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Investment Update - Summer 2018

Posted on August 10th, 2018


Heating up – Stock markets
After a volatile first quarter most stock markets heated up in the second quarter, much like the climate. While the weather set new records, with the hottest May and hottest day ever recorded in the UK, equities also teetered towards new heights. However, they did not quite make those reached in January, despite global indices rising 8%.

Over the past three months, UK stocks performed strongly correlating nicely with one of the strongest World Cup performances from the England football team for almost 30 years. Yes, it had been that long since we last reached the semi-finals!

Before we read too much into the correlation between stock markets and global sporting tournaments, it is worth noting that Germany had one of the best performing markets, but put in a disappointing show on the field. We also had French shares lagging the wider market, so perhaps there is little in it after all, just as you might expect. Then again, Italy’s stock market had been the worst, with negative returns and, for those readers who don’t follow football, they did not even qualify for this year’s tournament.

World Cup Winners
At a corporate level, there were some real beneficiaries of the World Cup including the pub company Marston’s, International Consolidated Airlines (selling three million tickets for the World Cup) and ITV, whose revenues ballooned by 48%, although admittedly that included a period shared with the hugely popular ‘Love Island’.

Italian Economy
World Cup aside, Italy has been struggling with political uncertainty following the rise to power of the populist party Five Star Movement. Initial threats of leaving the Euro have dissipated, with the majority of the electorate wishing to remain in the Eurozone. However, rather than continued austerity, the new Government is proposing debt forgiveness and increased spending to get the economy moving. This caused Italy’s borrowing costs to spike as investors reduced exposure, worried about the increasing default risks in such a scenario. It also served as a reminder that Europe is likely to remain behind the curve with regard to raising interest rates. The first rise is not expected until next summer, despite President of the European Central Bank Mario Draghi indicating that Quantitative Easing tapering could come to an end at Christmas time.

Dollar Boost
The FTSE 100’s strong performance was helped by a stronger dollar, giving a lift to dollar earners which make up a large proportion of the UK’s top 100 companies. Naturally, US positions also gained from a UK investor perspective based on the exchange rate alone. For the same reason, emerging markets have struggled as many export commodities which, being priced in dollars, have become more expensive. Debt servicing costs are also squeezing developing nations that mostly issue debt denominated in dollars.

Consumer - China
Currency volatility has picked up over the past year and we expect this trend to continue. President Trump’s Trade War talk has been a big factor causing the greenback ($) to strengthen significantly - over 6%. One time tax breaks for corporates repatriating earnings also boosted dollar demand. Even currencies typically pegged to the dollar fell - the Yuan being the most relevant example and with good reason. The proposed tariffs, in total covering $200bn worth of goods, has taken its toll on the Chinese currency.

We expect Yuan weakness to serve as the main tool of defence against such import tariffs. A weaker currency will offset (only) some of the rising cost to overseas buyers, to keep Chinese goods competitive. Otherwise, we expect to see a broad range of responses from exporters, potentially affecting more than just US consumers. To justify higher prices, Chinese firms could innovate or improve the quality of goods. Unfortunately, more likely, the quality of goods could deteriorate, enabling firms to maintain margins at today’s prices or some products may just disappear altogether. In short, there are no ideal outcomes for consumers.

The world economy is still doing well. US consumer confidence is at a 17 year high and unemployment is running at 3.8% - its lowest level since 1969. In the UK, unemployment is also at a low not seen since 1975. This all sounds great, but is still consistent with our well-known cautious stance. When consumers are confident about the future, they are far more prepared to part with their cash, overpay for goods and generally stretch their spending. This is all good for the economy today, but equities, in which we invest, tend to price in what will happen one to two years out, so we are less blinded by today’s rosy picture.

Rates ‘they are a rising’
We are seeing some softening of house prices in the US and in London as well. This may well be a sign that higher interest rates are beginning to bite, as new home sales hit an eight month low in the US. As we have indicated previously, interest rates remain our key focus and although the US kept rates on hold in July, they rose the month before. The third hike of the year is widely anticipated in September with several more rises expected next year. In contrast to Donald Trump’s preference for no interest rate rises, the Federal reserve is intent on following a tighter monetary path which conflicts with the President’s expansionary fiscal policy.

In the UK, markets are discounting any further movements in interest rates for a while, following the rise just announced that took rates from 0.50% to 0.75%. This was widely anticipated, essentially being the delayed rise that had been expected in May.

Central banks recognise inflation risks and are acting accordingly. However, bond markets are signalling that rate rises will be capped at a level much lower than those we became accustomed to over a decade ago. We share this view and, as such, are mindful of the inflation risks it presents over the medium to long-term. For this reason, we maintain our preference for real assets, including infrastructure, property and commodities. We are also conscious that in the short-term, the combination of political uncertainty and tighter monetary policy is likely to contain markets. On this basis, we are identifying opportunities amongst structured investment products that have attractive payoffs in the event markets move sideways or even if they are slightly up or down.

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.

Copyright © 2018 KMD Private Wealth Management, All rights reserved.

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