Commentary on May 2017
Apart from a mid-month hiccup, when President Trump sacked the Director of the FBI for being too inquisitive, stock-markets performed strongly with record closing highs in the US, UK and Germany. In sterling terms, Europe was flavour of the month gaining over 5%, with the UK and Japan not far behind. Shares in the US and emerging markets took a breather, rising around 1.5%, and UK fixed interest bonds rallied around 1% over the month.
Sterling weakened as a shockingly inept election campaign by the Conservatives brought fears of a hung parliament in which a ‘coalition of chaos’ could potentially rule. Approaching election day markets appear sanguine over the eventual outcome with equities close to record highs and 10-year bond yields back at 1%.
Europe was the new ‘go to’ area, and not just for half-term holidays. With the threat of Euro-scepticism subsiding after an emphatic Macron victory, investor sentiment hit a decade high, encouraged by improving growth data and subdued inflation.
Minutes from the recent meeting of the US Federal Reserve concluded that it would be prudent to wait for further confirmation that the recent slowdown was temporary before removing their accommodative policies. However, they did also discuss planning to gradually reduce their bond holdings acquired via their quantitative easing programme. After a month of mixed economic data, but improving corporate earnings, bond markets have priced in a 90% likelihood of a June interest rate rise.
OPEC reached a deal to extend production cuts into 2018, but fickle traders had expected more and knocked $3 off the price of a barrel of oil.
Economic data from the US and UK are still pretty mixed; the underlying trends remain positive but question marks remain over how sustainable they are in the face of rising interest rates in America and prolonged Brexit negotiations in the UK. By contrast, Europe delivered stronger growth with industry surveys hinting at more to come.
Company earnings in Europe, Japan and the US beat expectations across a broad spectrum; the Eurozone saw the highest number of corporate earnings upgrades since 2010. This is encouraging news but, particularly in the US, it should be borne in mind that challenging share prices needed this simply to justify existing levels.
For now, stock-markets appear unshakable, which is partly down to the collective global analysis of all potential events. Simply put, investors feel that once a concern has been widely discussed then the possibility of it happening is reflected in current asset prices, leaving little reaction if the event takes place.
Due to the ongoing central bank asset-purchase programmes, fixed interest bonds are expensive; whilst this remains the case equities, by comparison, offer better value, leading to a ‘buy the dips’ mentality on any set-back. We’re concerned at how complacently investors are viewing this relationship given that
a) we’re no longer in a deflationary environment, and
b) the balance of monetary policy is shifting from one of adding stimulus to gently removing it.
For now, the need for income will probably continue to support asset prices, but we feel that markets are overdue a correction and retain our cautious positioning.
How are we currently positioned?
We continue to favour equities and absolute return funds over fixed interest. We are still holding the additional bond fund bought in January, but with 10-year yields dipping below 1% we are looking to reduce our exposure.
The weaker currency helped our UK companies that have overseas exposure to out-perform those more reliant on the domestic economy, though all showed gains over the month.
A greater uncertainty over wider geopolitical issues and a global mountain of debt, mean that we anticipate an interesting and possibly volatile period ahead. Previous events have highlighted the benefits of holding a robust, diversified portfolio over the costs of taking bets on major outcomes. We’re maintaining diversified portfolios with the capacity to take advantage of opportunities when they become available.