Investment Newsletter June 2017
Lacking Confidence?
Mike Deverell Investment Manager
Until recently the UK economy has been doing very well, defying some of the more pessimistic projections around the time of the EU referendum.
Chart 1 shows CPI inflation (orange line) over the past decade compared to wage inflation (grey line). The shaded area is the difference between the two.
However, one of our concerns has been that the sharp fall in the pound over the past 12 months would translate into higher prices in our shops. This could then have a knock-on effect on the economy as people spend more of their earnings on the essentials, leaving little for discretionary spending.
From the financial crisis in 2008 until 2014, real wage growth was negative. We then saw real earnings growth for the next two and a half years, before recently dipping back.
Some recent data releases underline this concern. Inflation figures released this week were higher than many had expected, with CPI at 2.9% and RPI at 3.7%. The following day, wage inflation figures were surprisingly poor, with growth falling to 2.1% including bonuses and 1.7% excluding bonuses. Wages are growing less than prices which means incomes are falling in real terms.
Whilst the economy has performed well over the past couple of years, this chart shows how fragile this can be. Wages have fallen in real terms for close to seven of the past ten years, so some people are substantially worse off in real terms than a decade ago. The consumer is one of the main drivers of economic growth. In fact, since the referendum the strength of the consumer has surprised a few people. Perhaps this was a reaction to the fall in sterling, with people
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 June 2017
hurrying to make purchases before price rises started to feed through. Regardless, the strong retail sales data late last year helped keep the economy buoyant. However, as Chart 2 shows we have recently seen sales growth fall quite sharply, which may be the effect of price rises beginning to bite. This has coincided with a weaker period in the economy, which grew just 0.2% in the first quarter of 2017, down from 0.7% in Q4 of 2016. Given the rising inflation, the Bank of England has been considering whether to put interest rates up. Three members of the Monetary Policy Committee (MPC)
this week voted to increase rates to 0.5%, whilst five voted for them to remain where they are. The MPC is in something of a quandary. Increasing rates might help fight against high inflation, but it would also lead to higher borrowing costs which could hurt those already squeezed by rising prices. The uncertainty as we move into Brexit negotiations is unlikely to help matters, and so it looks like the UK economy may struggle somewhat this year. As a result, we hold less of our portfolios than usual in assets that are sensitive to the UK economy, such as commercial property.
Chart 1:
CPI
Wage growth 2.1
Real Wage growth -0.6
Source: Thomson Reuters Datastream / Equilibrium Investment Team
Chart 2: UK retail sale (exc auto fuel, % YoY)
Latest: 0.60%
Source: The Daily Shot
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 June 2017
Strong and stable
Portfolios have recently enjoyed a boost with the recent kick out of the Credit Suisse defined returns product. This product was set up on 9 June 2015 when the FTSE 100 was at 6,753. The product was designed to produce a 10% per year non-compound return which would be achieved if the market was above 6,753 on any of the first six anniversary dates. The FTSE was down over the first year and so the product did not kick out in June 2016. However, the market subsequently recovered and the product instead kicked out (matured) at the second anniversary of 9 June 2017. Those who bought at outset received a return of 20%. By comparison, over the same period the FTSE 100 was up 11.45% in price terms, or 20.71% assuming dividends reinvested. We have decided to reinvest the funds into a new product with JP Morgan. This was set up on 13 June when the FTSE 100 was at 7,500.44. If the market is at or above 7,500.44 on 13 June 2018 the product will kick out on that date with a return of 8.75%. We are currently in the process of applying the new product to client accounts.
The potential return is lower than the previous product due to the high market levels and low volatility, and as we have chosen the relatively strong and stable JP Morgan over the likes of Credit Suisse. When we buy a defined returns product we are taking on credit risk – in essence it is a loan to the investment bank. In the unlikely event that they default we could lose our investment. Credit Suisse has a credit rating agency rating of BBB+ whilst JP Morgan has a rating of A-. If the FTSE is not above its starting level on any of the first six anniversaries, the product ends and investors receive their money back unless the market is down 40% or more on that date (13 June 2023). If the market is down more than 40% then the loss is equal to the market loss in percentage terms. We acknowledge that such products can seem outwardly complex, so if you would like further information please speak to 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.
Investment Newsletter June 2017
General Economic Overview The global economy continues to grow. That said, some recent economic data out of the US and the UK has been disappointing. The US has increased interest rates for the second time this year. The Bank of England is considering doing the same in the face of higher inflation caused by the weak pound. However, global inflationary forces have waned somewhat with a fall in the oil price and delays in US President Trump’s spending and taxation plans.
Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets Our score is unchanged from last month as we continue to believe that many equity markets are fully or over-valued. In relative terms, our valuation indicators point to better value in markets like Asia including Japan.
-5
Fixed Interest The score is unchanged from last month. We continue to hold some index-linked gilts given the higher inflation picture but otherwise we prefer corporate bonds. We are generally positioned towards bonds which have low sensitivity to interest rate movements.
-3
Commercial Property The current growth in the UK economy would indicate very little capital appreciation in commercial property. However, rental yields remain ok. Brexit raises particular issues for the London office market and we are therefore 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.