Investment Newsletter November 2016
Optimism trumps pessimism? After the Brexit vote we saw some pretty strange market movements. Initially, UK stocks fell very sharply after the result was known. However, the market then quickly came to terms with the new developments and focused on the positives, such as the fall in the pound boosting profits of a number of UK companies.
Mike Deverell Investment Manager
However, that sharp change of direction is nothing compared to what we saw after the US election result. On the news that Donald Trump was to be the next president, US stockmarket futures fell so sharply that they hit a “circuit breaker” and trading was halted. At that point the futures were implying that the S&P 500 would fall more than 5% when the market opened. In the end, the S&P 500 actually went up 1.5% on the day. The US markets very quickly decided to focus
on the positives. In particular, Trump has pledged to lower corporate taxes which would boost company profits. He also plans to sharply increase infrastructure spending markedly, which could boost economic growth. Given the potential increase in growth, investors also decided this would lead to increased inflation. As a result, they are now certain that the Federal Reserve will put rates up, and this had led to bonds being sold off. We have noted in these newsletters before that bonds and equities had become increasingly correlated. Over the long term, these assets should typically move in different directions. Traditionally, the so-called “safe haven” government bonds such as gilts or US Treasuries do well when the economy is doing poorly and investors are nervous about investing in equities.
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 November 2016
When the economy is growing strongly, equities tend to do well and bonds do poorly. Recently, bonds and equities have often moved in the same direction as low interest rates and quantitative easing have given both assets a boost. This has all changed since Trump’s election.
US 10 year bonds
S&P 500
Having gone up together, one might have expected bonds and equities to fall together. However, the old patterns appear to have reasserted themselves and equities are going up at the same time that bonds are falling. Contrary to what we initially thought after the election, it now seems very likely that US rates will go up next month. It will be interesting to see if the current market trends continue after a rate rise, or whether that could lead to market jitters. In the meantime, the bond sell off has spread to the rest of the world, with UK gilts and German bunds also falling sharply.
The chart below shows the indexed performance of the main US stockmarket, the S&P 500, against the US 10 Year Treasury (their equivalent of a gilt). These lines have generally moved in pretty much the same direction over the past few months, but they diverged on the election result (shown as the dashed line):
Source: Thomson Reuters Datastream
now markets are ignoring any detrimental effect this might have on the US economy, however these fears have manifested themselves in other stockmarkets. Emerging market stocks have fallen sharply since the election, whilst UK and European stocks have remained fairly flat. Markets appear to be buying Trump’s “America first” rhetoric for now, but we believe there are many reasons to be cautious.
It is worth remembering that Trump has also promised to tear up various trade agreements. Should this lead to reduced trade this would have a detrimental impact on the global economy. For 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 November 2016
Actively selecting funds
Last week the Financial Conduct Authority (FCA) released a report following a study into the fund management industry. In essence, the report says that many fund managers charge too much whilst adding too little value. The FCA has essentially questioned the entire active management industry, pointing out that most funds don’t beat their benchmark index. Charges are a key part of our research but we do believe that we can add value by selecting active funds where appropriate. The average fund does indeed underperform, but we believe we can find above average funds which can add significant value. This is a controversial point amongst many investment professionals, with passive advocates arguing that it is not possible to work out in advance which funds will outperform and which won’t. We beg to differ and have recently carried out a review of our fund selection process which backs up this viewpoint. We developed our own sector screening tool several years ago which we use to help us select funds. Because all of the results of these screens are saved on our system, we are able to look back at which funds came out top five years ago. We can then review the performance of those funds since then.
In each sector except one, at least four of the top five funds identified by our tool beat both sector and index. The only exception was in the North American sector, where none of the funds the tool identified in 2011 beat the S&P 500 index over the past five years. Whilst our screening tool appears to be able to identify good funds, we don’t rely on it blindly and there are many other stages to our research process. Hearteningly, the funds that we actually selected for five years beat the main index and sector average in each sector. Even in North America our fund selection outperformed. This is because we were unconvinced by any of the active funds our screening tool identified and so selected an index tracker instead. This actually beat the S&P 500 Index as it tracks a slightly different index with a slightly higher weight to smaller companies. We went into our fund selection process in some detail in the most recent edition of Equinox. You can access this article electronically by clicking HERE. We are also happy to share the results of our fund selection analysis for those who are interested. Whilst we believe that the most important decision in investing is asset allocation, good investment management is about making lots of small differences. By consistently finding funds that outperform, these small differences can add up to a big number over time.
We looked at the top five funds identified in our 2011 sector screens in each of the main equity sectors we look to invest in. We then compared these funds to both the sector average and to the main index in each region over the past five years.
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 November 2016
General Economic Overview Economic data remains fairly robust across most of the world, although it is weaker in the emerging markets than developed markets. The election of Donald Trump, the strong dollar and likelihood of a US interest rate increase, may exacerbate this split. Inflation expectations have risen globally but especially in the UK given the weak currency. Despite this headwind the UK economy is currently performing well.
Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class Equity Markets Equity markets outside the US are slightly lower than last month and so we have increased our score from -4 to -3. We continue to believe that Japanese and Asian equities offer the best value in relative terms.
Score
-3
Fixed Interest Our score remains the same as last month at -2. Bonds have fallen over the month so momentum is negative but yields are now higher as a result. We continue to hold some index-linked gilts but otherwise prefer corporate bonds.
-2
Commercial Property Our score remains unchanged from last month. Rental income remains attractive but we are avoiding exposure to London given the high valuations and risks associated with Brexit. We remain light on property for now as most funds have high London exposure, but are looking for opportunities.
Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.
-3 -5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest and equity, and hold only a small amount of property. This is balanced by additional holdings in defined returns, alternative equity and tactical cash.
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. The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. 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. 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.