During the month to April 30th, 2018, most major equity markets enjoyed gains, although trading remained volatile against a background of significant geo-political, economic and corporate events. The European Central Bank appeared to become more “dovish” following some lower than expected consumer confidence indicators, affecting both equity and currency markets while quarterly corporate results were generally positively received. US market watchers had an especially busy month with tariff discussion (aluminium, steel, China, Russia), Syrian military involvement, some stock specific events such as Facebook, continuing White House “revolving door policy” as well as Donald Trump’s personal issues. In the Far East, North and South Korea made conciliatory advances, and though very early days, the largely symbolic meeting was well reported and received. The UK reported mixed economic data with satisfactory developments on the government borrowing side, inflation slightly lower than expected, but very poor GDP first quarter figures. The probability of a May interest rate hike has been reduced and economic downgrades for for the full year seem inevitable. Aggregate world hard economic data continues to show steady expansion, excluding the UK, as confirmed by the IMF and the OECD with some forecasts of 2018 economic growth in the 3.5% to 3.9% area. Fluctuating currencies continue to play an important part in asset allocation decisions, the US dollar being the major feature, largely on relative economic developments. Bond watchers saw US 10-year yield hit 3% before backing off towards the end of the period. Greater fluctuations in bond yields are likely to lead to higher equity volatility going forward. It is also worth mentioning the effect of geo-political actions on commodities with disproportionate moves in alumina, aluminium, soya and oil, during April, for example.
Global Equities rose over the month the FTSE ALL World Index gaining 1.18% in dollar terms and now showing a move of -0.43% since the beginning of the year. The UK broad and narrow market indices outperformed other major markets over the month in local and sterling adjusted bases. Emerging markets were the relative underperformers and declined in absolute terms. In sterling adjusted terms, Japan remains the outperformer on year to date performance amongst the major markets although still marginally in negative territory. The VIX index while still up about 55% from the year end levels, fell about 20% in April, somewhat surprisingly in my view. At the time of writing, the absolute VIX level stands at 15.9, far from the 9-10 level that prevailed much of last year and reflecting a level of uncertainty but far from the extreme levels experienced during major market meltdowns of the past.
Sector volatility remained high during the month, influenced by both global factors e.g. sanctions, tariffs as well as corporate activity. Oil and gas was the stand-out sector in April, helped by the 7.84% rise in the Brent price and good results and statements from both major UK stocks. Corporate activity is increasing and having an increasing bearing on sector indices e.g. Sainsbury’s 13% share price jump yesterday.
Gilt prices dropped over the month and are down 1.7% year to date in capital terms, the 10-year yield standing at 1.48% currently. Other ten-year yield closed the quarter at US 2.96% Japan, 0.04% and Germany 0.50% respectively. UK corporate bonds also dropped in price terms over the month. Amongst the more speculative grades, there continue to be mixed trends, with emerging market bonds, in local currency terms, showing price falls in absolute terms and yet the US lower grade bonds were moving in the opposite direction. Convertible bonds and floating rate issues continue to outperform gilts year to date in both capital and total return terms. Preference shares have recovered from the Aviva U-turn and remain attractive fixed interest alternatives. See my recommendations in preference shares, convertibles, corporate bonds, floating rate bonds etc. A list of my top thirty income ideas (all yielding over 5%) from over 10 different asset classes is available.
Amongst the major currencies, a stronger dollar was the major monthly feature rising 1.77% in trade weighted terms, largely on relative economic news The Japanese yen was the major faller on the other hand, while the Euro drifted slightly, and sterling fell quite sharply towards the end of the month on much poorer economic news and the prospect of difficult Brexit discussion over coming days and weeks. As mentioned above, the FX moves are becoming a growing factor in asset allocations discussions. It is no coincidence that last month, the major market gainers of FTSE100 and the Nikkei, both showed their largest local currency moves during periods of currency weakness versus the dollar.
A very mixed and volatile month for commodities with significant impact from geo-political events. Oil, for example reacted positively to certain shut downs as well as impending Iranian sanction discussions and increasing US/Venezuela tensions. Alumina and aluminium prices were buffeted firstly by tariff developments and then specific Russian sanctions. There were mixed trends amongst the other precious/PGM group metals. Most of the major global mining groups have just reported figures and rising commodity prices, capital discipline, balance sheet transformations and higher shareholder pay-outs have been a common theme. Soft commodities have also enjoyed strong price gains since the start of the year, wheat and soya for example showing price gains of around 18.2% and 27.2% respectively.
Over the coming months, geo-political events and Central Bank actions/statements will continue be key market drivers while first quarter results and many ongoing corporate events will likely add a further level of volatility. With rising bond yields, equity valuations and fund flow dynamics will also be increasingly important areas of interest/concern.
US watchers will continue to speculate on the timing and number of interest rate hikes 2018/2019, as well as fleshing out the winners and losers from any tariff developments. Additional discussions pertaining to North Korea, Iran, Venezuela, NAFTA and Trump’s own position could precipitate volatility in equities, commodities and currencies. In Japan market sentiment is likely to be influenced by economic policy, the recent yen weakness being a positive factor for equity investors. European sentiment will be tested by economic figures (temporary slowdown or more sustained?), EU Budget discussions, Italian politics and positioning ahead of Greek rescue package deadlines. Hard economic data (as opposed to sentiment surveys) will continue to show that UK economic growth will be slower in 2018 compared to 2017, and further down grades may appear as anecdotal second quarter figures trends are closely analysed. Brexit discussion have moved to a new level, discussions on the “custom union” being currently hotly debated. Political tensions stay at elevated levels both within and across the major parties and considerable uncertainties still face individual companies and sectors.
On a valuation basis, most, but not all, conventional government fixed interest products continue to appear expensive against current economic forecasts and supply factors, and renewed bond price declines and further relative underperformance versus equities should be expected in the medium term, in my view. On the supply point there are increasing estimates of US bond issuance against a background of diminished QE and overseas buying. Chartists and others are watching closely as the US 10-year flirts with 3%.
Equities appear more reasonably valued, apart from some PE metrics, (especially in the US), but there are wide variations, and opportunities, in both broad asset classes. Equity investors will be looking to see if superior earnings growth can compensate for higher interest rates in several areas. Corporate results from US, Europe and Japan have, on aggregate, been up to expectations over the first quarter of 2018, although EY noted that the number of UK profits warning were about 10% higher than the previous year at the nine-month stage, mostly in the home improvement, motor, government supply, restaurant and other retail areas. Outside pure valuation measures, sentiment indicators and the VIX index are showing significant day to day variation, after the complacency of last year.
In terms of current recommendations,
Continue to overweight equities relative to core government bonds, especially within Continental Europe and Japan. However, the equity selection should be very focussed. Certain equity valuations are rather high, especially on a PE basis (see quarterly). A combination of sharper than expected interest rate increases with corporate earnings shocks would not be conducive to strong equity returns.
- UK warrant a neutral allocation now moved from underweight and it is tempting to rebuild some UK equity exposure on certain valuation considerations, the recent bout of sterling weakness maybe providing a catalyst. Within the UK equity space, I suggest moving the balance of small/large cap stocks now back to neutral following both the outperformance of the former and the volatility in the currency (part post-election, part BREXIT). Ongoing Brexit debate, political stalemate and economic uncertainty could cause more sterling wobbles, which in turn could affect sector/size choices. I would expect to see more profits warnings, WPP being a recent example. Extra due diligence in stock/fund selection is strongly advised.
- Within UK sectors, some of the higher yielding defensive plays e.g. Pharma, telco’s and utilities have attractions relative to certain cyclicals 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. Concentrate on the major diversified although there are currently some attractive equity and fixed interest ideas in the mid/small cap area. 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), pharmaceutical (Glaxo, Shire?), packaging(Smurfit), retail(Sainsbury/Asda) is likely to increase in my view.
- Continental European equities continue to be preferred to those of USA, for reasons of valuation, and Central bank policy. Improving economic data adds to my enthusiasm for selected European names, although European investors may be advised to focus more on domestic, rather than export related themes. Look at underlying exposure of your funds carefully. 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 large 2017,and 2018 to date outperformance. Smaller cap/ domestic focussed funds may out perform broader index averages e.g. JP Morgan Japanese Smaller Companies and Legg Mason.
- Alternative fixed interest vehicles, which continue to perform relatively well against conventional government bonds, have attractions e.g. floating rate funds, preference shares, convertibles, for balanced, cautious accounts and energy/ emerging/speculative grade for higher risk. 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. If anything, recent sector “news” has highlighted the attractions of the sector.
- Alternative income, private equity and renewable funds have exhibited their defensive characteristics during recent equity market wobbles and are still recommended as part of a balanced portfolio. Reference could be made to the renewable funds (see my recent solar and wind power recommendations). Results from Greencoat on February 26nd and Bluefield Solar the following day reinforce my optimism for the sector. Selected infrastructure funds are also recommended for purchase after the recent Corbyn/Carillion inspired weakness (see note).
- 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. 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. The outlook for some specialist sub sectors and property outside London/South-East, however, is currently more favourable. Investors should also consider some continental European property plays. See my recent company note, after management update last week.
- I suggest a selective approach to emerging equities and would currently 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. As highlighted in the quarterly, Chinese index weightings are expected to increase quite significantly over coming years and Saudi Arabia, is just being allowed into certain indices.
Full second quarter is available clients/subscribers and suggested portfolio strategy/individual recommendations are available. Ideas for a ten stock FTSE portfolio, model pooled fund portfolios (cautious, balanced adventurous, income), 30 stock income lists, hedging ideas and a list of shorter term low risk/ high risk ideas can also be purchased, as well as bespoke portfolio construction/restructuring.
Good luck with performance! Ken Baksh 01/05/2018