Investment Newsletter September 2012
Risk On? The phrase that has most summed up investment markets over the past couple of years has been “risk on/risk off”, now being shortened by some to “roro”! Essentially, this means that risky assets (such as equities, commodities or the riskier parts of fixed interest) are either all moving up or all moving down together, depending on sentiment. We have been in a “risk on” phase over the past couple of months as markets recover, but how long could this continue?
Quantitative easing The Federal Reserve’s Ben Bernanke recently announced a further bout of quantitative easing in the USA. This could have a major impact on markets. Whilst we are now onto our fourth round of quantitative easing in the UK, QE in the US has a much bigger impact on the global economy and Bernanke has just announced a third tranche. QE effectively involves a central bank electronically “printing” money in order to buy bonds from institutions. The idea is to get more money into the financial system to stimulate the economy.
The most recent announcement has some differences to the first two periods of QE. Previous QE has been announced with a specified value of assets to be purchased. QE1 in the US was initially for $600 billion, later increased to $1.25 trillion. QE2 was for a further $600 billion and ran from November 2010 through to June 2011. The latest round of easing, QE3, is open ended, leading some to dub it “QE Infinity”! The Fed have Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | September 2012
not placed any constraints on the amount of easing it will undertake or the length of time in which it intends the carry out asset purchasing. The Fed has announced it will purchase $40 billion of bonds a month and said that interest rates will be kept very low until 2015. QE will continue for as long as the Fed feels is necessary. The potential size of QE is therefore unlimited. Unlike the Bank of England which has a mandate to control only inflation, the Fed is tasked with controlling both inflation and unemployment. The motives behind QE3 are centred on employment figures and the Fed has stated they are prepared to keep fuelling the economy through the easing programme until the labour market improves substantially. In a shift from inflation controlling measures, the Fed have also said that they will keep up this accommodative monetary policy for a considerable time after the economy strengthens.
What does this mean for markets? Whilst QE3 will affect the US bond market directly, this could feed through to other asset classes not just in the US, but globally. Institutions, having sold bonds to the Fed, will be cash rich. During previous bouts of QE this money has found its way into riskier assets and helped push markets higher. In addition, investors are faced with a market place where the traditional low risk assets are not yielding as much as they have in the past. Safe haven government bonds are reflecting negative real yields and the higher quality corporate bonds are also yielding much lower than average. This encourages investors to look for higher returns elsewhere. If we look back to QE1 and QE2, we saw big increases in the riskier equity, commodity and high yield bond markets.
Growth slow down We are seeing a slowdown of growth across world economies, from the US to Europe to China. The authorities are taking steps to try to resurrect growth. Whilst Europe is not currently following the US lead and introducing QE, the latest bond buying plan from the European Central Bank shares some of its characteristics. It has also improved sentiment and reduced risk. There has been a slight shift in rhetoric from the Germans, previously in favour of austerity and not much else, towards the more growth centred policies favoured by the more peripheral European countries. China’s economic slowdown has also been causing a concern. To put this in context, growth is predicted to be around 7.5% in China this year. The feared “hard landing� scenario would see growth come down to perhaps 6%. By comparison, many Western economies are not growing at all. The central bank policies in the West could have a knock on effect to equities in emerging markets as sentiment and liquidity improves. In addition, with inflationary pressures falling China has plenty of scope to stimulate their economy and improve their own domestic market. We have
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | September 2012
seen interest rates cut by the Chinese authorities and there is a strong suspicion that they will take further action to stimulate their economy. There is a saying in investing “don’t fight the Fed.” Basically, if the central banks are doing everything in their power to stimulate the economy, we shouldn’t bet against them.
What are Equilibrium doing? Our research leads us to believe that equity markets look good value, including those of emerging markets. In particular, within emerging markets, China looks extremely undervalued based on company earnings. With a growing economy, these earnings should remain relatively robust and so we believe there could be an interesting investment opportunity in China. The Chinese market has been one of the poorest performing markets during 2012 and is now back to 2009 levels, even though earnings in China have held up well. Being the contrarians that we are, the relatively low markets are a positive as far as we’re concerned rather than a negative! The ratio of price to earnings is now very low relative to history. To try to make the most this opportunity we are making a change to our standard equity portfolios. We are switching out of the Allianz BRIC Stars fund (which invests in Brazil, Russia and India as well as China), and investing instead in a fund which is solely focussed on China. We are not increasing the amount we hold in emerging markets and so this change adds minimal risk to the portfolio. However, we believe the potential returns to be much greater. The fund we are using is an Exchange Traded Fund (ETF) called the DB-X Trackers MSCI China ETF. This is offered by Deutsche Bank and is one of the largest and most liquid Chinese funds around. ETFs are very similar to OEIC or Unit Trust funds which we normally use. The main difference is that they are traded throughout the day, rather than just once a day as with most funds. The fund is a regulated fund and subject to the same tax treatment as a unit trust. Whilst there is a chance that volatility will return and many issues remain (particularly in Europe), we feel that market risk has receded somewhat. We hope that investors will start to focus on fundamentals again and this could push up equity markets which we believe remain significantly undervalued. If so, we feel the Chinese market could be one of the best performing asset classes.
Mike Deverell
Investment Manager
Equilibrium Asset Management LLP Brooke Court Lower Meadow Road Handforth Dean Wilmslow Cheshire SK9 3ND United Kingdom Visit us at www.eqasset.co.uk t : +44 (0)161 486 2250 f : +44 (0)161 488 4598 e : askus@eqasset.co.uk Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | September 2012
General Economic Overview The European situation appears to have settled down for now. A new round of quantitative easing in the US could have a positive economic effect. However, global growth remains muted at best with many Western economies barely growing. We expect more central bank stimulus to keep the economy on track. Inflation is falling back globally, however stimulus could eventually lead to this rising significantly.
Asset class key + positive - negative = neutral (normal behaviour)
+5 -5
strongly positive strongly negative
Equity Markets We remain very positive taking an 18 month view, based on valuations such as the Price/Earnings ratio. However, with the recent recovery we could easily see some short term downwards moves. We particularly favour the UK market although most markets show some value.
Outlook
+4
Fixed Interest Interest rate risk has receded for the short term but inflation could hurt bonds in the long term. Corporate Bonds still provide reasonable yields and could do reasonably well in this environment. We are avoiding Gilts whose values have been inflated due to recent risk aversion.
+1
Commercial Property Whilst the rental yield on commercial property remains attractive, this is diluted by high levels of cash in property funds. We are seeing capital losses although we believe that overall returns will probably be positive, but low. However, we don’t believe the returns are worth the risk of investing in property at present.
-5
Residential Property
-5
We believe prices are likely to remain flat over 18 months. Cash With interest rates remaining at record lows, returns on cash could remain below average for some time. However, there is a short term safe haven appeal. Balanced Asset Allocation For a typical balanced portfolio we are overweight equity and cash, neutral fixed interest and hold no property. 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.
-5