During the month to November 30th, 2018, major equity markets displayed a mixed trend, rising by 2.12% overall and the VIX index fell to 19.03. Although rising somewhat after the dramatic October fall, there continues to be an abundance of market moving news over what is traditionally a quieter calendar period, at macro-economic, corporate and political levels, and higher levels of volatility seem likely to persist over coming months.
The European Central Bank appeared to become more certain of removing QE, but delaying any interest rate increase until 2019, while economic news seems to have been weaker than forecast in recent months, particularly in Germany.PMI figures for October and November (provisional) point to a very slow fourth quarter. Political events were not in short supply as Italian bonds oscillated with the growing tension between the two-party Government and the ECB,a Greek state bond issue was pulled, street rioting surfaced in France and Merkel’s succession contest ensues. US market watchers continued to grapple with ongoing tariff discussions, Federal Budget, Turkish stand-off, NAFTA follow up and North Korean meeting uncertainty as well as mixed mid-term election results. US economic data and corporate results so far have generally been above expectation and the official interest rate was increased again in September to a range of 2%-2.25%. Provisional third quarter GDP growth figures showed very buoyant consumer trends alongside weak corporate investment and foreign trade, and a December interest rate increase is expected. In the Far East, China flexed its muscles in response to Trump’s trade and other demands while relaxing some bank reserve requirements and “allowing” the currency to drift to a recent low. Recent indicators and statements would suggest a slowdown in 2018 growth to a still very respectable 6%-6.5%, although the ongoing current tariff discussions could affect the projections. Japanese second quarter GDP growth appeared higher than expected and Shinzo Abe consolidated his political position, both perceived as market friendly, and the ten-year bond continues to trade near the recent yield high. At the October BoJ meeting, the current easier fiscal stance was reconfirmed although, more recently, there have been rumours of an end to QE. The UK reported mixed economic data with satisfactory developments on the government borrowing side, inflation as expected, but poor relative GDP figures and deteriorating property sentiment, both residential and commercial. Recent retail data shows mixed trends, some “weather related”, and indeed the poor October figures (Manufacturing and retail sales, consumer sentiment, automotive trends) showed quite a setback. Market attention, both domestic and international is clearly focussed on ongoing BREXIT developments and their strong influence on politics. Although the Budget presented on October 29th, showed a slightly higher GDP forecast and a more expansionary fiscal approach, the Chancellor made frequent references to the unsettling effects of any unsatisfactory Brexit outcome, and the end of the month saw both government and the Bank of England painting weak post-Brexit economic scenarios under all scenarios.
Aggregate world hard economic data continues to show steady expansion of around 3.5%, although forecasts of future growth have been trimmed in recent months by the leading independent international organization. Fluctuating currencies continued to play an important part in asset allocation decisions, volatile sterling being a recent example, while some emerging market currencies enjoyed a bounce from very weak levels. Government Bond holders saw mixed moves over the month-some more inspired by equity market moves rather than changed fundamentals.
Global Equities displayed a small upwards trend over the month of November the FTSE ALL World Index gaining 2.12% in dollar terms and now showing a negative return of 4.56% return since the beginning of the year. The UK broad and narrow market indices, however, both fell by 2.07% over the month and have both underperformed world equities in sterling adjusted values from the end of 2017 by over 10%. The S&P Index, Japan and most emerging markets showed gains over the month, while USA and Japan remain the only major sterling adjusted indices to still show positive returns year to date. The VIX index fell 13.7% % over the month, but the current level of 19.03 still indicates a degree of nervousness.
Sector volatility remained very high during the month, influenced by both global factors e.g. commodity prices, tariffs, as well as corporate activity. Oil and mining stocks fell significantly while telecoms generated strong returns. Over the ten-month period, pharmaceuticals are outpacing the worse performing major sector, telecommunications by around 39%.
Gilt prices fell over the month and are now down 4.30% year to date in capital terms, the 10-year UK yield standing at 1.23% currently. Other ten-year yields closed the month at US 3.11%, Japan 0.10%, and Germany 0.28% respectively. UK corporate bonds fell 2.31% in price terms ending November on a yield of approximately 2.76%. Amongst the more speculative grades by contrast, emerging market debt, in local currency, rose, albeit from a low base. Floating rate bonds and convertibles outperformed gilts over the month and are still recommended. 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.
A quieter moth for the major currencies with small gains for the pound and dollar. Currency adjusted, the FTSE World Equity Index is now outperforming the FTSE 100 by around 10% since the end of 2017 and about 24% since the June 2016 BREXIT vote.
A generally weak month for commodities with particularly large falls suffered by oil. Soft commodities showed little change and now occupy leading positions in the year to date price changes.
Over the coming months, geo-political events and Central Bank actions/statements will be accompanied by a quieter corporate season, as well as lower trading volumes and wider dealing spreads. With medium term expectation of rising bond yields, equity valuations and fund flow (both institutional and Central bank), dynamics will also be increasingly important areas of interest/concern, and it is expected that any “disappointments”, economic or corporate, will be severely punished.
US watchers will continue to speculate on the timing and number of interest rate hikes 2018/2019 and longer-term debt dynamics, as well as fleshing out the winners and losers from any tariff developments -a moving target! Corporate earnings growth will be subject to even greater analysis after the buoyant first half year/nine months, amidst a growing list of headwinds. Additional discussions pertaining to Saudi Arabia, 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. The recent China/Japan summit may signal closer co-operation in the area. European investment mood will be tested by economic figures, EU Budget discussions, Italian bond spreads, German, Turkish and Spanish politics, and reaction to the migrant discussions. It must also be remembered that the QE bond buying is being wound down over coming months.
Hard economic data and various sentiment/residential property are expected to show that UK economic growth slowed during October/November, 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! At the time of writing the House of Commons vote (Outcome and content!) appear very difficult to call. Whichever Brexit direction is signalled, it is highly likely that near term quarterly figures will be distorted, and general asset price moves will be confused, in my view, by a mixture of currency development, political machinations, international perception, interest rate expectations. It should also be remembered that the forthcoming OPEC meeting, December 6th, could have an important bearing on a large sector of the FTSE 100 Index.
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 should be expected in the medium term, in my view. See my recent ‘iceberg’ illustration for an estimate of bond sensitivity, particularly acute for longer maturities. Price declines are eroding any small income returns leading to negative total returns in many cases. On the supply point there are increasing estimates of US bond issuance against a background of diminished QE and overseas buying. European bond purchases are also winding down. Apart from debt implications, corporate earnings growth and discounting purposes, remember that higher bond yields also are starting to play into the alternative asset argument. In the US for example the ten-year bond yield at 3.1%, is over 100 basis points higher than that on equities.
Equities appear more reasonably valued after recent price falls, but there are wide variations. Equity investors will be looking to see if superior earnings growth can compensate for higher interest rates in several areas. Helped in no small part by tax cuts, US companies have been showing earnings growth more than 20% so far this year, although the current quarter is widely expected to be the peak comparison period, and ‘misses’ are being severely punished e.g. Caterpillar,3M Facebook, General Electric, Kellogs, and Twitter. Accompanying corporate outlook statements are being carefully scrutinised.
Outside pure valuation measures, sentiment indicators and the VIX index are showing significant day to day variation, after the complacency of last year. The current level of 19.03, though off the recent extended level, reflects the uncertain market mood, as does the relatively high put/call ratio.
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.
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 rather high, especially on a PE basis (see quarterly), although not in “bubble” territory. A combination of sharper than expected interest rate increases with corporate earnings shocks would not be conducive to strong equity returns. 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, selected tech shares etc etc.
Full quarter report available to 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, 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!