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Fund Management with Ken Baksh

January 2020 Market Report

 

During one-month period to 31st December 2019, major equity markets registered strong gains. The FTSE ALL-World Index rose by 2.18% over the period, up by 23.9% since the beginning of the year. The VIX index fell by 1.45% to end the period at 12.26, a rather “complacent” level by historic standards.  Most fixed interest products continued to fall, in price terms, during the month. Sterling strength and Yen weakness were the main currency moves, while   the Chinese Renminbi stayed reasonably stable versus the US dollar as “phase 1” of the trade talks continued. Commodities displayed a mixed price performance overall.

 

The European Central Bank saw Christine Lagarde,the new President, present at her first official meeting, and recent economic indicators signalled a stabilisation, although growth is still very anaemic. Political events have featured further signs of discontent in Germany (coalition split?) and France (pension and other reforms), renewed Spanish coalition concerns, and inevitable squabbling re the EU (ex-UK?) Budget.

 US market watchers saw some “progress” with Phase 1 Chinese tariff negotiations, while certain European barriers were introduced! Federal Budget concerns, Iranian sanctions, Venezuela, North Korean tensions and Trump’s personal issues (impeachment?) were still very much in the news as the 2020 election draws closer. US economic data still indicates a solid consumer trend although relatively buoyant first quarter GDP growth figures did include a large element of inventory building and more recent official figures have been mixed. Corporate results/forward looking statements have taken on a more cautious tone, especially related to tariff developments (actual or rumoured). Official interest rates have been reduced three times to a range of 1.5% to 1.75%, much as expected, and a “pause” was indicated by Fed Chairman Powell at recent meetings

In the Far East, China /US trade talks dominated the headlines, while official and anecdotal evidence point to a steadily weakening economy. Recent data releases pointed to 6.0% quarterly GDP growth with risks growing to the downside, although the move on 2nd January 2020 showed signs of continued financial support/concern. Hong Kong remains still very volatile. Japanese annual economic growth was downgraded slightly to 0.8%, mainly on a weaker trade performance, although 3rd quarter GDP, recently released, surprised to the upside. The recent Upper House election result confirmed the LDP current strong position while at the Bank of Japan meeting, the current easier fiscal stance was reconfirmed, although the scheduled October 1st VAT increase was applied.

The UK continued to report somewhat mixed economic data with stable  developments on the labour front but  poor corporate investment , volatile retail sales, inflation as expected, weak relative GDP figures and poor property sentiment, both residential (especially  London) and commercial (especially retail).Figures announced on 30th November  by the CBI show historic and prospective output falling by about 10%.Business and market attention, both domestic and international, is clearly focussed on ongoing BREXIT process under new Prime Minster ,Boris Johnson, where at the time of writing, the Withdrawal Bill has been passed, but the long process of renegotiating new trade arrangements has yet to start. Both the Chancellor and Bank of England Governor have made frequent references to the unsettling effects of any unsatisfactory Brexit outcome, as have a growing number of business leaders and independent academic bodies. Political factors aside, economic and corporate figures will inevitably be distorted over coming months. GDP growth of around 1% for full year 2019 looks likely, with a similar projection for 2020.

 Aggregate world hard economic data continues to show 2019 expansion of around 3.0%, although forecasts of future growth continue to be reduced by the leading independent international organizations. As well as slowing projections in the developed markets of USA, China and Europe, a number of developing economies are experiencing headwinds for a variety of reasons e.g. India and  much of Latin America There appears to be a growing chorus of further action on the fiscal front e.g. infrastructure spending, as other instruments e.g. interest rates, may have limited potential from current levels. Fluctuating currencies continued to play an important part in asset allocation decisions, sterling/yen 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 rose by 2.18% over December, the FTSE ALL World Index showing a gain of 23.9% since the year end. The UK broad and narrow market indices, both advanced by around 3% over the monthly period, but lagged world equities in sterling adjusted terms by about 6%, since the beginning of 2019. Along with the UK, Asia and Emerging Markets outperformed during the month, but lagged over the twelve-month period, while USA and Continental Europe showed above average gains for the year. The VIX index fell, reflecting a greater risk-taking mood to a level of 12.26, and down 51.77% since the beginning of the year.

 UK Sectors

A mixed month for UK sectors with oil for example bouncing strongly in December but amongst the lagging markets over the full year, while telecoms were some of the weakest names in December.  Over the full year, industrial shares, pharmaceuticals and real estate showed the largest gains all over 20%, while telco’s, banks and oil companies were amongst the relative losers.

  Fixed Interest

Gilt prices fell over the month, the 10-year UK yield standing at 0.73% currently.  Other ten-year yields closed the month at US, 1.92%, Japan, -0.02%, and Germany, -0.19%. Since June 2019, over $6 trillion of government debt has moved back into positive yield territory.  UK corporate bond prices also fell slightly over the month, while more speculative grades rose. Floating rate bonds rose while the favoured convertible bond was redeemed, as expected, after showing a year to date return of about 10%. See my recommendations in preference shares, convertibles, corporate bonds, floating rate bonds, speculative high yield etc. A list of my top thirty income ideas (many yielding around 6%) from over 10 different asset classes is also available to subscribers.

 Foreign Exchange

Sterling was again the main mover amongst the major currencies during December largely on political news, while the dollar weakened. Since the beginning of the year, sterling appreciated approximately 4% against both the US Dollar and the Euro. The dollar stayed reasonably stable versus the Chinese Renminbi as tariff discussions continued. As ever, FX decisions remain crucial in determining asset allocation strategy. As an example, largely on the back of the December UK election result, sterling adjusted FTSE outperformed the world index by about 3% in December.

Commodities

A mixed month for commodities on global growth concerns and supply shocks. The oil price advanced, and gold also rose, while coal and natural gas showed large price declines. Over the full year Brent Oil showed a respectable gain of over 20% but the largest gain amongst the major commodities was enjoyed by palladium up over 53%

Looking Forward

Over the coming quarter, geo-political events and Central Bank actions/statements meeting, will continue to dominate news headlines and market sentiment, in my view. Regarding corporate earnings/statements, it will be interesting to see if the recent “relief” factors of US/China truce, UK election, European and Japanese stabilisation, lead to a more optimistic tone. Calls for more fiscal response on the part of governments opposed to limited Central Bank monetary fire power will intensify, in some cases allied to environmental issues.

 

 US watchers will continue to speculate on the timing and number of further interest rate moves during the 2020/2021 period while longer term Federal debt dynamics, impeachment progress, election debate and trade” war” winners/losers (a moving target) will increasingly affect sentiment. Corporate earnings growth will be subject to even greater analysis, amidst a growing list of obstacles. 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. More equity specific issues e.g share buy-backs,ETF developments, TOPIX constituent changes, should also be monitored.  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 generally sluggish economic figures and an increasingly unstable political backdrop, now encompassing France and Germany.

 

Hard economic data (especially final GDP, corporate investment, exports) and various sentiment/residential property indicators are expected to show that UK economic growth continues to be lack-lustre and it is too early to see if any post-election euphoria feeds into consumer sentiment. The election result has however had a more immediate effect on certain utilities, infrastructure project plans etc.  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.

 

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 (but watch costs, underlying holdings and history very carefully), alternative income and other vehicles may be warranted as equity/gilt returns will become increasingly lower and more volatile and holding greater than usual cash balances may also be appropriate, including some outside sterling. Both equity and fixed interest selection should be very focussed. Apart from global equity drivers e.g. slowing economic and corporate growth, tariff wars and limited monetary response levers, there are many localised events e.g. UK trade re-negotiation, US elections, European political uncertainty,Asian poitical “hotspots” that could upset many bourses, some still relatively close to recent record levels.

 

·         I have kept the UK at an overweight position on valuation grounds despite the recent post-election relief bounce. 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. Sterling volatility should also be factored into the decision, making process.  

·         Within UK sectors, some of the traditionally defensive, and often high yielding sectors such as utilities and telecoms may bounce against a more “friendly “political backdrop. Many financials are also showing confidence by dividend hikes and buy-backs etc. Oil and gas majors will be worth holding after the flat 2019 performance, remembering 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. Small cap domestic stocks are currently receiving post-election support.

·         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 after the 2019 outperformance. 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 and 2019 underperformance 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, have attractions e.g. preference shares, convertibles, for balanced, cautious accounts and energy/ emerging/speculative grade for higher risk e.g. EnQuest,Eros. 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 on related issues while a yield of 9.1% p.a., paid quarterly, is my favoured more speculative idea.

·         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) which continue to outperform in total return terms. Selected infrastructure funds are also recommended for purchase especially now that the political risk has been reduced somewhat. New issues in this area e.g. Aquila and JPM are likely to move to larger premiums.

·         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. One possible exception to the sentiment above is the growing attractiveness of certain assets to overseas buyers.   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 several emerging economies in both Asia and Latin America showed 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, Argentina or embarking on new political era e.g. Mexico and Brazil (economic recovery?). 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!

 

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

kenbaksh@btopenworld.com

 

2nd January 2020