Category: Investment Committee

By Tim Sharp, Hottinger & Co.

The success of the vaccine roll-out in western economies seems to have checked the economic impact of the increased cases of the Delta variant with increasing evidence that the relationship between new cases and hospitalisations and deaths has been disrupted, while the developing world where vaccination penetration remains low, risks remain elevated[i]. This has caused some jitters in financial markets that the removal of restrictions may be delayed with the inevitable effect on global growth.

 

The IMF released its latest report this week on global growth, warning that limited access to vaccines risks hindering the global recovery by splitting the world into two blocs. However, by cutting the forecast for emerging markets and increasing the forecast for the developed world the overall global growth forecast remained at 6% for 2021. The UK gained the biggest uplift to 7% with the economic impact of the rise of the Delta Variant in the developed world difficult to calculate. The second risk is that inflation may prove to be more persistent than currently anticipated prompting a more aggressive central bank reaction[ii].

 

Interestingly, fund flows into fixed income have overtaken equity flows year-to-date in July, according to Barclays, although equity flows are also still positive. The level of Treasury holdings on bank balance sheets has soared in line with the savings rate and there has been a public warning from a consortium of 30 private and public sector experts including Timothy Geithner, Larry Summers, and Mervyn King regarding the stability of Treasury markets. Recommendations include a single marketplace, and a mechanism by which the Fed can provide participants with a short-term swap for cash to provide liquidity that can dry up at times of extreme stress as was seen in March 2020[iii].

 

The US Treasury ten-year continues to ignore the current strength of inflation preferring to believe that temporary supply bottlenecks are the route cause, due to an uneven reopening, with the yield dropping to 1.24%. Moreover, there are signs that some pressures are easing with prices in lumber and other raw materials lower, and the semi-conductor shortage working its way through in the auto sector[iv]. It would appear that markets have suffered a growth shock rather than fears surrounding elevated inflation which has expressed itself in a curve flattening as long duration bonds reflect global growth fears.

 

Morgan Stanley challenges the notion that global growth is weakening instead seeing a strong economic recovery underway. They believe second quarter US GDP is going to be approximately 12% and continue to estimate global growth for 2021 of 6.5%i. We continue to believe that despite the recent value to growth rotation, the movement towards stocks with stable earnings, strong cash flow generation and robust balance sheets will provide an element of consistency and protection to valuations.

 

Second quarter earnings have started strongly with Absolute Strategy Research (ASR) predicting 55% year-on-year gains although guidance remains key for investors particularly when valuations are so stretched[v]. Interestingly US Treasury thirty-year yields have dropped to 1.89% while the S&P500 dividend yield is 1.76% and until bond markets start reacting more consistently to the expected path to higher inflation this will help underpin equities. Most notable to us has been the strong results from the global banking sector which has seen loan reserves reduced following unexpected corporate strength during the pandemic, the resumption of dividend payments in many regions, and strong revenue gains. We believe that a strong performance from banks will further underpin equity markets and add to investor confidence.

 

The outperformance of US equities has been related to the strength of the US dollar over the last two months, in our opinion, and the rise of long-term growth stocks as bond yields have fallen. The S&P 500 gained another 2.3% in July versus 1.7% for the MSCI World Index. If the rotation back into growth stocks proves to be a short-term reaction to the rise in Covid-19 cases, then we would expect to see European equities come back to the forefront. The EU’s Next Generation Recovery Fund sees 71% of spending aimed at key green and digital transmission investments which are expected to have long term productivity enhancementsiv.

 

Fears of global slowdown, rising coronavirus cases, weaker commodity prices, a Chinese Producer Price Index inflation rate of 9% and a stronger dollar, was not a comfortable environment for developing markets although the difference between commodity exporters and importers saw Latin America outperform Asia and the broader index albeit to the downside[vi]. Declines in Chinese internet stocks such as Alibaba, and Tencent have been significant as Chinese regulators continue to step up their oversight and plan heavy penalties in the technology, private education and food delivery sectors causing anxiety amongst investors[vii]. This also leaked into the heavily debt-laden real estate sector where the authorities are trying to cool demand with new restrictions. We believe a renewal of the long-term trends including a return to dollar weakness should see emerging markets recover once more.

 

Following last month’s research into corporate debt markets we believe corporate credit spreads offer little value to investors with added duration risk, and in line with our views on the relative attraction of emerging market currencies we see emerging market local currency debt as an area of fixed income that still offers opportunities to investors. The expected path of developed market government bond yields and the expectations of a continuation in the steepening of the curve leaves investors looking to reduce bond exposure in the interim. We continue to favour the relative valuation of developed equity markets and the strengths of quality stocks particularly in the UK and Europe. The flash GDP release for the Euro Area rose by 2% quarter-on-quarter in the second quarter well above consensus expectations of 1.5% marking the beginning of a cyclical rebound that could see pre-crisis levels by the fourth quarter[viii].

 

[i] Morgan Stanley – Summer Doldrums _ Where Do We Stand? – July 25, 2021

[ii] IMF World Economic Outlook – Fault lines widen in the global recovery – July 2021

[iii] Financial Times – Flawed $22tn US debt market a threat to stability, warn grandees – Colby Smith, July 29,2021

[iv] Absolute Strategy Research – Investment Committee Briefing – July 1, 2021

[v] Absolute Strategy Research – Supply Constraints and Inflation Favour Cyclical Stocks – July 15, 2021

[vi] Comparison of MSCI Indices on the Refinitiv platform by Hottinger Investment Management

[vii] https://www.cnbc.com/2021/07/28/investing-china-stocks-among-asias-worst-performing-amid-regulatory-scrutiny.html

[viii] Barclays – Buckle up, we’re in the fast lane now – July 20, 2021

By Tim Sharp, Hottinger & Co.

June, much like May has been dominated by concerns regarding rising inflation. The statement following this month’s Federal Open Market Committee (FOMC) meeting was more hawkish than expectations but rather than suggesting the US Federal Reserve (Fed) is going to pull back from Average Inflation Targeting we believe pointed to the fact that the committee had started to discuss a timetable for reducing or tapering Quantitative Easing. There was actually no change in policy and little change in economic outlook, although the committee members’ “dot plot” interest rate projections showed seven members electing to pencil in the first hike for next year and most had moved to two hikes in 2023. This probably indicated that the Fed was potentially behind the curve and is now more aligned with markets[i].

 

The rebound in global demand and the continued increase in job openings has seen several bottlenecks emerge in supply side production, as well as logistical constraints, that have pushed US core inflation to its highest rate since 1995[ii] leading many investors to question the transitory nature of the strength in inflation. For our part we tend to agree with the Fed and the Bank of England that the current jump in inflation is tied to irregularities in the reopening of economies and the continuing fiscal support offered by governments making employment in low paid sectors less attractive meaning that this may prove to be the peak in near term inflation pressures[iii]. There is little doubt in our opinion that the risks point to higher inflation over time and that the loose monetary and fiscal conditions probably rule out future deflationary trends.

 

From a developed equity perspective, markets had a wobble following the FOMC meeting as the change in rhetoric caused a rotation into defensive stocks away from cyclicals sectors. Absolute Strategy Research (ASR) point out that this actually started in May when indicators suggested inventory conditions were tight and the FOMC meeting purely underlined this message[iv]. Morgan Stanley have been ahead of consensus with their mid-cycle transition from consumer discretionary into consumer staples but are receiving push back from clients due to the belief that the savings glut will perpetuate the re-opening trade. Morgan Stanley counter that over-consumption in 2020 will likely curtail the re-opening trade and discretionary spending is more early cycle than mid-cycle[v]. Interestingly, June saw Russell 2000 Growth Index significantly outperform the Value Index by approximately 5.29% with Banks and Resources stocks under pressure, suggesting that the reflation trade may have peaked near-term. However, we believe the underlying current in equity markets remains optimistic and investors took advantage of opportunities in the recent re-balancing to invest in long term equity holdings.

 

In our opinion, we have reached the stage where owning robust, fairly valued stocks in companies with strong cash flow and low debt; that have shown an ability to perform in different parts of the cycle will likely offer an element of downside protection in long-only portfolios. This description lends itself most naturally to defensive, value stocks but we also see many examples of expensive equities in such sectors. This could be an opportunity for good stock-picking to overcome sector allocation, and growth vs. value, however, we still favour banks and materials as the best way to play rising long term inflation trends.

 

Regionally, we have positioned ourselves to take advantage of the green energy investment that is being rolled out in Europe and continue to believe that the discount currently experienced by UK equities vs. other developed markets will close. We posit current M&A trends suggest the value in the UK has been recognised at an institutional level and we believe that equity investors will also want to increase their participation in UK markets[vi]. During June the FTSE All-Share index was flat on the month while the MSCI Europe ex UK Index gained 1.89%. Finally, Japan is the last developed value market that continues to underperform developed markets, the Nikkei 225 Index was 0.24% weaker over June. There are good reasons for Japan to outperform in this environment as pointed out by ASR – weaker Yen, rising US Treasury yields and stronger dataii. However, the vaccine roll-out has seen a slow take up by the population so the threat of another wave of the Delta variant cannot be ruled out, and the slowdown in China has potentially also affected Japanese sentiment- in our opinion.

 

Developments in bond markets, most notably the lack of further upside in 10-year US Treasury Yields despite rising inflation concerns also point to the markets belief that current inflationary pressures will prove transitory. The current 10-year benchmark yield started the month at 1.61% already well off the high of 1.73% and is currently 1.46% with inflation break-evens already pricing in high inflation expectations. Our investigations into credit markets concluded that the tightness of spreads, with the likelihood that developed markets could only tighten further, leaves very little return for investors.

 

 

Moreover, we believe it is unlikely that the outlook for the second half of the year will disrupt credit markets so our emphasis should perhaps shift to Emerging Market debt. The case for Emerging Market currencies to strengthen over the course of 2021 further suggests to us that a local currency emerging market debt fund may be an efficient way of capturing positive returns.

 

The expected path of developed market government bond yields and the expected continued steepening of the curve leaves investors looking to reduce bond exposure in the interim. With the risks to inflation firmly to the upside the move to include commodities, real assets, and alternative strategies at the expense of traditional fixed income exposure will continue to occupy this committee and other multi-asset investors. Gold had rallied strongly in May but failed to hold on to those gains in June falling from a high of $1908 to $1770 over the month. The future path of Gold will probably be a trade-off between a weaker dollar and rising real yields following already stretched break-evens rather than any correlation to Bitcoin, suggesting to us a move lower under this scenario in the medium term.

 

[i] The J.P. Morgan View – FOMC meeting isn’t a game changer – June 21. 2021

[ii] Absolute Strategy Research – Investment Committee Briefing – June 2021

[iii] https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2021/june-2021

[iv] Absolute Strategy Research – Long duration Reprise – Back to the Future – June 22, 2021

[v] Morgan Stanley Sunday Start – Great Expectations – June 6, 2021

[vi] Hedge Fund Short Sellers Face Off Private Equity in Morrison Supermarkets Deal – Bloomberg

by Adam Jones

With the global pandemic now firmly in the rear-view mirror we have been reflecting on the performance of various economies and markets over the past 12 to 18 months. Since the pre-pandemic peak in late February 2020 global equities (as measured by the MSCI World Index) have delivered returns of c.17% to UK investors. Europe has closely followed suit (delivering a 14% return) but the clear laggard has been the UK itself, with the FTSE 100 being effectively flat over the same period.

This is perhaps unsurprising given the number of headwinds over recent years, but as the clouds begin to part we find ourselves becoming increasingly optimistic on the outlook for the UK.

Enthusiasm for UK equities, which had already been dampened by protracted Brexit negotiations, has struggled further under the weight of the pandemic given a particularly high market exposure to those sectors most affected by lock-downs.

Even prior to the Brexit vote global fund managers have generally been underweight the UK market, preferring instead to maintain exposure to those markets geared toward secular growth dynamics (US Tech being the clearest example);

 

 

This makes absolute sense in a world where economic growth is scarce and interest rates are low. However, for now at least, that does not appear to be the situation we find ourselves in.

Successful vaccine roll-outs are beginning to take hold and continued re-opening looks set to drive a wave of demand from consumers all across the developed world, many of whom are waking up to the fact that their bank accounts are full of unspent earnings and/or unemployment benefits.

Household savings rates here in the UK remain elevated and from our (perhaps optimistic) perspective this provides a supportive backdrop for spending in the months ahead;

 

 

   Source: ONS

The true scale and duration of fiscal support packages is yet to be seen given the politics involved, however there is little doubt that it will come through in one form or another. This provides yet another leg of support for the stool of economic growth.

As a thought exercise we felt it useful to identify and expand on some of the key reasons why we feel the UK market is especially well placed to deliver more attractive returns on a forward-looking basis;

• An increasingly robust intellectual property base – The UK offers an almost unparalleled breadth and depth of IP, spanning its football clubs (almost half of the top 30 global football clubs by revenue) to its universities (3 of which consistently feature in the world’s top 10 universities). This is not to mention the disproportionate impact UK scientists had on the impressive and rapid development of a Covid vaccine.
• Economic strength – Whilst not boasting the headline GDP growth numbers sported by some other countries the UK can hold its head high in having maintained a consistently low unemployment rate (particularly when compared with those in Europe & the US).
• Funding strength – One consequence of higher bond yields (which we have seen over recent months) is that it increases the cost of a governments borrowing. This is likely to become more of an issue over time and it is worth noting the UK has by far the longest average term to maturity of its debt across the developed world (17.8yrs vs just 6 in the US). This essentially means the UK has fixed its borrowing costs for a much longer period and thus has lower refinancing risks than many other economies.
• Falling political risk – Clearly Brexit and the associated uncertainty has weighed heavily on the UK as a whole. However, with the most critical negotiations now behind us we see many reasons to believe that excessive risk premia associated with Brexit should begin to recede. It also feels increasingly clear to us that leaving the EU also allows the UK government to turn its attention more toward stimulating domestic investment and growth.
• Cheap equity valuations, cheap currency – The UK market continues to trade at a significant discount to other developed markets and has more recently traded at lower earnings multiple than the (arguably much riskier) Emerging Market equity universe;

 

This is a fact that does not appear lost on overseas investors given the significant pick up in M&A activity YTD, with overseas corporate and private equity investors looking to take advantage of this apparent dislocation.

All in all, we can think of far more reasons to own UK equities here than not to. Whilst it is very possible that we are being overly optimistic about the outlook the balance of risk and reward appears to be very much in our favour.

By Tim Sharp, Hottinger & Co.

Equity markets appear to have stalled during May as the two main catalysts of reopening economies and reflation seem to have run their course in the short term. The MSCI World Index is up 1.26% in dollar terms during the month and despite the continued apparent “buy-on-dip” mentality which is still holding markets firm, the bounces in growth and reopening plays have been shorter lived each time. The S&P 500 outperformed the NASDAQ again in May 0.55% versus -1.53%, but the near-term catalysts do not seem to be enough to drive valuations from here at present.  Towards the end of the 1^st quarter the correlation between increased volatility and returns was high, suggesting strong risk appetite amongst investors, but this month the same measure for global equity risk appetite is far more neutral[i]. Furthermore, as noted last month, the share price reaction to the Q1 US earnings beats continues to be muted by historical standards as investors look at the guidance for signs that companies will be able to sustain margins[ii]. The question is whether this leads to a broader weakening in risk appetite that would point to a near term high in bond yields.

 

The European earnings season is by contrast slower to evolve than its US counterpart with 217 out of 600 companies having reported at the time of analysis, however, earnings have beaten expectations by 31% which would be the best result in over a decade according to Absolute Strategy Research (ASR)[iii]. This would point to a quicker recovery than initially expected with year-on-year earnings growth of approximately 150% and the sales-earnings ratio points to a profit margin exceeding pre-pandemic levels. ASR confirm that this would be the highest level for 15 years further underlining our belief in the prospects for European equities[iii]. European equities have had a solid month with EUROSTOXX gaining 1.87%, the CAC 40 gaining 2.83% and the DAX 1.88%.

 

We believe the UK could be the cheapest of the main equity markets based on historical metrics, with a high weighting towards both value and the reflation trade through energy, basic materials, financials, and consumer staples sectors. The FTSE 100 has had a flat month up 0.76% while the more domestically oriented small cap index gained 1.97%. The vaccination rollout has gone well and the government looks to have strong approval ratings following recent elections, so the domestic landscape in the UK should be attracting investors. We posit that the contraction in Q1 GDP reflected the tighter restrictions following the rapid spread of COVID variants, while statistics suggest a rapid recovery is now underway and that the gap that exists to other developed markets could close by the year end.

 

Despite warnings from many economists that a transitory increase in inflation should be expected as restrictions ease, the markets have still been surprised by the strength of supply side inflation and an unexpected tightness in labour markets. We are now in a period where base effects will push the annual rate of inflation higher, but we are also witnessing considerable supply chain cost pressures coupled with increases in demand. Although these pricing pressures are expected to dissipate over the coming quarters, markets were jolted by May’s employment report which determined that just 266,000 new jobs had been added versus an expectation of 1,000,000. Many new openings are reportedly unfilled by a workforce that seems unenthused by the prospect of employment[iv].

 

The pandemic has seen a move from monetary policy responses, such as quantitative easing after the Global Financial Crisis, to an increase in fiscal policy by developed economy governments looking to build an infrastructure capable of supporting the bounce back in global growth. The increase in infrastructure spending has also seen increased momentum in green infrastructure spending, particularly in Europe, in the build up to the COP26 climate summit in November. The need to provide plans on how to achieve the transition to a sustainable world will also highlight the costs to both public and private finances, with ASR pointing to an estimate of $1trn of additional spending per year[v].  Increases in government spending normally lead to a focus on the tax regime for funding. While there is more emphasis on employee welfare and the living wage, it is widely reported that the Biden administration under Treasury Secretary Janet Yellen has been pushing for a landmark agreement that will see a new base in place in the developed world for corporate taxation that will inevitably reverse the trend in lowering the corporate tax burden. This will potentially affect future earnings, increase the pressure on margins, and further add to investors anxieties regarding valuations in our opinion.

 

The uneven vaccine rollout still seems to be hindering the growth trajectory in many developing countries as countries such as India struggle to cope with hospitalisations. We believe that the disparity that exists in vaccine access could be a long-term drag to global growth and could be detrimental to developed and developing economies alike as the pervasive spread of the virus will significantly heighten the chances of new vaccine-evasive variants mutating. Although the Shanghai SE Composite Index bounced 4.89% in May, Chinese equities have also been weak for most of the year as credit conditions have tightened, restraining economic activity particularly in areas such as real estate. We expect this will influence global growth and may create a headwind for commodity prices in the medium term. Copper eked out a gain of 2.12% after a volatile month while Gold rallied 7.79% again suggesting that perhaps investor risk appetite may be waning.

 

We have noted on many occasions that historically there exists a negative correlation between equities and bonds and have used this as a reason to hold over-priced government bonds in a multi-asset portfolio. However, at inflection points we see that all asset classes tend to align, and ASR have noted that over the past 3 months the US stock-bond correlation has been at its highest in 20 years at 44%, meaning that on several days of equity weakness over the last month, bond markets have not rallied as expected[vi]. The US Treasury 10yr yield still sits at around 1.58%, similar to where it started May. This positive correlation may point to an increased investor concern at the inflation risk premium and the inherent uncertainty, or it may prove transitory much like the inflation currently being observed in western economies. Nonetheless, we believe it is further proof that bonds do not currently provide the same hedge of equity risk that they once did.

 

As inflation expectations reach an inflection point, the nervousness in financial markets has led to our continued focus on alternative investments. We are monitoring our existing alternative and multi-asset strategies with a view to comparing them to other options and strategies with lower correlation to traditional asset classes over past periods of volatility to ensure we have the blend of exposures that we currently desire.

 

[i] Absolute Strategy Research – Risk appetite reaches inflection point – May 26, 2021

[ii] Absolute Strategy Research – Strongest Earnings Season in 15 yrs – April 29, 2021

[iii] Absolute Strategy Research – European Earnings on a Tear – May 11, 2021

[iv] Ft.com – https://www.ft.com/content/73bdd783-ad53-4d78-93d8-39c895b88bc4  – May 27, 2021

[v] Absolute Strategy Research – Investment Committee Briefing – May 3, 2021

[vi] Absolute Strategy Research – The Great Stock–Bond Correlation Conundrum – May 24, 2021

By Hottinger Investment Management

October saw US Treasury markets finally catch up with reality, in our opinion, and in doing so trigger significant global equity market volatility. The yield on the 10 year US Treasury moved sharply higher from 3.06% to touch 3.23% driven almost entirely by real yields rising because headline inflation fell slightly to 2.3 yoy in October. Financial markets seem to us to have been pricing in half the rate hikes that were currently being suggested by the Fed’s dot plot so it seemed a fair assumption to us at least that a market reaction to a hawkish speech by Governor Powell aimed at jolting markets followed up by reactionary rhetoric from President Trump would see markets react negatively to the potential end of an aging economic cycle. Furthermore, the increased tariff measures from the US administration aimed at China have also triggered a number of US companies to raise concerns over the increasing costs of protectionism. In Europe too trade tensions seem to have affected economic activity with new export orders falling significantly this year and in Germany, in particular, the new car emissions tests seem to have contributed to slowing manufacturing numbers during October in an industry already suffering in the crossfire of the US / China trade war.

As seen in February, a market looking to reduce risk in already extended equity market sectors also went through a significant rotation out of cyclical growth into defensive value. Indeed, despite the prospect of rising rates and bond yields many bond proxy equities showed their flight to quality credentials but another significant factor over late summer has been the value of cash at 2.3% moving above the yield of the S&P500 (1.9%), with investors seeing a modest real return in 2 year Treasuries at 2.9%. For long periods the argument that there is no alternative to equities has led to investors overpaying for growth and potential disruptive technologies that many investors have now become increasingly anxious about this late in the cycle.

However, 3^rd quarter US GDP estimates came in stronger than expected at 3.5% qoq driven above consensus expectations by strong consumer spending assisted directly by the fiscal advantages introduced by President Trump. On the global growth front, the picture is clearly mixed. Growth has slowed at the world level from 3.8% over the 2017 calendar year to 3.5% annualized figure for Q3 2018 and has been a negative surprise for markets clearly contributing to the October sell-off. Behind the headline rate, the performance of the European Union and China, which account for about a third of global GDP, have contributed the most to the slowdown, with the central bank in China continuing their policy of monetary easing – going against the grain globally –  to support domestic and export activity.  On the other hand, the United States, the United Kingdom and Japan are all growing at faster rates than they achieved in 2017, with all countries expanding above 2.5% over the most recent quarter on an annualized basis. In emerging markets, India is strongest expanding by over 8% in Q2 2017 and facing tailwinds from demographics, urbanization and economically favourable policy reforms from the Modi government. Whether India becomes the new China, putting in year after year of 7%+ growth, remains to be seen but the signs suggest it might.

Furthermore, 3^rd quarter earnings season has seen 85% of US companies beat EPS estimates so the back drop to the October sell-off was still broadly positive although investors did seem to be focusing more on company forward guidance for signs of possible future slowdown. The possibility that equity investors may have already seen peak earnings during the middle quarters of this year has increasingly caused an air of caution that spilled over in October. As calculated by JP Morgan A.M. the S&P500 moved by more than 1% on a daily basis ten times during October while only managing that feat 8 times in the whole of 2017. The index was down 6.9% on the month leaving it up only 1.4% on the year. The fact that the volatility trigger was an increase in real yields means that the normal negative correlation between bonds and equities also broke down with the Treasury market falling approx. 0.50% in aggregate over the month meaning that multi-asset investors also found it difficult to escape negative markets.

The nature of the correction was felt across all markets with Europe (-6.5%), Japan Nikkei index (-9.1%), UK FTSE All-Share index (-5.4%) and MSCI Emerging Markets (-8.8% in $ terms)all feeling the effects of the risk off sentiment. In fact many global markets found themselves in bear market territory down 20% on the year with only 20% of all asset class types yielding a positive return. The advent of QE brought with it a move away from market fundamentals towards political and central bank influence over investors and, arguably, the existence of a central bank back stop a reduction in volatility that favoured risk assets. As QE turns to QT (quantitative tightening) and economic strength is left to stand on its own feet a return to normal volatility in the latter stages of an economic cycle is to be expected especially if signs begin to show that the economic data is also turning. A return to fundamentals may also see the market signalling system become clearer increasing market opportunities for active investors.

By Hottinger Investment Management

A booming economy has left the US equity markets well ahead of the other regions over the summer months and September has proved to be a month of retrospection with the first signs of a possible rotation from cyclicals into more defensive sectors. However, whenever this has happened previously it has proven to be short lived, but it is probably true to say that US markets have become a little more anxious as we head into October, which has always been a difficult month historically.

Economically, in September, JP Morgan report that US consumer confidence hit its highest level since 2000; initial jobless claims fell to the lowest monthly average level since 1969 while wage growth rose to the highest level since 2009 and retail sales grew more than 7% year-on-year. The level of fiscal stimulus announced by the Trump presidency is unprecedented this late in the cycle and when combined with the move from quantitative easing to quantitative and monetary tightening the threat of the US economy overheating has definitely increased as a risk. The US yield curve remains very flat with the 2 – 10yr curve only positive by 40 basis points, although the economic signals emanating from the bond market have been severely dulled by central bank intervention.

The Federal Open Market Committee’s meeting in September delivered a well-choreographed 25 basis points hike for the third time  this year and a removal of the last of the QE wording that policy remains “accommodative” in the official statement paving the way for another 25bps in December. Indeed US Treasuries lost 1% over the month and 10yr Yields finished at 3.06% following this latest tightening round. So far the Fed has managed the expectations of financial markets very well with the gradual monetary tightening not shocking the market; every time the US 10yr Treasury breaks above 3% it fails to consolidate its positon to move towards 3.5% decisively despite the expectation that we may have passed peak growth. While core inflation risks remain under control, financial markets are unprepared for a more aggressive Fed approach and risk assets remain in favour.

During September the S&P500 printed another all-time high of 2940.91 but failed to hold that level into month-end finishing still positive +0.43% at 2913.98. The headline numbers do not tell the full story though as the fact that the NASDAQ fell 0.78% in September might suggest. The high valuations surrounding some cyclical stocks saw investors implement a certain level of rotation during the month as the FAANG+ index fell 4.19% and the S&P Banks Index fell 4.37% while defensive sectors such as Healthcare gained 2.80%. The narrowness of sector returns over the third quarter has seen many equity investors ride the IT wave (FAANG+ is still up 22% YTD vs. 9% S&P500) while the outperformance continues creating a lot of “froth” that is reliant upon earnings growth surprising on the upside into year end. Many market analysts including Absolute Strategy Research believe that earnings will fall significantly in Q4 bringing into question equity valuations. This rotation into value stocks is the most significant since the February hiccup but it could face headwinds if inflation fails to materialise and unemployment continues to fall.

In the UK, financial markets remain under pressure as fears of a no deal Brexit gain momentum as well as latest round of political party conferences got underway. The FTSE All-share gained +0.53% while Gilts fell 1.62% and sterling was flat. In theory a no-deal Brexit would be good for the equity market due to the expected fall in sterling depending on your opinion of what is already priced in. However, many are now more anxious of a pending Corbyn government than they are of the type of Brexit deal that is achievable leaving the outlook for UK financial markets cloudy at best. Elsewhere in Europe the banking system has been called into question twice over the summer due to exposure to Turkey and Italy which has added to wider market fears following last year’s significant outperformance. European equities fell 0.31% over the month as trade war rhetoric between the US and China continued to add to the forecasts of an already slowing Chinese economy, which will have a knock on effect to European exporters.

The highlight of the month was Japan which saw the Nikkei 225 rise 5.49% and $/Yen weaken 2.4% meaning that Japanese equities were stronger in dollar terms as well. The economic background of the strongest jobs market since 1974 and expanding bank lending have been equity supportive, but also the beginning of bi-lateral trade talks with the US and discussions in the Diet regarding a new fiscal package following Prime Minister Abe winning a third term has also helped create a positive backdrop.

From an asset allocation perspective, the favouring of US equities probably relates to their historical outperformance in poor market conditions due to the depth of diversification and liquidity while emerging markets as a bloc remain challenged by a strong dollar environment particularly those countries with large current account deficits that have increased their dollar-denominated debt. With regards to Europe, we think the end of ECB stimulus and limited fiscal support coupled with concerns over growing levels of household and corporate leverage heighten risk in investing in the region.

By Economic Strategist, Hottinger Investment Management  

What’s the value in a reserve currency?

Being in possession of a global reserve currency is often seen as a privilege for a country and its citizens. In times of growth, the use of a reserve currency to grease the wheels of international trade can reduce the borrowing costs for that country. In times of panic, investors pile in to buy the currency, pushing its value up and making imports cheaper.

Reserve currencies are an essential feature of a global economy that relies on a basket of national currencies, and are an important asset for investors to manage the risks from their investments.

The best reserve currencies are those that perform the three essential functions of money best. A currency is strong when it acts as not just a medium of exchange and a unit of account, but also as a store of value. When investors choose to store some of their wealth in a foreign currency, they trust the government in charge to keep inflation low and public debts within manageable limits.

Reserve currencies can fall out of favour

Since the end of the Second World War, the United States has managed the world’s dominant reserve currency, the dollar. But today, that status may be under threat as the US government under Donald Trump abuses its privileged status by running large budget deficits and putting trading sanctions on other countries in a way that runs against international agreements.

Are we therefore seeing the beginning of a shift away from the dollar to other global currencies? One way we can begin to form an answer is to look to history. During much of the 19^th century and the first part of the 20^th century, the British pound was the world’s reserve currency. Many of Britain’s colonies and trading partners pegged their currencies to gold sterling; the City of London was the world’s banker, with the Bank of England its line of last defence. In 1914, according to Barry Eichengreen of the University of California, sterling accounted for almost 90% of global foreign-denominated debt. By the end of WWII, still up to 60% of foreign-denominated debt was in sterling as the US dollar came to ascendancy. Many countries, however, maintained sterling pegs well into the 1950s.

The rise of the United States to prominence in the global economy throughout the 20th century naturally made it both able and willing to provide the reserve currency, and it was essential that it did. Eichengreen claims that the dollar overtook sterling in the 1920s if one excludes Commonwealth countries but well after WWII if one does not.

The political arrangements of Bretton-Woods that followed WWII and paved the way for US dominance as well as the high debts that burdened the UK after the war provided the death knell for sterling. This, alongside the decline of the British Empire, weakened sterling’s grip within the Commonwealth and made it infeasible for the UK to remain the head of a global fixed-exchange rate system, as it required a tight monetary policy at a time when domestically the opposite was called for and demanded.

The chart below shows the effects of the sterling-dollar transition that took place in the 1940s. Since that period, the real value of the British pound has been around 20% lower than what it was during the first half of the 20^th century. The nominal value has fallen further. One pound bought five dollars at the start of the 20^th century; today it buys less than $1.30, a 70% devaluation that is due both to the loss of sterling’s status as the global currency but importantly also the UK’s higher long-term inflation rate compared to the US.

Dollar reserves rose from 30% of global reserves in 1950 to just under 70% by the mid 1960s. Peak dollar came just after the end of the Bretton-Woods system in 1973, at which 80% of reserves were held in dollars.

Which currency dominates today?

Today, the dollar is still considered dominant part of a basket of global reserve currencies, some of which could grow in prominence in coming decades.  Over 60% of reserves are still held in dollars, with the rest shared across the euro (20%), the yen (5%), sterling (5%), the renminbi (1%) and swiss franc (0.2%).

It’s a diversified mix that suggests that in an age in which most exchange rates float against each other rather than remaining fixed against that of a global leader, there is more scope for competition for leadership as investors can choose which nation offers the most stable currency.

Over the last thirty years, the Japanese Yen and the Swiss Franc have been popular choices, as attested by the real strength (see chart). Sterling did well between 2009 and 2016 as the UK built a reputation for fiscal restraint. However, none of these currencies can serve as the dominant reserve currency as the economies that back them are too small, which means that investors come up against valuation and liquidity issues when these currencies essentially become too popular.

Competition for reserve currency status will ultimately be between the world’s big three economies: the US, the EU and China.

Despite greater competition, the dollar has held its value through most of the post-Bretton Woods period, as the chart above shows. Fluctuations aside, a dollar today buys more or less in real terms what it did in 1980. Indeed, all of the major global currencies have fluctuated around parity over the period, which can be expected for currencies that float against each other – the so called Law of One Price ensures that nominal exchange rates move in opposition to differences in inflation across countries.

The exception is the Chinese renminbi, which has weakened by up to 60% in real terms since 1980, as a result of a conscious decision by the Chinese authorities to peg its currency against others at a weak rate to boost the country’s export sector.

Many consider the Chinese renminbi to be the natural successor to the dollar as China grows to become the world’s largest economy later this century. It’s possible, but it would require China to either open up its financial markets to global capital, providing a safe asset, or impose itself as the new figurehead of a fixed rate currency system. Neither of these looks likely for some time, so the dollar is likely to keep its preferred status over the renminbi.

The fate of the euro is potentially more interesting. With the Trump administration using the dollar’s important role in facilitating international business to impose crippling sanction on adversaries such as Iran, Europe is beginning to consider ways to circumvent the dollar payment system for its businesses.

There is nothing theoretically stopping the euro rivalling the dollar as a reserve currency, especially between those countries that have a close trading relationship with the Eurozone. Emerging market economies may also find a more diversified global reserve system to their advantage, as it would reduce the sensitivity of their economies to US interest rates.

However, until reforms are made to put the single currency on a more sustainable footing, allaying fears that the Eurozone could one day break up, that prospect looks unlikely for some time.

It looks therefore as if the US will continue to benefit from having the most popular global currency. It is in US interests to maintain dollar primacy, keeping funding costs and import prices low, and having what amounts to the best defence against the vicissitudes of the global economy.  One group that does badly from this deal is US exporters and manufacturers, as a strong dollar undermines their competitiveness. This group has the sympathy of the US President, who has a preference for a weak dollar.

Investing in currencies

Having access to a range of currencies with safe-haven status is extremely valuable to investors. While first and foremost, any investor should consider her personal requirements – such as her preferred home currency, the balance of her international investments, her liquidity needs and the nature of her liabilities – there is value in considering which currencies are emerging as safe havens. For example, holding Yen between 1980 up until any time before the financial crisis would have yielded an average real return of over 40% (see chart), excluding any return on the investments held in those currencies. Holding the Swiss Franc between the financial crisis and 2015 would have yielded an average return of close to 40% on the currency alone.

With the global situation more volatile than it has been since the end of the Cold War, and with so many things that we once thought of certainties now in doubt, now is a good time to reconsider where the best places are to hold and preserve capital.  Those places will have strong, responsible governments with open and liquid capital markets, low and stable public debt, and a willingness to accept a strong currency. And in today’s world, all of those things are contingent.

By Hottinger Investment Management

August tends to be a quiet month due to the holiday season with problems only arising when major events combine with low volumes and reduced liquidity. In recent history, this has meant that the month has become one of the more turbulent of the year; however, the anticipated increase in volatility particularly in the US stock market largely failed to materialise.  The major earnings figures released in July showed equities performing well in the US, Europe and Asia, most likely reflecting the strong economic tailwinds that have seen most global regions performing well. However, the rather benign 1% increase in the MSCI World Index masked quite different performances at regional level.

The US stock markets continued to play a significant, positive part with the S&P500 finally surpassing the January high to print a new all-time high of 2,916.50, and, the current equity bull-run became the longest in history on August, 22 2018 at 3,453 days beating the rally of the 1990s that ended with the dot-com crash in 2000. The S&P500 rose 3.03% during August but continues to be surpassed by the NASDAQ (+5.70%), driven by the small selection of consumer technology companies as represented of the FAANG+ Index.

US Treasury yields having momentarily hit 3% in 10 year maturities at the beginning of the month recovered to closer to 2.82% during the month, as fears of an overshoot by the Fed in raising rates or an inflation surprise failed to weigh on investors’ worries. Interestingly, as Morgan Stanley point out, the yield spread for US investment grade corporate bonds has failed to fully re-tighten after they widened out during the equity weakness in March, even though equities have recovered all their lost ground. Such divergences do not tend to last for long, and if they do they tend to signal the end of an economic cycle. This situation underlines our cautious equity stance at present.

Europe was again the main region to see investor outflows over the month as European equities weakened 2.7% and the trials and tribulations in Italy also caused Eurozone Government Bond yields to edge higher. The European banking sector has a significant exposure to Turkey, which provided the month’s emerging market shock by announcing the fastest pace of inflation since 2003, causing the Turkish Lira to collapse 40% vs. the USD. The US Dollar Index gained 3.79% over the month and other vulnerable EM currencies such as Argentina Peso, Brazilian Real and South African Rand suffered contagion while Emerging Market equities lost 2.9% over the month. The on-going trade dispute between the US and China continues to undermine the Chinese Yuan but the more robust Asian markets only gave up 1.25% over the month.

During the UK House of Commons summer recess the frailties of both Conservative and Labour parties managed to dominate domestic headlines while sterling lost ground against the Euro (-.51%) and the USD (-1.28%). Brexit headlines continue to exploit deep divisions within the ruling Conservative Party, and many industries are becoming noticeably anxious about maintaining trade with the Eurozone after March 2019 when the UK is supposed to leave the EU. UK domestic orientated stocks have tended to lag the large cap global exporters this year so there are possible opportunities for UK investors amongst depressed valuations; however, the UK FTSE All-Share index fell 3.46% over August.

The macroeconomic focus was largely on the thinking of the Federal Reserve and the proceedings of the Jackson Hole summit. There, we learned that while Fed Governor Jay Powell believes that the ‘gradual process of normalization remains appropriate’, he also said that ‘there does not seem to be a risk of inflation acceleration’. He expressed the view that monetary policy should respond not to academic models of where interest rates should be but instead to conditions in the actual economy. This was an important statement because many models such as the Taylor Rule point to much higher interest rates than the market expects over the next 18 months. The median FOMC member, often using these models as a guide, expects the Fed Funds Rate to be 3.5% by the end of 2019, which would mean a 25bp rise each quarter (or another 6 rate rises). Markets think that two or three are more likely. Fed overshooting provides the greatest risk to the US economy in the near- and medium-term.

If the Fed is moving in a more flexible direction, and they see signs that productivity is picking up (which would subdue inflation), then it is possible that the long recovery will not be choked off by monetary policy. However, we have yet to see enough evidence that this is indeed the dominant Fed view; combined with the tightening bias in other regions and concerns over debt and the easiness of financial conditions, we still think that monetary headwinds will strengthen in 2019, creating less favourable and more volatile conditions for risk assets.

Last week, Blackrock CEO Larry Fink wrote a letter to CEOs calling for them to “serve a social purpose”. A key phrase reads:

“Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.”

He explicitly tied financial performance to meeting sustainability objectives:

“Your company’s strategy must articulate a path to achieve financial performance. To sustain that performance, however, you must also understand the societal impact of your business as well as the ways that broad, structural trends – from slow wage growth to rising automation to climate change – affect your potential for growth.”

When the man who oversees $6trn in assets says sustainability matters, the theme cannot really be regarded as a purely ethical activity.

I was in Zürich last week for the 2nd FINEXUS conference on Financial Networks and Sustainability, attended by leading practitioners, policy makers and academics. The purpose of the conference was to assess how sustainability criteria can be better integrated into the policies of central banks and development banks, the lending decisions of retail banks, and the portfolio decisions of asset managers.

If the forecasts for climate change are right, we are currently on course for irreversible environmental damage. We all know what this means: coastal flooding, water shortages, and lower crop yields; not to mention the effects on our oceans and for biodiversity. As the impacts of climate change will be concentrated in the Global South, we can expect huge intercontinental migrations that make the 2015 Syrian refugee crisis look like the tip of an iceberg.

The 2015 Paris Agreement commits countries to take action to limit the amount of global warming to 1.5C by 2100.

As Stanislas Dupre – member of the High Level Expert Group on the EU’s sustainable finance taskforce – explained at the event, the investment industry is funding a path that leads to warming of 4-6 degrees on the basis of its current choices, financing infrastructure that locks in emissions for decades to come.

Putting these two facts together means that investment managers who do not take sustainability seriously are likely to find themselves on the wrong side of transition risk in the coming decade. This is because commitments to the Paris Agreement make it highly likely that governments will regulate their economies to discourage and penalise carbon-intensive activities. It has almost nothing to do with the moral case for unilateral action and everything to do with the future tax, regulatory and legal changes made by governments which have committed to going green.

Asset managers who hold securities tied to carbon-intensive firms may therefore face significant losses. Huge amounts of capital need to be mobilised into green investments, and states committed to the Paris Agreement will take steps to facilitate this process. The ultimate risk that firms and investors face during the transition is being left holding stranded assets that have lost their value by either regulatory or technical changes.

There are other kinds of transition risk – such as the risk of a bubble in green assets – but the one that is immediately relevant for industry is the risk of stranded assets. This could plausibly arise in a number of ways:

• An announcement on a global (or national/regional) price for carbon
• New technological breakthroughs in the low-carbon sector
• The achievement of a price parity between renewables and fossil fuels
• Changes in legislation reflecting the legality of GHG emissions
• The forced nationalisation of selected assets
• An increase in pressure from shareholders, employees and activists to limit GHG
• Commitments to reduce implicit subsidies of fossil fuels (which are very large)
• An increase in accuracy in the monitoring and measurement of emissions for attribution to firms
• An increase in social awareness of the risk of GHG emissions

Any of these factors could affect the long-term return from carbon assets in portfolios.

The conference also hosted panels that discussed the need for stress-testing for climate and transition risk. This would be an activity that would help asset managers, central banks and development banks understand the possible consequences of the renewable energy transition.

This is a new area of research that could inform the policy of central banks in the future, especially when it comes to QE. If it is understood that carbon assets present a threat to financial stability as the effects of climate change on the economy take hold, central banks could make the case to favour ‘green’ assets (such as green bonds and companies that have low carbon intensity) when engaging in asset purchases.

A future Basel IV agreement could see rules that impose stricter capital requirements on banks that lend significantly to carbon-intensive activities. These policies could therefore reduce the cost of capital and increase its availability for green companies.

Other policies could have a similar effect. Mafalda Duerte from the World Bank’s Climate Investment Funds explained how state development banks could further raise the NPV of green activity by issuing green bonds that pay for subsidies and ‘credit enhancements’ to green firms.

Further, tax benefits could be offered to issuers of and investors in green assets, again with the aim of lowering the cost of capital as well as increasing the depth and liquidity of green asset markets.

These policies and others create transition risk for firms and investors, and they need to be assessed and quantified.

There is no immediate threat to existing portfolios but the message from the conference was that the status-quo will be costly in one way or another, and quite soon. Companies that invest for the long-term need to consider the issue of sustainability. There are opportunities as well as risks, and there will be returns for being on top of both.

 

The growth of passive investment products such as index tracking funds over the past few years has been significant as investors are attracted by low fees and the premise that the majority of active managers will not outperform the market over time. Passive investing, or indexing, involves buying a basket of assets that have been included in an index, such as the FTSE 100 Index or the S&P500, or sectors thereof without having to undertake the research and due diligence associated with an active investment decision as performance will mirror the overall movement of the market.

However, some investors argue that the increase in passively allocated money risks distorting the price discovery process. Active investors look to invest in companies whose shares and bonds look cheap and sell those that look expensive, thereby holding management to account by basing decisions on fundamental factors such as earnings growth; competitive prospects and management performance. Price agnostic or passive investors reduce the proportion of share price movements that are based on fundamentals, creating serious market anomalies by being obliged to buy already over weighted and overpriced assets.

This situation is more serious in the less liquid markets of corporate and high yield bonds where passive funds offer total liquidity in an index such as the Citi World Government Bond Index where the level of liquidity of the underlying index components may not compare. Furthermore, the more indebted a company, the more bonds it is likely to have issued, the greater its weight in the index meaning that a passive bond fund will effectively hold a high weighting of bonds in the less credit worthy members of the market place.

The use of passive products in less diverse markets could further contribute to overvaluation and provide a destabilising effect. For example buying sector specific exchange traded funds (ETF) such as the technology sector where market capitalisation may be skewed to a small number of very large companies that would risk breaking some basic investment rules regarding insufficient diversification and exposure to large individual holdings. The performance of the technology sector since Trump’s presidential win has seen Facebook, Apple, Google, Microsoft, and Amazon become over 40% of the Nasdaq 100 Index, which would be in breach of European fund rules if an active manager was to follow the same asset allocation.

Modern portfolio theory would argue that the primary driver of portfolio returns is asset allocation, which is the process of combining various asset groups with different risk and return characteristics (e.g. equities, bonds, cash, private equity, hedge funds, real estate) into one portfolio that will produce optimal, risk adjusted returns. An active investor believes he can outperform a set benchmark by using his skills in market timing, stock selection or style tilt. Smart-beta strategies are semi-active products that reweight on a regular basis in order to maintain an allocation that historical back testing would suggest has been the optimal mix over time. This blurs the boundaries between active and passive by offering the investor one asset allocation remedy based on past performance that any standard market disclaimer would state may not guarantee future success.

There has been a long debate over the relative merits of active and passive approaches to investment when both approaches probably deserve a place in a diversified portfolio. Recent opinion concludes that the ability of active management to generate alpha is probably cyclical;  underperforming when returns are overly concentrated or highly correlated such as times when interest rates are low, and, outperforming as economic growth improves, interest rates normalise and market inefficiencies increase. Active managers also have the benefit of making the decision not to be fully invested by holding cash in difficult times which should provide significant downside protection.

In our latest Global Insights publication we stated that the uncertainty surrounding potential US policy leaves US equity valuations priced for perfection whereas we believe European equities are under-estimating the strength of the eurozone economy and over-estimating the political risk. Since the French Presidential victory by Emmanuel Macron populist fears have largely been priced out of equity markets with European equities hitting a year’s high the following day coinciding with the VIX volatility index on the CBOE, known as the markets fear gauge, dropping below the psychological 10.00 level despite the chaos emanating from the White House.

 

The VIX Volatility Index Year-to-Date

Source: Bloomberg

 

This highlights that highly liquid conditions created by the different levels of quantitative easing implemented by Central Banks have been highly supportive of equity markets. Central Banks have been big buyers of financial assets creating more predictable markets and altering long standing asset class correlations. This has made portfolio diversification more difficult for long term investors and created an environment where macro-driven hedge funds have struggled to make the risk-adjusted returns that made them so popular. Furthermore, it could be argued that the increasing use of the $4tn passive investment market through exchange traded funds has created further indexation of investments and under-pinned many over-valued sectors of markets through blind investing.

Companies have accumulated significant cash on their balance sheets, which has been steadily returned to shareholders through share buybacks, dividends and M&A. As a generalisation, this wealth has accrued to the better-off members of society with a lower propensity to consume meaning it has been re-invested into financial markets creating worsening inequality and seemingly a de-coupling of financial markets from the real economy that seems to have coincided with the rise in populism.

According to Absolute Strategy Research (ASR), in their Equity Strategy Weekly publication dated May,18 2017, over the last 111 years major market corrections have often had part of their origin in inappropriate rate rises which removed liquidity from equity markets. This time the risk of raising headline rates is with the US Federal Reserve and China is also tightening policy but further the reduction in the pace of QE in particular the potential for ECB tapering. ASR attributes much of the rally in risk assets in 2016 to growth in both US and Chinese M1 money supply rather than political events and M1 money growth has decelerated as policy has tightened in 2017.

Ideally excess liquidity leads to improving economic fundamentals and constructive government policies to justify higher asset prices. We are currently focusing on three medium term possible headwinds for markets, the clearest being the US political environment raising doubts over the implementation of the President Trump pro-growth agenda.

Equally, Beijing will continue to try and cool the housing market and run the economy at the official target growth rate of 6.5%.  This was reflected in the significant slowdown in PMI and Industrial Production readings in April along with a marked deceleration in Private investment growth to 6.9% from 7.7% in April, all consistent with moderating growth momentum.

Thirdly, a European government bond taper tantrum in H2 17 along the lines of the US taper tantrum in 2015 would be significant with so many European issue trading in negative territory. Interestingly the market seems to have more confidence that hard data will eventually mirror sentiment in Europe. Eurozone PMI’s hit their highest levels for 6 years in April with business expectations the main driver showing broad based positive sentiment across the Eurozone. President Draghi is questioned at every ECB meeting Q&A session to comment on the potential for changes in monetary policy as the European economy shows signs of continued recovery.

Unusually low interest rates and quantitative easing have boosted market liquidity and supported financial markets and as this liquidity is constrained there is a reasonable possibility that risk assets will moderate.

Global equity markets finished April strongly, with the Eurozone now assuming a relatively benign outcome of a Macron victory to the French election. MSCI World rose 1.4% over the month and 7.2% year-to-date in dollar terms. The Eurozone was the best performing region up 2.04% enjoying both a strongly rising equity market and Euro; political pressures in the Netherlands, France and Germany have weighed on the eurozone so far in 2017 but stronger growth and falling unemployment are supporting real wages and consumer spending. Eurozone equity markets have gained 6.8% so far this year despite the uncertainty of Brexit negotiations. Rising inflation expectations, loose monetary conditions and markets priced for bad news all help us to prefer European equities at present. We believe European equities are under-estimating the strength of the eurozone economy and over-estimating the political risk.

The other clear winner over the month was Emerging Markets with the MSCI Emerging Index also up 2.04% in dollar terms. The weaker dollar environment (the Dollar Index -1.3% in April) complements the robust company, bank and country balance sheets that lead us to favour Asian markets. We think that emerging economies stand in good stead to withstand any shocks delivered from developed economies where the main uncertainties currently lie particularly while the reflation trade is allowed to run.

Japan was also a strong performer during April up 1.52%, but that was largely currency related as indicated by the weakness of Euro/Yen down 2.4% on the month. Japan is still struggling to make economic headway despite its massive quantitative easing programme but there are still many opportunities amongst Japanese equities and signs that inflation is picking up giving us hope that optimism will be realised.

The UK is feeling the pressure of BREXIT as inflation is beginning to affect spending plans and the realisation that a hard result seems more likely. The triggering of Article 50 has created clarity and as such allowed the pound, which had discounted the worse case scenario of the UK crashing out with no deal, to appreciate approximately 1% vs. EUR and 3.25% vs. USD.

GBP vs. USD Year-to-date

 

Source data: Bloomberg

This obviously had a detrimental effect on the long running overseas earnings trade and consequently the FTSE 100 fell -1.62% whereas the more domestically orientated All Share index only fell -0.69%. The forthcoming election on June 8 will mostly likely see a larger Conservative majority but the outlook will remain uncertain so the financial markets are now left to react to media feedback on the progress of negotiations and the reality of economic statistics.

The first 100 days of the Trump administration have been dominated by the failure of the attempt to reverse Obamacare and its effect on the ability of the government to successfully implement its other plans. There now exists a level of caution over the continuance of the reflation trade, although stocks are currently buoyed by the quarterly reporting season, they are priced for perfection so the uncertainty surrounding US policy will cause a negative reaction if there is a perceived threat to the boost to global growth that has already been accounted for by investors.