Investment Update– Spring 2019
- Momentum continues
- Tech Supremacy
- Watching Number 10
- Are we there yet?
The New Year brought with it a fresh wave of optimism. Our last Update indicated that stocks rose early on this year, resulting in the best January for 30 years. That momentum has continued beyond Q1, with US markets now back to the highs of 2018. The UK has also enjoyed a rebound, albeit not quite back to its peak. In this latest run, both equity and bonds have benefitted from softer inflation and signals from the Federal Reserve that interest rate rises are to remain on pause. In fact, the Treasury market is actually pricing two rate cuts, in line with the currently inverted US yield curve. With a strong labour market, we think the Fed will be patient before making any move from here. However, some key officials have indicated that the Fed may be more inclined to allow above trend inflation to make up for previous years where it was below.
It is hard to gauge if President Trump’s political agenda concerning China is wholly focused on his belief that they wish to achieve ‘technological supremacy’. That said, we do appreciate the concerns over security and Intellectual Property rights. Huawei became one of the latest casualties of US policy with firms being banned from trading with them unless they have a Government license. Several other Chinese video surveillance firms may also be blacklisted soon as well.
Amidst the trade tensions, only one thing is clear – policymaker’s lives are a bit more complicated these days. While trade tariffs are inflationary in the short-term, they also risk a slowdown in growth. The former would usually imply ‘rate rises’, the latter ‘rate reductions’. Having potentially already moved rates up too far, a ‘wait & see’ approach seems most appropriate from here. We believe that any escalation in the trade war is more likely to drive rates lower and in line with previous priorities on growth. This is important as many signs still indicate interest rates remain the key influence on markets. Rising interest rates played the biggest part in both the 2018 sell-offs, as well as contributing to the recent rebound following prospects of a change in direction.
Watching Number 10
We cannot overlook the influence of global political events in the short-term, with Brexit also back in the spotlight. Theresa May’s support hit an all-time low following the rejection of her latest ‘new’ deal. The biggest market impact so far has been a slide in the pound, now commonly used as a ‘Brexit barometer’ – with greater weakness being evident during times when a ‘no deal’ or ‘hard Brexit’ appear more likely, such as now.
Theresa May’s resignation could increase the chances of a ‘no deal’ Brexit, not least because approximately two thirds of Conservative Party members (responsible for picking the new leader) think ‘no deal’ is a good idea. As the support for Nigel Farage has just demonstrated, perhaps a ‘Brexiteer PM’ such as Boris Johnson may now be the only way for the Conservatives to win more votes. However, any new leader would still be faced with current party divisions and lack of a majority. Therefore, the risk of a general election cannot be entirely ruled out.
To some extent, the slide in the pound is likely to be factoring in the increased risk of a Labour government – which markets would view negatively, if only off the back of expected tax rises. We feel these risks should be balanced against the increased chances of a second referendum, rather than a new Prime Minister calling a general election and risking becoming the shortest serving PM in history. In that event, one could read into the popularity of the Brexit Party meaning a ‘Brexiteer Win’ would be most likely in a second referendum.
While the news is in the headlines, there is always a danger of markets over-reacting and to some extent, we feel the pound has probably factored in the increased Brexit risks for now. In the long-term, we still see scope for Sterling to grind higher from here and are positioned for this.
In recent years we have reduced exposure to foreign currencies. Therefore, while our portfolios will not lose out from a weaker pound, we will not gain significantly from overseas funds. However, overall, our preference towards UK funds should benefit as internationally-focused, UK-based firms become more competitive and experience improved earnings from their foreign revenues. Our commodity positions will also benefit from being priced in dollars.
Are we there yet?
We expect political factors will contribute to volatility but on the positive front, they should also contain interest rate rises. This may provide a future opportunity to top-up equity positions on market weakness, as valuations become more appealing against dismal savings rates.
With low interest rates, manageable inflation, a low oil price and fair valuations (with the exception of the US) markets may not yet be in overheat. However, risks of slower growth remain amid political uncertainty, fading stimulus and a more challenging environment for company profits with rising wages and trade wars.
A slow-down in earnings could easily be the catalyst for the next downward move, although in reality, equity market falls tend to precede earnings slumps. Ultimately, we need to see growth risks recede for the current upward trend in equities to be sustained. This may be difficult in what has already been a very long economic expansion by historical standards. One in which the growth in earnings have been trending above GDP growth for some time. This cannot be sustained forever since earnings are just one component of GDP. US Earnings (or profits) have grown faster than usual in recent years, as they did in the 1920s and 1990s. They reached their pre-crisis high in 2011 and have since grown more than 50% faster than the average growth rate of 4%.
Mindful that the ‘fixed interest’ alternative to equity still offers little growth potential, we are not reducing equity at present. Instead, we continue to add to value stocks which have been a slight drag on performance and will continue to be if ‘growth’ or even ‘sentiment driven’ investing continues to beat fundamentals-based ‘value’ investing. We keep a close eye on this position maintaining discipline within our strategy as our long-term conviction in value stocks recently hit its highest level.
The details, views and opinions expressed above are KMD’s, can change at any time and are not intended to be advice or a solicitation to make an investment. Professional advice should be sought before acting on any information contained in this document. The value of investments can fall as well as rise and your capital is not guaranteed. Past performance is not a reliable indicator of future performance.