Investment Newsletter December 2017
Liquid lunch
Mike Deverell Investment Manager
Over the past few years markets have become hooked on massive amounts of stimulus from central banks.
their QE programmes (with China also stimulating its economy through government spending).
All the major central banks have carried out quantitative easing (QE) in one form or another, essentially pumping money into the system to help economies recover from the hangover of the financial crisis.
In fact, the amount of money pumped into the system in the past year or two has vastly exceeded what was created in the immediate aftermath of the financial crisis.
Perhaps this has worked because over the past year or so the global economy has been extremely strong. It almost doesn’t matter where you go in the world, there have been robust levels of economic growth. The only slight exception is the UK where growth has been more anaemic, being hit by Brexit uncertainty and the weak pound. Despite the rosy global economic picture, central banks in Europe, Japan and the UK have continued
Many people think all this liquidity is one of the main reasons why markets have been so exuberant and why we have seen so little volatility. However that begs the question, if markets are drunk on liquidity, what happens when the punchbowl is taken away? The US Federal Reserve has just started reducing the size of its balance sheet. Many people think this has a similar effect as “reverse QE�. Meanwhile the European Central Bank is about to reduce its own QE programme, interest rates have gone up in the US and
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter December 2017
the UK, and China has started to curtail some of its government spending. Tighter monetary policy means there will soon be less liquidity sloshing around the financial system. Chart one shows the relationship between global excess liquidity (light grey) and share prices relative to cash (black line). There is an extremely strong relationship between liquidity and markets. If the chart is right, then market returns relative to cash are likely to be lower going forward.
The liquidity indicator has been moved forward by one year on the chart and doesn’t include forecasts for future changes. If liquidity reduces further through tighter monetary policy then equity returns are likely to come down even more than the chart is indicating. After such a long uninterrupted party for stocks, we do start to wonder just how bad the hangover is going to be…
Chart 1: Liquidity conditions and risk asset prices
YoY% change in developed equities vs cash relative performance (left) Global excess liquidity (right, deviation from trend, led 1 year) Source: Bloomberg, Shiller, Deltec
Defined returns
If stock market returns might be harder to come by going forward, then we think defined returns investments look attractive by comparison. For example, on 2 December 2014 we set up a defined returns product with Barclays when the FTSE 100 was 6,742. The product promised to pay a return of 9.15% should the FTSE be at or above 6,742 on the first anniversary date. It did not need to go up substantially, only to not go down. The product terms also meant that, should the FTSE be down over the first year it would roll onto the second anniversary, where the potential return would now be 18.3% (9.15% x 2).
On the first two anniversary dates in 2015 and 2016 the FTSE 100 was below its starting level. In fact, the last anniversary was one of only two days after September 2016 that the index had been below 6,742! Despite our disappointment last year, the product has now kicked out on the third anniversary providing a return of 27.45% from launch (9.15% x 3). Over the same period, the FTSE 100 index is up 22.3% including dividends and so the product has been very successful by comparison. We’ve decided to reinvest the proceeds into a similar product, this time with Societe Generale. This was set up on 6 December 2017 when the FTSE was at 7,348
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter December 2017
and will potentially return 9.5% should the market be the same or higher in a year’s time. This new product works in exactly the same way as the Barclays one, so if the market is down over one year it rolls on to the second year when the potential return is 19% (9.5% x 2). There are in fact six chances to receive this return with the potential gain increasing by 9.5% for each year.
The product is also subject to credit risk and if Societe Generale went bust investors could lose 100% of their capital. As a result we limit the amount of the portfolio we invest in such products. If you would like more information on how these products work, please get in touch with your usual Equilibrium contact.
The product was launched at £1 per share. If the FTSE is never higher than the starting level on any of the first six anniversaries, then it will end and investors will receive back £1 per share. However, if the market is down by 40% or more on that specific day then investors would lose money proportionally to the drop in the index. For example, if the FTSE was down 45% investors would lose 45%.
Fund facts
The first of our monthly fund factsheets are now available by visiting www.eqllp.co.uk/your-money/ investments/funds. These show the position of each of the funds at the end of each month. Unlike most funds, our factsheets show you all the holdings rather than just the top 10. We will also produce quarterly reports showing what positions are working well or not so well, and how this has impacted on performance.
on how the funds are operating. We have therefore also set up a feed on our website which shows the up to date position of each fund so you can see how it changes on a daily basis if you wish. We’d like to take the opportunity to wish everyone a happy Christmas and a prosperous New Year!
As always, we want to be open and transparent and provide clients with as much information as they wish
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter December 2017
General Economic Overview The global economy is still seeing robust growth in most regions. The UK has underperformed this year, partly due to the impact of inflation from the weak pound. Inflation is probably near its peak and is likely to fall back unless there is a further drop in the value of the pound. The Bank of England recently increased rates from 0.25% to 0.5%. We think it unlikely that they will make further increases any time soon. However, the US is likely to continue putting rates up as well as continuing to slowly unwind quantitative easing. Asset class key + =
positive negative neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class Equity Markets Most western equity markets look expensive in our view. We think there is better value in Asia and Japan where markets look somewhat cheaper and earnings growth has been robust.
Score
-5
Fixed Interest Fixed interest tends to underperform when interest rates go up. Although we think it unlikely we will see another rate rise soon this is a risk to be aware of. We continue to prefer corporate bonds to government bonds but also hold some index linked gilts as a hedge against further inflation.
-4
Commercial Property The latest property indicators show a potential pick up in rental growth and investment enquiries, which is feeding through into prices. We are still avoiding London which is reliant on overseas buyers who could be hit by proposed changes to capital gains tax.
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 (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire SK9 3ND. Both companies are registered in England and Wales.