Commentary on November 2016
Stock-markets lost ground over the month with developed markets falling by 2-5% and emerging markets by 6-10%. The two notable exceptions were the US and Russia, both seen as beneficiaries of the new Trump era. Stock indices in the US repeatedly hit new highs during the month as the dollar, shares and bond yields all rose on what investors hoped would be an updated version of Reaganomics. Most stock-markets subsequently rallied in early December, led by further record highs in the US.
Bond yields continued to rise on concerns that the global policy mix appeared to be swinging from monetary policy (central bank bond buying and lower rates) to fiscal policy (higher rates and more debt). For the first time in years there was a growing concern that central banks were deliberately underplaying the risk of inflation to safe-guard economic growth.
In European politics, the Italian constitutional referendum played out as expected with a ‘No’ vote, closely followed by Prime Minister Renzi’s resignation. The fall-out was brief and the day ended with most markets, and the euro, higher; the Italian stock-market is now 5% higher than just before the referendum!
The global economy continued to provide positive surprises with rising third quarter growth numbers and forward-looking business indicators ahead of expectations; unemployment numbers fell to the lowest for some years in the US, UK and Eurozone. Moving into December, manufacturing data in the UK and Germany disappointed but this had no effect on share prices.
For some years, investment markets have interpreted bad news as good news, reasoning that bad news meant lower interest rates or, in the case of the US Federal Reserve, that a rise would be postponed. Conversely, ‘good news was bad news’. But as the year progressed this has morphed to a new mindset where, certainly for developed equity markets, ‘all news is good news’, regardless of the implications for interest rates.
Witness the reaction to the UK’s Brexit referendum, the US election of The Donald and the ‘No’ vote in the Italian referendum; all deemed to be extremely negative events, more because of the uncertainty they created than their effects on interest rates. But each in turn saw a diminishing negative reaction followed by a positive, glass-half-full, interpretation of events.
This strange phenomenon is due in part to the existing positioning of investors’ portfolios. There’s an old stock-market adage, “climbing a wall of worry” which refers to conditions where markets are perceived to be over-valued or surrounded by negative sentiment yet continue to rise. Investors positioned for a fall face the choice of being left behind or paying up to join in the rally. So long as there are potential buyers then shares will continue to rise; in recent times this has been complicated by the actions and utterances of central banks.
Events next year should add some substance to this year’s unknowns; the inauguration of Donald Trump as President will bring policies instead of random comments on Twitter (his preferred social networking site), the triggering of Article 50 will start protracted Brexit negotiations, and Europe faces potentially pivotal elections in the Netherlands, France, Germany and possibly Italy.
How are we currently positioned?
Asian and emerging market funds detracted from performance but our higher-risk funds benefited from the weighting in Russia. Our currency-hedged Japan funds gained from a rising stock-market and strengthening sterling, putting them nearly 7% higher on the month.
We continue to view fixed interest bonds as offering little reward for the risk of capital loss and prefer a combination of property, absolute return funds and equities. In the UK, the lower currency increases the likelihood of higher inflation, supporting our preference for short-dated index-linked stocks within the fixed interest sector.
A greater uncertainty over wider geopolitical issues and a global mountain of debt, mean that we anticipate an interesting and possibly volatile year ahead. Events this year have highlighted the benefits of holding a robust, diversified portfolio over the costs of taking bets on major outcomes. We’re maintaining our diversified portfolios with the capacity to take advantage of opportunities when they become available.