Investment Newsletter February 2017
Making Wall Street “Great Again” It’s quiet out there. Perhaps too quiet? From reading the news you might conclude it is a relatively volatile time in world affairs, especially since President Trump took office and began to make his mark. The new executive seems likely to be very different to the previous administration in all sorts of ways, and some of their policies will affect various companies and sectors dramatically. Some of this will be positive, some may well be quite negative.
Mike Deverell Investment Manager
However, this uncertainty and volatility is not present in markets right now. At the time of writing there has been a record 41 days without a 1% intraday move on the S&P 500. The previous record was 34 days, as seen in Chart 1 which goes back to 1962. After a surge late last year, markets have become much flatter recently. The trend is still positive but each daily
movement is now much smaller. It is almost as if we are in “wait and see” mode. Low volatility might seem desirable, however it can also be seen as a sign of complacency in the market. Economic theory suggests that the longer a period of stability, the sharper the instability that follows. Investors begin to assume that the low volatility will continue indefinitely and begin to take on more risk. The longer we go without a sharp pull back, the more investors believe the more optimistic predictions and the less attention they pay to any less positive evidence. Periods of very low volatility in markets therefore tend to precede much sharper moves. Markets won’t remain this calm forever but we wait to see what will be the catalyst for change and whether that catalyst is positive or negative for markets.
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 February 2017
Chart 1: S&P - Number of consecutive trading days without a 1% intraday move (1962 - 2017)
Source: Source: @CharlieBilello, Pension Partners
Short and sweet
A few weeks ago I finally got around to watching The Big Short, Adam McKay’s excellent 2015 film based on Michael Lewis’s book about the financial crisis. This examines the build up to the housing bubble and the wide mis-selling of mortgage related securities which caused the crash. It also follows the story of some of the people who saw it coming. Right at the end of the film the narrator reads the following lines: In the years that followed, hundreds of bankers and ratingagency executives went to jail. The SCC was completely overhauled, and Congress had no choice but to break up the big banks and regulate the mortgage and derivative industries. Just kidding! Banks took the money the American people gave them, and used it to pay themselves huge bonuses, and lobby the Congress to kill big reform. And then they blamed immigrants and poor people, and this time even teachers! And when all was said and done, only one single banker went to jail. These lines have come to my mind several times over the past few weeks when reading the news from across the pond, not least when we consider the Trump administration’s planned reform of banking regulation. After the financial crisis, the US enacted a piece of regulation called Dodd-Frank, named after the congressmen who proposed it. This legislation was designed to stop a repeat of the financial crisis by forcing banks to hold more capital and to take less risk with it. Essentially, the idea is that any losses from a similar crisis in the future should be smaller, and banks should have sufficient capital to deal with them.
Critics argue it is a flawed and complicated piece of legislation that requires reform. Some argue that it curtails bank lending which in turn hurts the US economy. Others dispute this, pointing to figures showing healthy levels of lending and little evidence of credit demand exceeding supply. Despite some legitimate criticisms, few would argue that legislation to control the systemic risk in the banking system is not a good idea. The Big Short reminds us just how close the world’s financial system came to collapse as highly geared banks had to be bailed out by governments. Nobody wants to see that again. The man tasked by President Trump to review banking legislation is Gary Cohn, formerly Chief Operation Officer and President at Goldman Sachs. Mr Cohn has just received a payout in cash and shares from his former employer of $285m. Goldmans brought forward this award, which was due over the next few year, and paid out prior to Cohn’s appointment as director of the National Economic Council. Paying it prior to appointment is supposed to avoid any conflict of interest. Cohn is a known critic of the Dodd-Frank act, and there is no doubt that the big banks would be pleased with its demise. The share prices of all major banks have gone up since Trump’s appointment, partly on rising interest rates but partly because of the potential relaxation of regulation. Goldman Sachs has just hit a new record high, finally surpassing the 2007 level it achieved before the great crash. Whilst the media has focused on Trump’s dealings with Russia and his actions on immigration, it is his actions on regulation, as well as on trade, which could be bigger issues for investors in the long run.
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 February 2017
General Economic Overview The global economy continues to perform well with relatively robust growth in all major regions. Given the anticipation of increased fiscal spending in the US in particular, expectations of higher growth and inflation are now being priced into markets. It looks likely that the US Federal Reserve will put up interest rates at least two more times this year. The weakness of Sterling is adding to inflationary pressures in the UK which may force the Bank of England to increase rates back to 0.5%, but they are unlikely to go much higher.
Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets We hold our score at -5, which means we expect returns over the next 18 months to be significantly below the long term expected return on equities of 10% pa. Valuations look stretched in many regions but in areas like Asia including Japan there remains some value.
-5
Fixed Interest The rise in rates of inflation in many developed economies and the Federal Reserve’s outlook for higher interest rates provide a challenging backdrop for bonds. Our score is unchanged at -3 since last month. We continue to hold some index-linked gilts but otherwise prefer corporate bonds.
-3
Commercial Property Our score for property remains unchanged from last month as property yields remain attractive but there will be little in the way of capital growth. We believe there are particular issues in the London office market and therefore are avoiding this part of the market.
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.