global markets - arbuthnot latham...global markets april 2017 introduction page 2 market moving...
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Arbuthnot Latham & Co., Limited is wholly owned by Arbuthnot Banking Group PLC with roots extending back to 1833. We have offices in London, the South West, the North West, and Dubai, and provide four core services: Private Banking, Commercial Banking, Investment Management and Wealth Planning.
Our thoughts on
Global MarketsApril 2017
Introduction Page 2
Market Moving Themes Page 4
Around the World Page 10
The Asset Markets Page 12
Our report discusses general developments within global markets over the first quarter of 2017, with a focus on the issues influencing portfolios. Following an economic and market summary, we expand upon a number of themes before concluding with a review of the major asset classes.
Introduction
Economic and Market SummaryA broad overview of developments in the global economy and markets over the past quarter, highlighting our thoughts from a macro perspective.
Market Moving Themes
Global Economic OptimismFollowing the election of Donald Trump and a spike in soft data in the US, the Trump ‘reflation’ trade has become a popular theme amongst our peers, with much of the cause attributed to the new US President. Taking a step back and looking through the trend in global data shows, however, that ‘reflation’ was on the way prior to Trump and attributing this to his election is somewhat misguided.
Brexit BifurcationThe UK equity market has performed well since the Brexit referendum, rising ahead of many investors’ expectations and breaking new records in the new year, but this masks a substantial divergence in performance between international companies listed in the UK and those companies that more appropriately reflect the fortunes of the domestic economy. We discuss the changing fortunes of the UK equity market and what has driven performance against a seemingly poor economic backdrop.
Around the World
A snapshot of the more esoteric financial and economic news that UK investors may have missed over the quarter from around the globe.
The Asset Markets
A Quarterly Review of the Major Asset Classes and OutlookThis section records some of the key data for the major asset classes within portfolios, combined with our outlook for each.
2
Economic and Market Summary
A year ago the developed world was struggling with deflationary pressures, implementing drastic forms of money printing combined with interest rate reductions to create a compensating inflationary force. Today, at last, inflation is rising across developed economies, with the United States now able to raise interest rates (enabled by robust economic growth), and with expectations for two more rate rises in 2017. The UK too has displayed inflationary forces, posting a Consumer Price Index (inflation) figure of 2.3%, above the Bank of England’s target rate of 2%, although growth in our home economy is not at sufficiently comfortable or steady levels for the Bank of England to move interest rates just yet. In Europe too, the tide is turning and negative interest rates may soon be withdrawn.
“Inflation is rising across developed economies, with the United States now able
to raise interest rates.”
Whilst disinflation had been a phenom-enon associated with the post 2007/8 Global Financial Crisis (GFC), deleveraging and bank balance sheet repair and the descending oil price has also been a major factor in reducing goods prices and represented a ‘good’ deflationary force in recent years. Advances in technology, particularly in respect of the ease and speed with which shale oil can be turned on or off to meet demand, now conspire to suggest that the oil price will be range bound (we suspect typically between $40-$60) for many years to come and thus the benefits we have enjoyed are now at an end. This one off ‘windfall’ enabled standards of living to rise as remaining disposable income increased and helped combat concerns that wages have hardly risen over the same period.
But as this vexing problem now takes a back seat, investors are faced with the fallout from the post GFC era.
There is no doubt that Quantitative Easing and Central Bank policy action has resurrected the banking and financial systems to a state of health, necessary to enable developed economies to function properly. However, the methods by which money printing was orchestrated left most of the additional capital swirling around the capital/asset markets, making the asset owners richer. At the same time, central policies aimed at keeping their populations calm through the objective of full employment, aided by free flow of labour within the EU and within the US, have worked too. However, in doing so, there has been a marked decline in productivity in the developed world and wages have barely risen. Demographics (changing workers’ age profile), the dearth of capital investment, a sharp increase in regulatory bureaucracy (particularly in the finance sector), and a related reduced supply of credit (being directed by solvency requirements rather than the most productive use) appear to have all conspired to slow productivity growth.
“There has been a marked decline in productivity in the developed world and wages have barely risen.”
These features explain, in the most part, the rise in populism which I believe will increase in an environment where ‘bad’ inflation is on the rise and wages remain challenged in the absence of productivity improvements. The backlash has been directed at the freedom of labour movement that seemingly generates competition and suppresses wage growth and, by association, at globalisation. But the wave of populism can also be traced to issues of national sovereignty, representation in democracy, immigration, free trade, redistribution of income and anti-corporatism. It has also been influenced by the over burdensome state involvement in the economy and on business and personal freedoms.
StJohn N R Gardner MBA, FCSI, FCII, DipPFS
Head of Investment Management
Global Markets
3
This has already thrown up results in the political arena in the US and UK which financial commentators found surprising, and could do so again in Europe this year and next. The popular narrative has changed from globalisation being associated with opportunity and progress towards being viewed as a threat, and President Trump looks set to reverse some of the policies that had led to rapid globalisation since the 1990s. If implemented, these de-globalisation policies could have a number of effects, such as making global growth slower and/or more volatile, and would have differing impacts on emerging economies depending on whether they have deeply integrated global value chains or are mainly involved in traditional commodity trade or provision.
There are few policy tools to contain voter discontent. The proposed solution, to use fiscal policy to stimulate growth through infrastructure projects, tax and transfer policies to address income inequality and provide benefits and skills training to displaced workers, appears unlikely to work and may indeed worsen the problem due to distrust of government policy. Furthermore, countries with the most discord have the least fiscal capacity. So, it would seem that the de-globalisation agenda is here to stay and to be worked through slowly, during which time global growth will remain subdued.
“Popular narrative has changed from globalisation
being associated with opportunity and progress
to being viewed as a threat.”
Nevertheless, we should take comfort from the fact that the developed world’s financial system is now more robust following its meeting of new stringent capital requirements. It means that lending can now be reallocated to the most productive sectors. The new confidence also brings greater certainty to business decision making. If voters maintain their pressure in rejecting burdensome central policymaking, then businesses can plan with greater assuredness and begin once again to invest for greater profit through efficiency gains.
“Take comfort from the fact that the developed world’s financial system
is now more robust.”
Innovation is still abound, with technological advances gathering pace, each one improving standards of living. The low level of investment should revive once the capital stock adjusts sufficiently or the ongoing technological innovations make investment more profitable. Such technological improvements and investment should help contain inflationary pressures and aid workers’ productivity, allowing them to benefit via rising wages.
“The developed world has borrowed from the future and that this will have a long dampening effect on global growth.”
Indeed, markets have reacted favourably to this gradual emergence from the post GFC firefighting policies, as inflation, interest rates and global growth all look positioned to return towards historical norms. Nevertheless, there is a recognition that the developed world has borrowed from the future and that this will have a long dampening effect on global growth to the extent we should accept lower and more volatile investment returns than those we have become used to.
Your investment team is working hard to analyse all the economic factors to link them to potential market reactions and thus make appropriate decisions in your portfolios to protect capital and provide investment returns within a risk framework we have discussed with you.
Introduction
4
Market Moving Themes
Global Economic Optimism
On March 9th, the President of the European Central Bank, Mario Draghi, famously declared Europe’s victory against deflation. This is another momentous occasion for the charismatic front man of the ECB when we consider that for the majority of 2016 headlines focused on the rising pressure of deflation in developed and emerging economies, as commodity prices tumbled, fears of a Chinese Yuan devaluation intensified and global growth continued to slow. Then ‘The Donald’ won the US Presidential Election and almost overnight all expectations seemed to change, with the overriding theme of late 2016 and 2017 becoming reflation.
Is ‘Trumpflation’ responsible for this change in expectation?
For us, the simple answer is no. For the first time in nearly six years we are seeing synchronised acceleration in developed and emerging market economies. March flash Purchasing Managers’ Index (PMI) numbers for Germany and France produced some of the strongest on record since 2011, with German composite PMI at 57 and French composite PMI at 57.6 (a number above 50 signals expansion).
“For the first time in nearly six years we are seeing
synchronised acceleration in developed and emerging
market economies.”
In emerging markets, China’s exports were 11% higher, in Yuan terms, in the first two months of 2017 than in 2016, and February exports from Taiwan were up 28% compared with 2016, whilst in South Korean exports rose 20%. Finally, global industrial production has shown monthly gains with the three-month annualised rate reaching 5.8% – the strongest since July 2011.
What is driving global investment and production growth?
In the developed world, a key driver remains accommodative monetary policy, as the Fed is very much on a slow normalisation trajectory and despite two subsequent rate hikes, the ‘real’ policy rate (current interest rate less inflation) is still below the ‘neutral’ rate (based on employment levels).
Global Markets
Source: Bloomberg
Jonathan Clatworthy Director, Investment Management
Farah Hertog Investment Managers’ Assistant
Figure 1: Industrial Production, YoY%
5
Fiscal policy both inside and outside of the US is also turning moderately expansionary which should kick start a positive feedback loop of accelerated growth, increased investment and rising inflation. In addition, domestic demand in developed markets has started to increase as corporates and households near the end of the post-crisis deleveraging cycle and are pushing growth forecasts higher.
“The rebound in commodity prices from
their 2016 lows has significantly improved
the investment growth outlook.”
With regard to emerging markets, data shows most economies are moving out of a very tough economic adjustment phase and have experienced significant improvements in macro stability. Current account deficits are narrowing, currencies have become more competitive (following devaluations 2013-2016) and interest rates remain high, giving them scope to relax monetary policy and boost demand further amid the current pick-up. Furthermore, the rebound in commodity prices from their 2016 lows has significantly improved the investment growth outlook for GDP growth in commodity-exporting countries, which make up a significant portion of emerging markets.
It is fair to say that President Trump’s strategy team has recognised that macro-prudential policies, like the Dodd-Frank Act, have put significant constraints on the ability of the financial system to extend credit post the Global Financial Crisis. With Trump looking to roll back provisions of Dodd-Frank and deregulate the financial and other sectors there may be a meaningful shift in banks’ lending capacity, which is likely to support further business and investment growth. However, we feel it is premature to assume this in the economic activity before the policy has even been written, though this does provide additional optimism for the medium-term future.
Market Moving Themes
Source: OECD March 2017 Interim Economic Outlook; OECD November 2016 Economic Outlook database; and OECD calculations.
© Adrian Hancu – Getty
Figure 2: Global GDP Growth
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
2010 2011 2012 2013 2014 2015 2016 2017 2018
Actual Growth Growth in absence of fiscal contribution
Fiscal initiatives contribution
6
Global Purchasing Manager Index
Dec
-14
Jan-
15
Feb-
15
Mar
-15
Apr-1
5
May
-15
Jun-
15
Jul-1
5
Aug-
15
Sep
-15
Oct
-15
Nov
-15
Dec
-15
Jan-
16
Feb-
16
Mar
-16
Apr-1
6
May
-16
Jun-
16
Jul-1
6
Aug-
16
Sep
-16
Oct
-16
Nov
-16
Dec
-16
Jan-
17
Feb-
17
Mar
-17
Global
51.4
51.6
51.9
51.5
50.8
51.1
50.9
50.8
50.5
50.4 51
51
50.7
50.9 50
50.7
50.2
50.1
50.4 51
50.7 51
51.9 52
52.7
52.7 53
53
Developed
52.1
52.3
52.6
52.7
51.9
52.1
51.8
52.1
51.9
51.7
52.6
52.3 52
52.1
50.8
50.9
50.5
50.3
51.2
51.4
51.2
51.5
52.6
52.9
53.7
54.2
54.1
53.9
Emerging
50.7
50.7
51.1 50
49.6
49.8
49.9
49.1
48.6
48.5 49
49.2 49
49.4
48.9
50.2
49.6
49.5
49.2
50.3
50.1
50.3 51
50.7 51
50.8
51.3
51.6
UK52.3
52.4
54.1 54
52.3
52.2
51.5
52.3
51.8
51.3
54.9
52.5
51.3
52.3
50.9
51.2
49.7
50.7
52.5
48.2
53.5
55.2
54.6
53.5 56
55.4
54.5
54.2
US
53.9
53.9
55.1
55.7
54.1 54
53.6
53.8 53
53.1
54.1
52.8
51.2
52.4
51.3
51.5
50.8
50.7
51.3
52.9 52
51.5
53.4
54.1
54.3 55
54.2
53.3
Canada
53.9 51
48.7
48.9 49
49.8
51.3
50.8
49.4
48.6 48
48.6
47.5
49.3
49.4
51.5
52.2
52.1
51.8
51.9
51.1
50.3
51.1
51.5
51.8
53.5
54.7
55.5
Japan 52
52.2
51.6
50.3
49.9
50.9
50.1
51.2
51.7 51
52.4
52.6
52.6
52.3
50.1
49.1
48.2
47.7
48.1
49.3
49.5
50.4
51.4
51.3
52.4
52.7
53.3
52.4
Singapore
49.6
49.9
49.7
49.6
49.4
50.2
50.4
49.7
49.3
48.6
48.9
49.2
49.5 49
48.5
49.4
49.8
49.8
49.6
49.3
49.8
50.1 50
50.2
50.6 51
50.9
51.2
Euro Zone
50.6 51
51
52.2 52
52.2
52.5
52.4
52.3 52
52.3
52.8
53.2
52.3
51.2
51.6
51.7
51.5
52.8 52
51.7
52.6
53.5
53.7
54.9
55.2
55.4
56.2
France
47.5
49.2
47.6
48.8 48
49.4
50.7
49.6
48.3
50.6
50.6
50.6
51.4 50
50.2
49.6 48
48.4
48.3
48.6
48.3
49.7
51.8
51.7
53.5
53.6
52.2
53.3
Germany
51
.2
50
.9
51
.1
52
.8
52
.1
51
.1
51
.9
51
.8
53
.3
52
.3
52
.1
52
.9
53
.2
52
.3
50
.5
50
.7
51
.8
52
.1
54
.5
53
.8
53
.6
54
.3 55
54
.3
55
.6
56
.4
56
.8
58
.3
Italy
48
.4
49
.9
51
.9
53
.3
53
.8
54
.8
54
.1
55
.3
53
.8
52
.7
54
.1
54
.9
55
.6
53
.2
52
.2
53
.5
53
.9
52
.4
53
.5
51
.2
49
.8 51
50
.9
52
.2
53
.2 53
55
55
.7
Spain
53
.8
54
.7
54
.2
54
.3
54
.2
55
.8
54
.5
53
.6
53
.2
51
.7
51
.3
53
.1 53
55
.4
54
.1
53
.4
53
.5
51
.8
52
.2 51
51
52
.3
53
.3
54
.5
55
.3
55
.6
54
.8
53
.9
Brazil
50
.2
50
.7
49
.6
46
.2 46
45
.9
46
.5
47
.2
45
.8 47
44
.1
43
.8
45
.6
47
.4
44
.5 46
42
.6
41
.6
43
.2 46
45
.7 46
46
.3
46
.2
45
.2 44
46
.9
49
.6
Russia
48
.9
47
.6
49
.7
48
.1
48
.9
47
.6
48
.7
48
.3
47
.9
49
.1
50
.2
50
.1
48
.7
49
.8
49
.3
48
.3 48
49
.6
51
.5
49
.5
50
.8
51
.1
52
.4
53
.6
53
.7
54
.7
52
.5
52
.4
India
54
.5
52
.9
51
.2
52
.1
51
.3
52
.6
51
.3
52
.7
52
.3
51
.2
50
.7
50
.3
49
.1
51
.1
51
.1
52
.4
50
.5
50
.7
51
.7
51
.8
52
.6
52
.1
54
.4
52
.3
49
.6
50
.4
50
.7
52
.5
China
49
.6
49
.7
50
.7
49
.6
48
.9
49
.2
49
.4
47
.8
47
.3
47
.2
48
.3
48
.6
48
.2
48
.4 48
49
.7
49
.4
49
.2
48
.6
50
.6 50
50
.1
51
.2
50
.9
51
.9 51
51
.7
51
.2
South Korea 4
9.9
51
.1
51
.1
49
.2
48
.8
47
.8
46
.1
47
.6
47
.9
49
.2
49
.1
49
.1
50
.7
49
.5
48
.7
49
.5 50
50
.1
50
.5
50
.1
48
.6
47
.6 48
48
49
.4 49
49
.2
48
.4
Taiwan 50
51
.7
52
.1 51
49
.2
49
.3
46
.3
47
.1
46
.1
46
.9
47
.8
49
.5
51
.7
50
.6
49
.4
51
.1
49
.7
48
.5
50
.5 51
51
.8
52
.2
52
.7
54
.7
56
.2
55
.6
54
.5
54
.5
Mexico
55
.3
56
.6
54
.4
53
.8
53
.8
53
.3 52
52
.9
52
.4
52
.1 53
53
52
.4
52
.2
53
.1
53
.2
52
.4
53
.6
51
.1
50
.6
50
.9
51
.9
51
.8
51
.1
50
.2
50
.8
50
.6
51
.5
Based on that evidence, one thing seems quite clear: the recent surge in global economic activity is not all down to President Trump. Though his rhetoric may be inflationary, he has yet to be able to effect any policy significant enough to impact the data referenced above. Economic indicators globally are flashing green almost across the board and there are many reasons for optimism which can’t be ignored.
Among all this positivity, it is important to remember that there is some cause for concern. Whilst Q4 2016 was all about the ‘reflation’ trade, as it has come to be known, where assets positively correlated to a rise in inflation have outperformed, in the last month there have been headlines within the investment community of the trade starting to unwind already.
These have quoted such risks as policy uncertainty and the danger of central banks tightening too quickly, which could significantly damage aggregate demand and investor confidence. Further to this, populist victories in European elections could potentially bring about a crisis for the EU adding to the headwinds of protectionist policies around the globe. Finally, a major deceleration in Chinese growth, resulting in a sharp fall in commodity prices and a deterioration in trade, could have a significant impact on GDP growth for the region; this is most notably a concern for emerging markets.
We will of course keep a close eye on these developments, as they are real risks, though we currently see them more as ‘tail’ events. So for now, let us revel in the resurgence of economic optimism.
Market Moving Themes
Source: Bloomberg
7
Brexit Bifurcation
In early January this year the FTSE 100 closed at new highs for a record 10 consecutive days, breaking the prior eight-day record set in the aftermath of Tony Blair’s election in 1997. As it did so, press commentary cited the FTSE’s recovery from its initial jitters on 24th June as evidence of the strength of the UK economy. However, with substantial overseas revenues, a material decline in the value of sterling on a global trade weighted basis and substantial changes to the effective risk-free rate in the United Kingdom, dismantling the contributing factors to UK corporate performance following the referendum is more complicated than the index level belies.
“The largest 100 companies derive upwards of
70% of their revenue from overseas.”
At its heart is a reminder that the UK equity market is far from a perfect measure of the health of the UK economy. Indeed, whilst economic indicators point to a more resilient post-referendum economy than many predicted, and the headline equity market has gone from strength to strength, underlying trends do not necessarily paint such a rosy picture for domestic corporate expectations, with markedly different performance at a sector and company level.
Performance of an equity market can be judged through a myriad number of prisms, but it is perhaps the relationship of GBP sterling to UK equity markets that has been most pronounced in the aftermath of the referendum. The FTSE 100’s new highs coincided with 30-year lows in the value of sterling versus the US dollar and similar moves on a global trade-weighted basis.
This is largely because the UK equity market is one of the most mature of the developed world, attracting companies seeking capital investment and a global investor base across the market capitalisation spectrum. The largest 100 companies derive upwards of 70% of their revenue from overseas, and it is not just a mega cap phenomenon; mid cap companies, traditionally seen as more indicative of the UK economy also derive less than 50% of revenues from the UK on average. Amongst small caps, somewhat surprisingly, UK-based revenues are once again in the minority.
Under a market value weighted index, the UK equity market is arguably therefore a better bellwether of global economic fortunes, comprising a largely international asset base and international revenues, and much of the underlying performance of the market can be attributed to external factors. Accordingly, when the value of sterling falls relative to foreign currencies, the value of the UK’s equity market tends to rise in sterling terms.
Market Moving Themes
Ed Fetherston-Dilke Investment Managers’ Assistant
Figure 3: Weakness in UK Equity Market performance relative to MSCI World shows strong correlation to GBP (Trade Weighted) weakness
70
76
82
88
94
100
106
75
80
85
90
95
100
105
Jan 2016 Apr 2016 Jul 2016 Oct 2016 Jan 2017 Apr 2017
MSCI United Kingdom (GBP) relative to MSCI World (GBP), Indexed, Jan 2015 = 100
GBP Effective Exchange Rate, Indexed, Jan 2016 = 100
Source: Bloomberg
8
The correlation has been particularly stark through 2016, surrounding the referendum and in the immediate aftermath, with investor concerns dominated by the Brexit threat most commonly reflected in currency markets. Figure 3 shows the relative underperformance of the MSCI UK Index versus its global counterpart, measured in sterling terms. Whilst the UK market has performed well in absolute terms, it has been underwhelming relative to global equity markets.
As importantly, the effects have been seen across equity sectors, with price changes in the hours, days and months after the referendum result was announced reflecting sterling’s devaluation rather than idiosyncratic effects on particular industries. Where in the past equity performance has been driven by sector specific effects (for instance, the high number of oil and gas or mining companies in the index relative to the wider economy), the moves post- referendum tended to be more indiscriminate.
Even financial stocks, particularly hard hit in the immediate aftermath, have proved far more resilient than the market first advertised, for whilst initial moves suggested substantial weakness in the likes of Barclays and HSBC, subsequent trading has proved that much of their (predominantly overseas) business will be largely unaffected, and with sterling devalued, command a higher price in sterling terms.
To demonstrate the bifurcation between those companies with predominantly domestic or international revenues, we compiled separate indices from the largest 350 companies in the UK (excluding Investment Companies), splitting out those with non-GBP revenues greater than 75% (according to each company’s most recent reported results) and those with domestic, UK-based revenue greater than 75%. The resulting groups comprised 77 companies with low domestic revenue exposure, and 122 companies with high domestic revenue exposure. These were then weighted according to their market capitalisation, and compared for performance purposes. The results are stark.
Figure 5 shows a substantial divergence between the performance of international companies exposed to currency fluctuations, and those companies that have greater domestic focus. Whilst the basket of international companies has appreciated by a little over 30% since the beginning of 2016, those more domestic names have retreated nearly 10%.
Studying the data more closely, whilst there is substantial volatility and divergence between the two groups around the referendum, it is notable that the divergence begins in early 2016, some four months prior to the referendum.
Market Moving Themes
Source: Bloomberg Figure 4: Sector Performance from pre-referendum close
-11
% -8% -5%
-4% -3%
-3%
-2%
1% 1% 3%
-6% -3
%
2%
0%
17
%
10
% 14
%
13
%
9%
17
%
16
%
7%
13
%
-13
%
26
%
2%
51
%
15
%
16
%
17
%
Financials ConsumerDiscretionary
Utilities Materials EnergyIndustrials Telecoms InformationTechnology
ConsumerStaples
Healthcare
1 day, to 24 June 2016 1 month, to 23rd July 2016 to 31st March 2017
9
In addition, those companies with international revenues have continued to outperform in the period after the referendum, despite the relative stability in the price of sterling – this has been less surprising given the equity market moves seen globally, following recoveries in PMI numbers and the positive reaction to the election of President Donald Trump in the US. However, we can see that domestic UK equities have been left behind.
“The relative under-performance of the more
domestically focused stocks within the UK
equity market reflects the additional risk premium applied by the market.”
We believe that the relative under-performance of the more domestically focused stocks within the UK equity market reflects the additional risk premium applied by the market to those companies which are believed to offer greater risk to investors as the Brexit negotiations come into view. However, where some specific companies are obviously vulnerable given the lack of visibility on trade deals, we have found that others are more positive than initial reactions suggested, and that increasingly the sector correlations seen in the market in past years are likely to break down.
In this environment we find a company-by-company analysis increasingly important in analysing potential investments. Areas of the market that look optically much cheaper than history may in fact reflect a heavy discount because of currency movements alone, and could provide substantial pitfalls against a less benign economic and regulatory backdrop. Similarly, we believe that there are companies that have been substantially discounted despite little exposure to currency fluctuations, whilst retaining the ability to grow through a market cycle.
As an example, we see little value in domestic supermarkets given cost price inflation and poor pricing power – the UK consumer has been used to food price deflation for some years and we do not expect supermarkets to be able to pass on the increases in prices as effectively as past cycles – whilst housebuilders, which had been heavily discounted after the referendum, continue to provide a limited supply of new housing into a structurally supported housing market with long-term demand pressure.
Undoubtedly there remain great uncertainties regarding the UK’s trading relationship with the European Union, and we expect further volatility as details emerge and a deal, in whatever form, appears. The UK’s economic backdrop has a greater level of uncertainty as a result, but we are reassured by the improving longer-term trends for the global economy which should be supportive of UK equities even if the Brexit process provides a greater headwind than is currently expected.
Market Moving Themes
Source: BloombergFigure 5: Performance Comparison (1st Jan 2016 – 31st March 2017)
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Index: Low Domestic Exposure Index: High Domestic Exposure
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Sierra Leone Shining Brightly
The 13th largest diamond ever discovered was found in Sierra Leone’s eastern Kono district. Weighing 709 carats (142g), it was unearthed by a Pastor who in turn handed it to the President to sell on behalf of the nation. It is unknown as yet how potentially valuable the diamond could be, as much depends on its quality and whether any ‘flaws’ exist within it, however last year an 813-carat stone sold in London for €63m. Diamonds accounted for 22% of total exports from the country in 2015, worth around $119m, however significant problems remain around smuggling and corruption.
Around the World
Global Markets
10 11
Around the World
Japan Ruling Party
The ruling Japanese Liberal Democrat Party (LDP) approved a change in its rules that allows its leader and current Prime Minister, Shinzo Abe, to run for a third consecutive three-year term when his current one expires next year. If he is still Prime Minister in August 2020, he would become Japan’s longest-serving leader since 1945. A period of stability was overdue, given that in the six years prior to him ascending to power, there had been six leaders in as many years. He is currently fighting a scandal regarding his wife and her alleged donation to a nationalist-style school involved in a shady land deal, which his Defence Minister is also embroiled in.
Win for Modi
In March, Indian Prime Minister Modi celebrated a huge win with the BJP in the 2017 Indian Assembly Elections in the politically important state of Uttar Pradesh. This victory gives the party the greatest majority since 1977, and makes Modi the most popular leader since former Prime Minister, Indira Gandhi. The result demonstrates support for the BJP’s reformist policies which include inflation control, measures for anti-corruption and healthcare reform amongst others. This momentum increases the chances of Modi’s re-election in 2019, and enables him to push on more aggressively with the party’s political agenda.
Trump and the Dakota Pipeline
The Standing Rock Sioux Tribe, along with thousands of other protestors who have been demonstrating against the building of the Dakota Access Pipeline, suffered a setback as President Trump gave the project a conditional go-ahead. The pipeline, which was originally put on hold by the Obama administration, will pass oil from Canadian tar sands through North Dakota to US refineries on the Gulf Coast. The fear is that any leaks could threaten the drinking water for the inhabitants of the area as well as endangering sacred historic artefacts. Going forward, the conditions upon which the project can continue are to be debated, and in opposition to Canada, President Trump’s initial view is that the US should build the pipes. Notably, this condition relates to business, as opposed to the environmental aspect of the issue.
Dutch Elections
European populism seemed to lose momentum in the March 15th Dutch elections, as Geert Wilders and the right wing PVV party (Party for Freedom) only managed to gain five seats. Mark Rutte, leader of the centre-right VDD (People’s Party for Freedom and Democracy) was strong at the polls, but lost 8 seats. The VDD remains the largest party, meaning Rutte is expected to continue as Prime Minister. Rutte’s strength at the ballots was likely to be a result of his tough stance against the Turkish president, Tayyip Erdogan, in the run up to the vote. As with the fragmented nature of Dutch politics, it will be some time before a final government is formed. The seven largest parties have already refused to enter into a coalition with Wilders’s PVV, so we can discount them from the outset.
Further Greek Economic Issues
Poor economic performance in Greece continues to worry investors as the EU and IMF remain at loggerheads over the stricken country’s enormous debt problems. The IMF is demanding a significant debt relief program from a very reluctant EU in order to take a full role, alongside the EU, in the next tranche of cash for Greece, which needs to pay €7bn of payments in July; something which is demanded by the Dutch and German parliaments. Debt is still at just under 180% of GDP, and with unemployment at 23%, the IMF remains very pessimistic about the Greek economy, saying, “Greece cannot grow out of its debt problem”. Growth remains incredibly fragile, with GDP shrinking 0.4% (-1.4% year-on-year) in Q4 of 2016 – much worse than previous estimates.
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The Asset Markets
A Quarterly Review of the Major Asset ClassesAll data sourced from Bloomberg unless stated otherwise.
Developed Market Equity
Performance: US equities continued their post-Trump rally into 2017, rising steadily after his inauguration on 20th January; the S&P 500 closed out the quarter approximately 6.1% higher. Smaller US businesses, as represented by the Russell 2000, lagged large cap peers by 4.6% through the period; despite this smaller companies still remain approximately 5% ahead of larger companies since the election in November.
European equities have continued their strong run following their US counterparts, tempered by risks surrounding the French Presidential Election, though we have seen minimal volatility with the favourite, Emmanuel Macron, showing a substantial lead in polls.
UK equities performed well also, with the broad index rising by 4% in the quarter, following global markets in the wake of expectations of increased inflation in the US and further afield. Smaller companies tended to outperform. Sterling strengthened marginally over the period against a weaker US dollar, pushing up towards 1.26 at the quarter end, but was flat against the euro at 1.175.
Japanese equities have lagged global peers, remaining flat over the quarter following a sharp improvement in Q4 2016, however unhedged investors have been buoyed by the strength of the yen, which has gained almost 3.5% versus sterling, and over 4.5% against the US dollar in the quarter.
Valuations: As we have communicated on multiple occasions in the past, US stock valuations are above historic averages and currently the S&P 500 trades at nearly 22x the trailing 12 months’
earnings; however, if future growth can justify the elevated valuations then investors need not panic. Continuing the trend set in the prior quarter, reported earnings for the period Q4 2016 for the largest US companies grew 5% on the previous year; encouragingly sales grew at approximately the same pace. Earnings are projected to increase by approximately 8.7% during Q1, which, although encouraging, reflects a tempering in analyst expectations which had forecast double digit growth for the period only three months earlier.
European equities are priced relatively cheaply compared to their US counterparts, in part down to sector differences and a greater exposure to financial stocks that remain relatively depressed. However, median P/E levels are deemed to be more attractive and so have seen inflows over the quarter as investors look beyond President Trump’s effects on US markets. EPFR showed that European equity managers received $1.5bn in the week of March 29, which was the largest weekly addition in more than a year.
In the UK, valuation metrics have been distorted by the material moves in the price of sterling following the referendum result, though in aggregate terms remain supportive relative to other developed equity markets, and should be seen through the prism of a devalued currency. Important dispersion exists between domestic and internationally exposed companies, however recent M&A activity points to a perception that the UK market, particularly those companies that may be less affected by the Brexit negotiations, is cheap relative to global peers.
In Japan we have seen a large rotation in the equity market away from the more expensive defensive stocks, and towards the relatively
Global Markets
Total Return % Change, Local Currency
3 month % change 6 month % change 12 month % change
MSCI United Kingdom +2.7% +6.1% +18.6%MSCI USA +5.7% +8.9% +15.0%MSCI Europe ex UK +6.4% +13.0% +14.9%MSCI Japan -1.0% +13.8% +11.4%
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The Asset Markets
cheaper cyclical names since mid-2016. Whilst this gyration has left the broad market’s price-to-earnings ratio fairly stable around 14x, we have seen some of the more extravagant valuations at sector level moderate somewhat away from their extremes. Opportunities remain, particularly amongst domestic value companies, relative to global peers.
Outlook: In the US, expectations for higher earnings growth mean that the P/E ratio for the next 12 months stands at a palatable, albeit still lofty, 18x. If Trump is successful in converting his pro-growth policies, investors should be sufficiently compensated, but if early tensions between the White House and Congress persist and the initial failure in efforts to repeal the Affordable Care Act are a reflection of things to come then we can expect analysts to downgrade earnings expectations. For the time being, we remain neutrally positioned in US equities, hopeful that companies may continue their recent earnings growth trajectory, yet anxious that Trump may have overpromised and is set to underdeliver.
The outlook for European equities is looking increasingly encouraging. A number of indicators suggest the recovery is getting some traction that should benefit European companies. Much will depend on benign political events, and we expect a smooth French election result to be met by a rally in Eurozone assets, before investors turn their attention back to Italy, Germany and the Brexit negotiations. Strong data recently paints a picture of increased economic activity. Improving global growth led by the US and emerging markets will provide decent conditions for further traction in the European recovery.
We believe that much of the outlook for UK equity markets depends on the terms of the UK’s exit of the European Union, both in terms of the value of sterling affecting overseas revenues, and the strength of the domestic economy underpinning more domestically focused businesses.
The strength of domestic retail spending will remain sharply in focus for many. There remain opportunities for businesses that can grow through what will be
a difficult and unpredictable late cycle. Very little is concrete and we expect further volatility at a micro level to rise as negotiations proceed. This is discussed in greater detail in our article on the state of the UK equity market.
In Japan, Abe’s meeting with Trump in February managed to avoid striking any controversial notes. Whilst there were fears of a confrontation over trade and manipulation of the yen, the conversation steered clear of these more combustible issues and focused on more familiar territory. Abe’s position continues to look very secure, and the BoJ maintains its stance that stoking inflation is their key focus, and consequently their policy has been stable in supporting this.
Emerging Market and Asian Equities
Performance: Emerging markets (EMs) broadly have continued to perform well in 2017, defying fears over China, President Trump and the Federal Reserve. The MSCI Emerging Markets index has risen 12.71% in 2017 thus far, compared to a 6.03% growth in the developed market-focused MSCI World index. Global indices including EMs have benefited from some fairly upbeat global Purchasing Manager’s Index (PMI) data, which reflects business sentiment, on the tails of a mooted worldwide economic ‘reflation’. 2017 Earnings-Per-Share (EPS) estimates for EMs, according to JPMorgan, have been revised up by 2% since July 2016 compared to a 2% downgrade for developed markets (DMs) in the same period.
Arguably the greatest tailwind for EMs in the last few months has been both the softening of tone and outright delay in any concrete trade and economy-related measures from the Trump administration. The much-vaunted tariffs and border-adjustment tax (BAT) on US imports, that some feared would hit export-orientated EMs hard, have thus far not materialised.
However, it is prudent to keep monitoring the situation, as the resultant recent inflows into EM assets could be reversed fairly quickly if the consensus turns back towards a free trade-averse
Total Return % Change, Local Currency
3 month % change 6 month % change 12 month % change
MSCI Emerging Market +11.1% +6.1% +14.5%MSCI China +13.2% +5.1% +17.2%MSCI India +11.7% +4.5% +14.6%MSCI Russia -4.6% +12.3% +22.8%MSCI Brazil +9.7% +10.8% +39.0%
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US government, especially as there has been a historical correlation between global trade and the performance of export-orientated countries in, for instance, the Far East.
On a regional basis, Asian ex-Japan and Latin American (LatAm) indices have outperformed Europe, Middle East and Africa (EMEA) in 2017 so far, with both the former rising over 13.5% and EMEA at 5.25%. Although it is accepted that China is no longer capable of the spectacular 8%+ annual growth rates seen in the last two decades, the most recent target of 6.5% communicated by the Chinese National People’s Congress (NPC) was seemingly enough to assuage fears over commodity-dependent South American countries – Chile and Brazil notable risers in Q1. The weaker Mexican peso helped exports in the months following the Trump victory, but has since climbed back to roughly pre-election levels, despite being weak versus a three-year history.
A government stimulus package in Turkey, including macro-potential easing and tax changes, helped performance of the MSCI Turkey index of +14.83% in the first three months of the year, in addition to a more stable lira providing more certainty for foreign investors.
Valuation: As mentioned previously, emerging markets (EMs) have continued to rally in Q1, with the MSCI Emerging Markets index currently valued at around 15.5x earnings, up from just under 14x at the end of last year. Their price to book value has similarly risen from 1.49x at the end of 2016 to 1.68x now. Although some limited convergence has taken place recently between Developed Markets (DMs) and EMs, on a trailing 12 month basis, EMs remain undervalued compared to DMs
– the MSCI World index (comprised of 23 developed economies) is priced at 22x earnings.
If we delve deeper into specific markets, the most expensive emerging economy remains India, with the MSCI India index trading at 22.5x earnings, a 10% rise since the end of last year. Investors were buoyed at the end of February when the reform-minded Narendra Modi, the Prime Minister, won an impressive victory in local elections in the populous northern state of Uttar Pradesh. As a result, the Indian Rupee had its best performance since 1975, rallying 4.7% against the dollar in Q1, with foreign holdings of rupee-denominated debt increasing by 360b rupees (£5.5b) in the same period, and $4.5b worth of funds flowing into Indian equities in March.1
Of the six largest weightings in the MSCI EM Index, only Russia has faltered in Q1, falling to a price-to-earnings ratio (P/E) of 7.14 vs 8.20 at 2016 year end. Brazil is still in recovery mode, with still a long way to go to reach their historic P/E high of nearly 40x at the end of 2015, making a gain of around 9% in Q1, similar to China (14.53x vs 12.81x). Taiwan had a smaller gain of 5% (15.03x vs 14.31x) whereas S. Korea was flat over the period.
Outlook: Three big themes dominate discussions regarding EMs in 2017 – China, President Trump and the Federal Reserve.
As mentioned above, although compared to the previous two decades Chinese growth is forecast to be lower at between 6.5-6.7%, the government is seemingly preparing for this slowdown by increasing fiscal spending up to a deficit of 2%. It is ostensibly making efforts to rebalance away from its corporate investment and debt-fuelled economic model towards one more balanced towards consumption; however corporate de-leveraging has only just scratched the surface of the huge debt levels of around 170% of GDP, a significant proportion of which is in state-owned enterprises (SOEs). A bit more certainty regarding Chinese growth is certainly positive for commodity-dependent emerging economies in South America and parts of Africa, and for potentially picking up some slack from weaker growth elsewhere.
President Trump’s softening rhetoric on global free-trade restrictions have allayed fears for now. However on the flip-side, Trump’s recent failure to get his signature Obamacare-repealing healthcare reform bill through congress has spooked investors who now worry whether the President’s US growth-boosting tactics are realistic. The combination of these two factors could well be positive for EMs, as historically EM markets have outperformed DMs when the growth differential between the two has diverged in favour of EMs.
Regarding the Federal Reserve, there has already been one 0.25% rise in the base rate this year and three more are pencilled in, dependent on economic conditions. This would historically have been harmful for EMs as it meant that not only did it make it more expensive for them to issue and service dollar-denominated debt, but a weaker currency relative to USD raised fears of inflation.
The Asset Markets
1 https://www.bloomberg.com/news/articles/2017-03-31/rupee-set-for-best-1q-since-1975-as-foreigners-pour-12-billion
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The Asset Markets
On a country-specific level however, some significant uncertainties remain. Whilst Russia is coming out of a recession, there are precious few signs that the economic sanctions imposed by the West will be lifted any time soon. Despite some positive signs pointing to higher growth in 2017, perhaps owing to the higher oil price, Q1 consumer data has not been robust and points to still-fragile consumer confidence amidst still-recovering incomes.
Geopolitical tensions also remain a worry around the South China Sea and North Korea. Whilst South Korean exports to China have recovered in the last 18 months, the latter is angered at the installation of a US-designed anti-missile system near Seoul, designed to counter North Korean threats, but which it sees as an intrusion on its territory. The Philippines and China in particular continue to sabre-rattle over Chinese territorial expansion and island-grabbing for military development in international waters, particularly the Spratly Islands 800km south-west of Manila.
It remains to be seen whether the EM rally will continue throughout 2017 with all the above uncertainties; however with some recent estimates declaring GDP growth across EMs to reach 4.4%, up from 4.1% four months ago, investors are cautiously optimistic.
Global Government Bonds
Performance: UK Gilts have made small positive returns in Q1, up around 1.8% on a total returns basis. The yield on benchmark 10 Year Gilts has fallen from as high as 1.5% in late January to the region of 1.1% by the end of March. With the BoE remaining rather quiet in the background, Brexit remains the proverbial elephant in the room for the UK economy. Data has been robust so far but every release is analysed particularly closely by the market for any telling signs as to the health of the UK economy. As a function of Brexit, and the subsequent fall in the pound, Inflation concerns remain a key driver for Gilt traders. As a reflection of this, UK Index Linked Bonds have been bought heavily as protection from this inflationary threat, returning almost 3% on the quarter.
Across the Atlantic in the US, the Treasury market has been broadly flat in terms of total returns. 10 Year Treasury yields have been range-bound between 2.3% as of late February and just over 2.6% in mid-March. This peak was struck just ahead of the 15th March rate hike, where the Federal Reserve moved to increase the Fed Funds rate by 0.25%, up to 1%. Federal Reserve Chair, Janet Yellen, suggested that she saw two more hikes as likely policy for this year, which was not as hawkish an attitude as some had feared. Consequently we saw yields fall off from this point and finish the quarter at around 2.4%.
Looking to Europe, the focus of course has been on the rise of populism and what this could mean for the bloc. Dutch elections eventually passed without incident, and the odds of a Le Pen victory in France have fallen noticeably, however the risks are still present. With this in mind, total returns for broad European Sovereign debt have been slightly negative over the last 3 months, losing almost 1.6%. At an individual country level, German Bunds have been the most resilient, down less than 1%. It has been French and Italian debt that has seen the greatest pain, down 2.1% and 2.3% respectively in Q1.
In summary, the first three months of 2017 have seen some rather subdued performance for the Sovereign Debt sector. In a broadly equity positive, low volatility environment, it’s of no real surprise that the global risk-free rates have been relatively unpopular so far.
Arbuthnot View: As ever, the two key factors that will dictate the future performance for Sovereign Debt will be monetary policy and the global market’s appetite for risk. With regard to monetary policy, the pace at which the Federal Reserve continues to hike rates will be critical for US Treasuries, and in Europe, any tightening of policy will certainly significantly impact European Sovereign Debt. With regard to the UK, Gilts will be dependent on the gradually clearer picture we get over Brexit, and the subsequent impact on the economy. In the wider context, should we see investors’ attitudes become less optimistic in the coming months, it is likely that
Bond Yields % (10 year) 31st March 2017 31st December 2016 30th November 2016United Kingdom 1.14% 1.24% 0.75%Germany 0.33% 0.21% -0.12%France 0.97% 0.68% 0.18%Europe 0.33% 0.20% -0.12%Japan 0.07% 0.04% -0.09%US 2.39% 2.44% 1.59%
1 https://www.bloomberg.com/news/articles/2017-03-31/rupee-set-for-best-1q-since-1975-as-foreigners-pour-12-billion
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Sovereign Debt will benefit as they flee risk assets and look to park funds in so called “safe-havens” – however we see no immediate catalyst for a change in market sentiment, and so expect continued muted performance from this asset class.
Global Corporate Bonds
Performance: US Investment Grade (IG) corporate bonds had a relatively good month in January posting returns of 0.4%. Credit spreads were virtually unchanged through the month as many investors sat on the side-line as the new US administration took to office. European IG corporate bonds fared less well, returning -0.6% as the political focus turned from the US to Europe in 2017. Credit spreads tightened in Europe as the ECB’s monthly CSPP purchases reached the highest levels to date. Sterling IG corporate bonds suffered a worse month with a return of -0.9%. Credit spreads remained virtually unchanged for Sterling IG over the month.
High Yield (HY) corporate bonds posted positive returns in January, outperforming both Government and IG corporate bonds. This performance can be seen in the tightening of credit spreads across US, European and Asian High Yield markets; default rates sat at the end of the month at 1.5% to 2.0%.
In February IG corporate bonds posted positive returns across the board, although relative to government bonds their performance was mixed.
US IG bonds outperformed US treasuries but sterling and euro corporate bonds underperformed their respective government bonds. Sterling IG bonds still had a very strong month returning 2.7% only to be outshone by gilts as investors looked for security. US IG corporate bonds returned 1.1% with European IG bonds returning 0.1% more at 1.2%. European US investment grade credit spreads tightened through February influenced by lower issuances and a resilient risk sentiment. In Europe, credit spreads took the opposite route and marginally widened with the uncertainty of the French election weighing concern on the market.
Sterling corporate bond spreads remained the same over the month.
Globally high yield bonds rallied throughout February. Spreads across US, European and Asian high yield became tighter with the combination of low supply, decent earnings and the low real yields investors can gain in government bonds. The US was notably strong in February with all sectors showing positive returns over the month.
March was a mixed month. IG corporate bonds posted varied returns across the different markets. US IG corporate bonds posted negative returns of -0.1% underperforming US Treasuries, European Investment Grade posted negative returns (-0.3%) but outperformed government bonds, whilst Sterling IG returned 0.6% outperforming Gilts. Spreads tightened modestly in Europe following comments from the ECB and encouraging economic data chiefly on GDP growth and inflation. US markets saw raised concerns over Trump’s administration ability or potential lack thereof to enact reforms and calling question on the longevity of the Trump reflation trade.
European HY outperformed US HY in March. The US market suffered due to lowering oil prices, interest rate volatility and policy uncertainty causing spreads to widen. The higher quality bonds outperformed. Europe, the antithesis of the US, saw an improving macro picture lead to credit spreads tightening and a positive return over the month.
Arbuthnot View: Investment grade corporate bonds have returned a solid 1.5% year-to-date, providing a defensive alternative to the more volatile government bond market, with the continued political and policy uncertainty the causation for this increased volatility. There is limited room for spreads to compress in certain regions, and with any good news and positive expectations already being priced in, the risk of disappointment and potential for negative surprises is mounting.
This is particularly apparent in US IG corporate bonds where the challenges that are being faced
The Asset Markets
Corporate Bond Yields % 31st March 2017 31st December 2016 30th November 2016Global Investment Grade 2.73% 2.76% 2.29%US Investment Grade 3.37% 3.42% 2.87%US High Yield 6.21% 6.48% 6.59%Europe Investment Grade 0.90% 0.83% 0.62%Europe High Yield 2.81% 2.87% 2.84%UK Investment Grade 2.46% 2.67% 2.23%
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The Asset Markets
by the Trump administration continue to increase and intensify shining doubt on future issues. Sterling IG credit has shown resilience over the quarter despite the political noise. The Bank of England’s Corporate Sector Purchase Programme has been instrumental in supporting the market and capping spreads. Now that Article 50 has been triggered, and with the CSPP now close to its GBP 10bn limit, the downside is increasing whilst the upside is somewhat diminishing. European IG markets have benefited their investors as a defensive alternative to the volatility present in government bond markets as political uncertainty rises. The ECB is likely to remain engaged in the European fixed income markets, potentially more than some believe. This support provided by the ECB should cap yields and spreads in the coming months.
High Yield credit markets have been riding on the wave of promises by the Trump administration and have been pricing in an optimistic outlook for growth and defaults. Hard data confirming whether these promises will be delivered is yet to be seen, leaving investors with a binary outcome ahead. As well as this, we now face an environment where central banks are starting to remove stimulus, something that markets may not be fully prepared for. US HY markets remain very sensitive to drawdowns in oil markets, although the US HY energy issuers have become more resilient – a consequence of last year’s forced deleveraging. Trump’s protectionist manifesto is now coming into play while uncertainty around the long-awaited tax return remains. With spreads at 380bp and implied defaults back below 1.5%, the risk-reward proposition is less attractive than it has been over the last few months with plenty of good news already priced in. European HY has been stable despite volatile European government bonds, and continues to act as a safe haven within the Global HY universe.
On a relative basis yields in European HY are not as compelling as in other regional HY markets. The outlook for defaults remains benign and the ECB is unlikely to remove its policy support as inflation gradually slows in the second half of the year.
Property
Performance: UK Commercial Property continued to show reliance into 2017 despite lingering fears associated with Brexit. Industrial assets were the strongest performer at a sector level, delivering a total return of 4.0% in the three months to February
according to CBRE; this was despite manufacturing PMI indicators beginning to tail off from 55.7 in January to 54.6 in February. Retail and Office Sectors lagged behind, just hitting the 2.0% total return mark. Retail Sales have started to exhibit weakness as inflation begins to hit the consumer’s pocket: the retailer’s response has been to focus on core shopping destinations, a trend that is likely to accelerate when business rates revaluation comes into effect in April. City and West End Office rents in London have fallen off their peak in H1 2016, and prospective tenants enjoy leverage in lease negotiations, often achieving extended rent-free periods. Regional offices have almost ignored the political risks around the property market, instead benefiting from a supply/demand imbalance with redevelopment attracting a larger tenant base.
Valuation: Yields across all sub-sectors remained fairly static, apart from London City offices which moved from 4.25% to 4.00% thanks to strong overseas buying interest and a weakness in rents. Trading volumes were markedly higher versus this time last year with a total of £7.2 billion transacted in February to mid-March (Property Data), anchored by the sale of the iconic ‘Cheesegrater’ – 122 Leadenhall in London – to a Chinese Investor, CC Land, for £1.15 billion. Overseas capital has accounted for 57% of all transactions so far in 2017.
Outlook: Despite some blockbuster transactions in the market, the volume of deals is still weak with the majority of investors taking a ‘wait and see’ approach. The current lack of liquidity in stock will support capital values unless the occupational market begins to weigh further on rental values, especially as income is viewed as the prime driver of returns going forward. Return profiles on UK Commercial Property are still attractive versus other asset classes with a significant amount of capital still waiting to be deployed from overseas.
The listed REIT sector has produced good earnings figures, forcing many participants to revise up forecasts. Developments have been pushed back in order to reduce supply to the market whilst increased risk premiums will halt any significant activity until further clarity on the shape of the labour market outside of the EU is clear.
Hedge Funds
Most hedge fund strategies performed well through the first quarter, following good returns in Q4 on the heels of the US elections. Equity long short strategies
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Important Information:
The information given in this document is for information purposes only and is not a solicitation, or an offer to buy or sell any security. It does not constitute investment, legal, accounting or tax advice, or a representation that any investment or service is suitable or appropriate to your individual circumstances. You should seek professional advice before making any investment decision.
The value of investments and the income from them can fall as well as rise. An investor may not get back the amount of money invested. Past performance is not a guide to future performance. Fluctuations in exchange rates may affect the sterling value and any returns from investments. The facts and opinions expressed are those of the author of the document as of the date of writing and are liable to change without notice. We do not make any representations as to the accuracy or completeness of the material and do not accept liability for any loss arising from the use hereof. We are under no obligation to ensure that updates to the document are brought to the attention of any recipient of this material.
Please note that this commentary may not be reproduced, distributed, disseminated, broadcasted, sold, published or circulated without prior consent from Arbuthnot Latham & Co., Limited.
have been one of the top performers through Q1 as the dispersion between stocks has increased, and individual stock performance has been driven more by earnings, as opposed to sentiment. Poorer performers have included CTAs (Commodity Trading Advisors) where clear trends in the market have been short lived, making it difficult for these strategies to capture. This is particularly evident in the commodity sector, which has been volatile and sideways moving, with a bias to the downside. Macro strategies have generally performed well in spite of a reversal in the ‘trump reflation’ trade and have been nimble to foresee changes in global FX and bond yields (which have paused in their ascent). Finally, with a flurry of merger deals going through, event-driven strategies have performed well also, as although the premium on deals has narrowed, so has the frequency of deal breaks.
Commodities
The Bloomberg Commodity Index returned -0.8% in the first quarter of 2017.
Crude oil prices in January and February were rather stable, trading within the $52-$55 range as initial data showed compliance by OPEC to production cuts at over 100%. March however was an extremely volatile month for oil prices. WTI reached its highest level since July 2015, hitting $56.37 before quickly tumbling to a 2017 low of $47.70. This was driven by persistent concerns of rising US inventory data, which has been the major contributor to the deterioration in sentiment as suggestions of a supply glut persisting in the face of OPECs production emerged. However, prices rebounded a week later as renewed fighting in Libya disrupted production, positive economic data out of Europe and globally boosted prospects for healthier oil demand, and speculation that OPEC members will extend their output cuts
beyond the June deadline increased. WTI closed the quarter back above $50 bbl. It is important to remember that the global rebalancing process is a complicated one and whilst we expect US production to be supported by higher prices the energy market looks set to move into deficit in the second half of the year, if not sooner, regardless. Nonetheless, expect to see some volatility along the way.
Precious metals started the year trading in a very similar way as they did at the start of 2016. Following significant pricing pressure in the lead up to the December rate hike, gold prices rallied after and returned circa 8.9% in the first quarter. Similarly, prices declined in the first half of March on expectations of a rate hike but rallied in the event as US real yields fell. A weaker US dollar, from continued uncertainty over President Trump’s economic policies and ability to implement his legislative agenda, will continue to be supportive for precious metals.
Base metals continued their post-Trump rally; copper and aluminium returned 5.46% and 15.9% respectively, but prices were volatile. Copper dipped in March on reports of somewhat weaker unofficial China manufacturing PMI data and as strikes in Chile’s Escondida mine came to an end. In contrast, aluminium rallied to reach a two year high as the Chinese government called for 28 northern cities to reduce aluminium capacity by 30%. Iron ore prices have been the most volatile as concerns about demand resurfaced and Chinese stocks reached record levels. Base metals continue to trade on supply and demand fundamentals, and whilst a stronger dollar has always been a headwind for commodities, a faster Fed tightening cycle in response to stronger economic activity and inflationary pressures need not act as a drag on base metal prices.
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April 2017
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