Investment Newsletter July 2016
It’s a mad world... Mike Deverell Investment Manager
A lot has happened in the last month or so since the EU referendum! In that time we have seen terrorist attacks and attempted coups, a change of prime minister and an entirely new cabinet. In the investment world, we have seen the FTSE 100 drop substantially from 6,338 at close on 23 June to as low as 5,788 intraday on 24 June – a fall of 8.7%. We have subsequently seen it bounce back markedly to 6,705 at close on 18 July. That makes the index 5.8% higher than before the referendum and 15.8% above the low after the result. The FTSE 100 has benefited from the fall in Sterling, with much of the revenues of the top 100 companies being generated overseas. Meanwhile, the more
domestic focused FTSE 250 remained down 2.5% at close on 19 July compared to where it was before the vote. We have also seen property funds close their doors to redemptions and apply big mark downs on the value of their buildings. Gilt yields have hit a new record low and the Bank of England has hinted that they will drop interest rates at their next Monetary Policy Committee meeting. It has therefore been a busy time in June and July adjusting your portfolios to the new post-referendum world. Below are some of the changes we have made to a typical portfolio just in the last two months: • Reduced exposure to UK domestic stocks prior to the referendum
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 July 2016
• Reduced property exposure pre-referendum • Sold all remaining property funds straight after the result • Bought index linked gilts in expectation of higher inflation due to the falling pound • Topped up fixed interest and alternative equity • Sold some defined returns In general, the market thinks the UK economy is likely to slow down as a result of the Brexit vote. Commercial property and more domestic-focused shares are areas particularly vulnerable to slowing growth. Chart 1 shows the consensus view of various economists for future GDP growth in the UK. As you can see, predicted growth levels were being marked down even before the referendum, but since then there has been a big move. In particular, the consensus for 2017 growth has dropped from 2.1% before the referendum to just 0.3% now. Chart 1: Leading forcasters cut UK’s 2016 and 2017 GDP growth projections drastically in wake of referendum
However, whilst many people believe the economy will slow, to date there is little evidence to support this as there have been very few data releases since the referendum. What we have seen are a few sentiment surveys. In particular, the latest survey from the Centre for Economic and Business Research, together with YouGov, shows a marked drop in business confidence. Chart 2 shows how business leaders believe that sales, exports and investment is likely to be lower than they had thought before the referendum. The last category, capital investment, is perhaps the most telling. Businesses are saying they are less likely to invest in new projects or equipment than they had previously planned, as a result of the uncertainty. This is a typical response to uncertainty and can bring about a kind of “self-fulfilling prophecy”. Businesses and individuals worry about a recession and put off spending as a result. This in itself can cause a slowdown. We hope that any slowdown will be mild and short lived, and the economy will rebound once we have a bit more of an idea of what the future will look like. In the meantime, we will manage your investments in a relatively cautious manner, aware of possible pitfalls but also on the lookout for opportunities.
Chart 2: Brexit: Business expectations for sales, exports and investments slashed Values: <100 point to contraction. >100 point to growth. Axis 100
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 July 2016
Defined returns
At the time of writing, we are waiting to see if the Morgan Stanley defined returns product kicks out. The product began on 22 July 2015 when the FTSE was 6,667. If the FTSE is above that level at close on 22 July 2016, then the product will end and give a 9.7% return. Should the FTSE not be above that level, then the product will roll on for another year and the same test will be applied. If the market is then above the starting level, the product will give a return of 9.7 x 2 = 19.4%. There are six potential chances to get this return. As I write the market is hovering around the 6,700 mark so there’s a pretty good chance of kickout, though it still might not. These products can be traded on the secondary market on any day. The product was launched at £1 per share and if the product kicks out in the first anniversary the price will then be £1.097 per share. However, if it does not kick out we believe the price will drop back to perhaps £1.03 to £1.04 per share.
Because of this very much “binary” outcome, we decided to hedge our bets and sell some of the product early. Generally, we sold half of client holdings in the security at around £1.073 or a 7.3% gain on the starting level. Should the product kick out later today then the average gain will be around 8.5%. This is giving up some potential gain but we think this would be a good return in the current environment with markets essentially having gone nowhere over 12 months. It also protects portfolios against the possibility of the price dropping back substantially. We await to see whether the FTSE is above 6,667 at today’s close. If it is and the product kicks out, we are already planning reinvestment options and will of course communicate these in a future bulletin or newsletter. If you would like further information about these products and how they work, please get in touch with your usual Equilibrium contact.
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 July 2016
General Economic Overview The outlook for the UK economy looks less rosy than it did prior to the referendum, with economists slashing their forecasts and the early signs are that both consumer and business spending has slowed. The falling pound has given a short term boost to companies that make their earnings overseas, but may also trigger inflation going forward. Despite this, we expect the Bank of England might cut interest rates and possibly carry out more quantitative easing to stimulate the economy. The US economy has rebounded after a weak quarter, raising the possibility of a rate rise. This could cause some problems for the rest of the world, causing the dollar to strengthen which could hurt emerging markets and commodities which are priced in dollars. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets After the referendum vote we have cut our outlook score from -1 last month to -4 this month. Whilst that partly reflects concern about the economic outlook, it is also because markets are now significantly higher. Within equities, Japanese and Asian markets look decent value, with the UK looking quite expensive in our view.
-4
Fixed Interest Given the prospect for low interest rates (or even falling rates) for some time, fixed interest could do reasonably well. The yield that the bonds held by our funds provide looks more attractive relative to cash and gilts and in our view this would more than offset any potential risk of increased defaults in a weaker economy.
-1
Commercial Property Our score for property was already -3 before the referendum, as we could see returns slowing and money flowing out of the sector. After the referendum we put this to -5 in the expectation we could see capital falls. However, the income yield remains attractive and as a result the downturn might be relatively short Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.
-5 -5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest and equity, and hold no 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, 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 Equilibriumâ&#x20AC;&#x2122;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.