Investment Newsletter October 2014
Trick or Treat? By Neal Foundly Investment Analyst
The markets are spooked and it isn’t even Halloween yet. What’s causing fear to rise?
human suffering. We agree there is a pressing need for international action to assist the health systems in Western Africa and implement preventative measures to restrict proliferation.
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Concerns over economic growth. Recent economic data has been patchy and the International Monetary Fund (IMF) recently lowered its forecasts for global growth from 4.0% it forecast in July to 3.8% today.
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A glut of oil reflecting weak industrial demand. The oversupply has weakened oil prices which may indicate that the pace of manufacturing and energy demand is faltering.
Sure, lower economic growth is not welcome but it is not necessarily a negative signal for the markets. The IMF downgrades to economic growth forecasts were focused largely on the Euro Area and Latin America, both of which have been sluggish for some time.
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The spread of Ebola virus disease that has resulted in over 4,000 deaths in West Africa and isolated cases in Europe and the United States.
Conversely, the IMF upgraded its expectations for US growth. Overall, the Fund is expecting the rate of global growth to rise from 3.3% this year to 3.8% in 2015.
Each of these spectres are menacing in their own way. The Ebola virus is by far the most serious in terms of
The remaining two economic shadows, however, can be an illusion.
European growth does look fragile. However, there still remains the possibility that the European Central Bank
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.
Investment Newsletter October 2014
Trick or Treat? cont’d
can pull a rabbit out of the hat and announce a full-scale quantitative easing programme to pump liquidity into the economy to bolster demand. The oversupply of oil can also be deceptive. Some commentators have pointed to the weak oil prices as an indicator of faltering economic demand. To put it into context, the oil price has fallen from
Opportunity Knocks
It is a clear indication of the state of market sentiment when such news is taken as bad news. Fortunately for us, we can take advantage of this dark mood to buy at advantageous prices. For Equilibrium clients, cash that had been held in portfolios has recently been put to work in the UK equity market. The UK has relatively strong prospects given the outlook for economic growth of around 3% this year and next. Now the concerns over the Scottish elections have passed, the UK economy is growing with strong consumer confidence. Internationally, it is an attractive investment market given the relatively easy access to financing and control of its own currency. The FTSE 100 Index started the year at 6749 and rose to a closing high of 6879 in mid-May. Since the asset markets’ fears rose in early September into October, however, the Index has declined by around 9% (circa 6,250 at the time of writing). Given the nature of the fears affecting markets, we believe this presents a good buying opportunity for
Building Blocks
The signs we are picking up from the commercial property market remain strong and positive. Individual real estate companies and property funds are reporting brisk business as companies take advantage of low funding costs to build or redevelop properties. One property company we follow closely recently reported better than expected profits declaring that “the improvement in the commercial market continues to gather momentum. There is a noticeable acceleration in tenant enquiries across our sites”. The latest data particularly points to strong performance from office properties. Office prices have risen by nearly 25% over the last twelve months according to the recent IPD data – that’s 5% more than residential properties in Central London have increased over the period.
around $100 in July to around $80 now – hardly precipitous when compared with, say, 1985 when the price fell from $27 to $12 a barrel. Notably, this did not result in global recession – indeed, global growth was only a shade below 4% that year. In the broader context, the majority of industrialists, consumers and even economists would agree that reductions in energy prices are welcome.
UK shares. As such, we invested the cash held in most portfolios for such a situation – the so-called ‘tactical cash’ – in the market at around 6500. We also created more cash in most portfolios by selling down alternative equity funds that had not been affected by the falls. As markets have moved down further we are now putting that additional cash to work by buying in again today at circa 6,250. We moved from generally a slightly “underweight” position in equities (holding less in shares than normal) when markets were high, back to a “neutral” weighting as they began to fall. As they have dropped further we have moved “overweight”. As fears lift, so we believe will the market as the fundamental attractions of the Index at these levels assert themselves. By buying at these prices, should markets simply move back to where they were our clients should come out of this volatile period better off. Halloween teaches us that things can be dressed up to look far more nasty and dangerous than they really are. As investors, we should ignore the wailing and bluster and see this as treat-time.
the amount of free office space in the UK is falling at a record rate. Indeed, a recent survey indicated that nearly half of local councils in the UK had seen office space decline. In addition to the significant capital growth in certain sectors, the sector offers generous yields as rental incomes remain buoyant. This sets a strong background for the relatively large positions in property in Equilibrium clients’ portfolios and whilst some of the very high growth rates may soften, we would see positive trends continue well into 2015.
One of the key drivers behind this performance has been the conversion of office space into housing. In 2013, the government relaxed planning rules to make it easier to convert empty offices into houses and, partly as a result, Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.
Market Views October 2014
General Economic Overview Whilst economic growth in the UK and US remains strong, the Eurozone is looking weak. This could have a knock on effect to the global economy if it does not pick up. The failure of the European Central Bank to carry out quantitative easing (QE) has not helped matters. Markets are also concerned about QE ending in the US and possible rate rises in the near future. However, with inflation falling we believe both the US Federal Reserve and the Bank of England will be cautious about increasing interest rates. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets Given the recent falls in markets we have upgraded our score from a neutral to a +3. We feel that fundamentally little has changed from a month earlier but we are starting from a lower level. We remain especially positive about Japan and the emerging markets whilst we are underweight Europe.
+3
Fixed Interest We believe that fixed interest will return slightly less than our neutral 6% pa assumption over the next 18 months. We prefer shorter duration bonds and corporate bonds over government bonds.
-2
Commercial Property We firmly expect commercial property returns to exceed our long term 7% pa assumption over the next 18 months. The asset class is seeing a lot of momentum and money flowing into the sector, pushing up property prices. We are just starting to see falling vacancy rates and rental increases which will aid the asset class. Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future. Rates may increase by 0.25% perhaps early next year.
+2 -5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest and overweight property, we have a roughly neutral position towards equity and alternative equity. A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5 means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall. These represent Equilibrium’s collective views. There are no guarantees. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser.
The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.