Investment Quorum Investment Committee notes November 2015
Investment Quorum Investment Committee notes November 2015
The following are brief notes from the Investment Quorum Investment Committee held on the 10th November 2015. They are designed to inform you of our current thinking around the world economies and other issues which inform our thinking around client portfolios and our investment strategies. They are not issued as an invitation to act without advice but for information purposes only. Should you wish to discuss further please don’t hesitate to contact your usual Investment Quorum wealth manager.
The Macro View
- Global economic growth remains moderate to slow with uneven prospects across the main countries and regions.
- It is projected that global GDP for 2015 is likely to be in the region of 3.5% and 3.8% for 2016 with uneven prospects across the main countries.
- The distribution of risks to the near-term remains high with uncertainties focused upon China and the emerging markets.
- Whilst the largest economy in the world, the United States, is still shows some good signs of recovery it has cooled since the summer with the leading indicators suggesting US growth will slow further.
- With the likelihood that Chinese economic growth will continue to slow over the coming months the fear is now that the effects from this will have ramifications for the rest of the globe.
- In many advanced economies prolonged low inflation, or deflation, poses a real threat and of course the risks that the Federal Reserve Bank will now raise rates pushing the world economy into a deflationary direction is creating volatility and uncertainty for equity and bond markets.
- In the UK the recovery is still on track, however, the resumption of austerity is likely to dampen down positivity. Also the start of interest rate normalisation in 2016 is likely to have a negative effect on growth. In terms of rate hikes it is expected that by the end of 2016 rates will be at 1.5% and will peak at around 2.5% by 2017.
- In the Eurozone the recovery should continue as fiscal austerity and credit conditions ease whilst a lower euro and energy prices support activity. Inflation is likely to remain close to zero throughout 2015 but the turn positive again in 2016.
- In Japan growth has disappointed despite a weaker yen and lower oil prices. Clearly, Abenomics faces some considerable challenges over the medium-term so as to balance out recovery with fiscal consolidation.
- The emerging markets have suffered the most in 2015 and with the likelihood of US monetary tightening, a firmer US dollar, weak commodity prices weighing on growth the picture still looks rather murky.
- Concerns over Chinese economic growth will continue to weigh heavily on market and investor sentiment especially as the Chinese authorities consider their options.
- In the FX market “currency wars” are still high on the agenda as the leading central banks manipulate their monetary policies to weaken their currencies.
The Fundamentals View
- Global risk appetite returned in October as investors began to factor in that the Federal Reserve Bank are unlikely to raise US interest rates until early 2016.
- In the Eurozone the European Central Bank president Mario Draghi signalled that the bank could ease monetary policy further in December through increased quantitative easing.
- The central bank of China, the Peoples Bank of China lowered their benchmark one-year deposit rate, and lending rate, by 25 bps to 1.50 per cent and 4.35 per cent respectively. Furthermore they announced a universal 50 bps cut to the reserve requirement ratio.
- This move by the Chinese authorities is aimed at addressing deflationary pressures, which have pushed up real borrowing costs, as well as offsetting the impact of capital outflows and a fall in FX reserves on domestic liquidity.
- In Japan the most recent economic activity indicators have raised doubts over the resilience of their economy and “Abenomics”, and whilst the BoJ has decided to keep its monetary policy on hold, maintaining its asset purchases at ¥80 trillion per annum, it is believed that they will raise this amount if core inflation and inflation expectations further deteriorate.
- Clearly, the emerging markets have suffered the most over recent months but this has now led to pockets of value being seen in those countries that are less affected from the collapse in the prices of commodities and a strengthening US dollar. Hence exports of EM manufacturers are holding up far better than EM commodity producers.
- In the UK the fallout from commodity prices, and worries about further austerity, has affected the large cap stocks more than the mid and small caps. Similarly, concerns are starting to mount over the possibility of a BREXIT. This in turn, could lead to a run on the pound and a correction in UK residential property prices.
- Unquestionably, the commodities market has collapsed in recent times and without China importing 50 per cent of every commodity produced the likelihood is that the commodities super cycle is over. None-the-less costs are being cut, restructuring is occurring at both the asset and the corporate level, and most importantly lower return projects are being cancelled and deferred.
- In the FX market we have seen some fierce movements as central banks have played a “race to the bottom” strategy weakening their domestic currencies through monetary policies and devaluations.
- Over the month of October we saw the MSCI All-Countries World Index rise by 7.7 per cent and the S&P 500 Index rally by 8.4 per cent. In Europe the MSCI Europe Index gained 7.3 per cent whilst the Nikkei 225 Index rose by 9.8 per cent. Finally, the MSCI Emerging Markets Index rallied 5.4 per cent whilst the MSCI China Index gained 9.1 per cent.
The ECB stimulus, Fed rate decisions, and Chinese authorities’ reaction to the market slowdown have been the dominant factors affecting global equity markets year to date.
- In terms of global liquidity, a two-speed world has emerged with the US exhibiting deterioration in monetary conditions and the euro zone, Japan and China seeing the opposite
- With none of these factors going away any time soon, the volatility peaks that have been seen throughout this year may well re-surface again over the coming months.
- If the global economic recovery falters and we do experience a period of deflation then bonds will do well, especially, Government bonds as their values increase as deflation inflates their values.
- The problem is that the yields on govvies have fallen throughout the world over to lows not seen for generations.
- In terms of equities it is the less indebted companies that offer investors the best opportunities as they have more stable earnings and growing dividend prospects.
- Conversely, with the central banks remaining very accommodative and able to supply further stimulus to the system we are likely to see further periods of positive investor sentiment, followed by sharp pull backs on any bad news.
- Since the sharp pull back in equity markets over the summer month’s stock valuations are back to more neutral levels while lower bond yields should provide support for equity markets.
- Corporate earnings remains a concern going forward as corporate profit forecasts are downgraded given the economic slowdown in China and the emerging markets. Equally, the quarterly earnings season has seen around three quarters of companies beat their earnings forecasts, but as the chart shows 2015 US earnings has been disappointing.
- In M&A we have seen around US$4.0 trillion of transactions this year which is a record; therefore, many corporate businesses with cash on their balance sheets seem to be taking advantage of the cheaper prices. Furthermore, many companies are increasing their dividends.
- Whilst we still believe that the outlook is improving it is still too early to become overly bullish. However, we still continue to prefer riskier assets such as global equities over expensive government bonds. In terms of specific regions, we favour the developed markets of the UK, Europe, Japan and the United States.
- In terms of sectors we would suggest that investors remain overweight sensitive sectors such as consumer spending, such as consumer goods, consumer services, technology and possibly financials. What might be interesting for the longer-term investor are basic materials and oil & gas.
- Whilst uncertainty still remains with regards to future Fed decisions, which could affect the direction of the US dollar, and of course the fairly bleak outlook for commodities, it might be too early to increase exposure towards emerging markets, never-the-less there is some value appearing.
The Main Risks considered
The risks are still skewed towards deflationary fears due to worries about the possibility of a Chinese hard landing, a bad Grexit or a US recession in 2016. Furthermore, the Fed could tighten too soon creating a “tightening tantrum” creating a bond market collapse, and a period of world deflation. Alternatively, there is a real risk that the Fed is already behind the curve which could eventually lead to a global push towards reflation, and of course a strong pickup in inflationary pressures.
We believe equities remain the most attractive of asset classes at this time for private client investors.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum, he worked within a larger asset managers, primarily as an Investment Director with Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Committee. This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed.
Investment Quorum is authorised and regulated by the Financial Conduct Authority.
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