The VIX index rose sharply to end the period at 18.22. Fixed interest products displayed a mixed performance, with certain core government bonds rising in price (yield declines) while more speculative products e.g. US high yield and emerging market bonds fell in price terms. Sterling was weaker mainly on political considerations, while the Japanese yen rose on safe have buying. There were large moves in the area of commodities where, excluding oil, very few now show year to date price gains.

The European Central Bank continues to err on the cautious side regarding economic projections, although the German first quarter GDP growth figure was stronger than expected and the more recent May EU sentiment indicator posted the first month on month rise since June 2018. Political events largely featured the MEP elections during the month where the more extreme parties did not reach some of the forecast gains, although several of the mainstream centrist parties did lose ground to a mixture of nationalist, liberal and green movements. US market watchers continued to grapple with ongoing tariff discussions (China, Mexico -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 relatively buoyant first quarter GDP growth figures did include a large element of inventory building. Corporate results/forward looking statements have taken on a more cautious tone, especially related to tariff developments (actual or rumoured). 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 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, although the outlook for the planned VAT increase in the autumn is still unclear. 

The UK reported mixed economic data with satisfactory developments on the government borrowing side, poor corporate investment , inflation a little higher than expected, weak relative GDP figures 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 MEP election implications, and their strong influence on domestic 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 many options are still possible at the time of writing. Economic and corporate figures will inevitably be distorted over coming months. 

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. Movements in the $/Yuan are also taking on increasing significance.

Equities

Global Equities fell 5.33% over May, the FTSE ALL World Index still, however, showing a gain of 9.51% since the year end, albeit following the very weak last quarter of 2018. The UK broad and narrow market indices, both fell by about 3.5% over the period, lagging world equities in both local and sterling adjusted terms since the beginning of 2019. Asia, including Japan and Emerging Markets showed particularly large declines. The VIX index, rose 35.2% to a level of 18.22, reflecting the increased uncertainty associated with equity investing

UK Sectors

Sector moves over May 2019 featured relative strength in the areas of oil and gas, pharma and consumers but there were large absolute price declines in utilities, telco’s and life companies. Over the five -month period, Mining, Consumer, Industrials and Life Assurance still lead the UK sectors. First indications show that “average” UK All Company unit trusts are out- performing the major indices so far this year Source (Trustnet). Balanced funds, however, are showing five month returns of between 5% and 6%, so far, before expenses, depending on risk attitude, largely reflecting the weight of Fixed Interest.

 Fixed Interest

Gilt prices rose over the month, the 10-year UK yield standing at 0.87% currently.  Other ten-year yields closed the month at US, 2.22%, Japan, -0.1%, and Germany, -0.27%, the latter breaking new records.  UK corporate bonds, by contrast, also rose by   0.34 % in price terms ending May on a yield of approximately 2.58%. Amongst the more speculative grades, there were falls for US High Yield and Emerging Market bonds. Floating rate bonds remained broadly unchanged.  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

Sterling was one of the main features during May, falling against all major currencies largely on political concerns. The Yen, by contrast, strengthened in trade weighted terms, on “safe haven” buying.

Commodities

A generally weak period for commodities with the notable exceptions of wheat, soya and corn on supply related issues. Oil, copper,iron ore prices fell, while gold remained barely changed closing the month at $1280.95.

Looking Forward 

Over the coming months, geo-political events and Central Bank actions/statements (e.g G20 meeting, late June) will be accompanied by the onset of the first half calendar year reporting season, where forward looking statements will be scrutinised even more than the historic figures, at this advanced stage in the cycle, and with increased headwinds. 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 e.g. Negative German and Japanese ten-year yields, 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 (a moving target) 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.  There is increasing speculation that China may announce more stimulative measures and key $/Yuan exchange rate levels are being watched closely. European investment mood will be tested by economic figures, EU Budget discussions, Italian bond spreads and the aftermath of the May MEP elections. It should also be remembered certain key European individual positions have yet to be decided.

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!

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. The equity selection should be very focussed. 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 on valuation grounds. 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. 
  • 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. It is worth noting that a number of emerging economies in both Asia and Latin America have shown first quarter 2019 GDP weakness even before the onset of any possible tariff effects. 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.

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! 

 (UK Society of Investment Professionals)

kenbaksh@btopenworld.com

1st June 2019

There will be no monthly report at the end of June, due to holiday. The quarterly will be available around the middle of July and then the normal monthly resumes end July