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Investment Review: September 2018

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.

Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.

Our quarterly report presents our views on the world economic outlook and equity, fixed income and foreign exchange markets. Please click the link to download.