Market commentaries

Below you will find our latest set of Monthly Market Commentaries covering a summary of the major investment markets and their respective returns within the period covered.
Please click on the headings below to download.

Market Commentary November 2018

Brexit deal agreed

UK equities ended the month slightly lower, and Sterling was little changed after Theresa May agreed a Brexit deal with the other EU leaders. The deal was widely expected, and the big question remains whether she will be able to get the deal ratified by the UK Parliament. This seems unlikely, and the likelihood of no deal or a second vote is increasing.

Malaise continues in European equities

Angela Merkel’s domestic political worries, the Italian budget issue and tensions with Hungary, as well as worsening economic data, saw European equities mostly lower in November. Peripheral and emerging markets generally performed well, but the major markets saw falls of 1-2%. Bond yields generally settled and buyers continued to be active in French, German and ECB issues.

Oil stocks down as WTI falls by more than 20%

Oil shares, which feature in many income portfolios, were hit during November as the price of oil fell by 22% during the month. President Trump has been keen to talk down the oil price, urging Saudi Arabia to allow it to go lower. WTI crude peaked at just over $76/barrel in October, but since then, has reached just $50, as producers have relaxed supply curbs to counteract the renewed sanctions on Iran.

Emerging Markets rally on G20 optimism

The G20 meeting at the end of the month was widely anticipated and saw President Trump and Xi Jinping meet face to face, with the result that the US agreed to suspend additional tariffs for 90 days to allow negotiations on a trade deal. Emerging markets rose and the Dollar fell by almost 2% against the Yuan.

Sources: Bloomberg, Trading Economics

During November, the North American markets continued to move ahead, though less aggressively than earlier in the year. Japan also saw a modest gain, with the UK and EU returning losses. Overall, the best performers were the emerging markets, in a reversal of October’s performance, and gains were seen across all continents, as the Dollar paused after its strong performance in 2018. The best return overall came from Turkey, which rose by 12.9% in Sterling terms, whilst India and China also rebounded strongly.

European markets extended their losses from October, although falls were mostly more muted. Returns from the major European markets were mostly small single-digit losses, ranging from -2.0% in Germany, through to +2.1% from Belgium. Emerging and peripheral European markets fared much better on the whole, with Turkey, Poland and Hungary all seeing strong positive returns. German political uncertainty, riots in Paris and, to a lesser extent, Brexit, all weighed heavily on the EU, whilst UK equities fell by a further 1.9% as the Prime Minister faced the prospect of her Brexit deal being rejected by Parliament.

Source: Bloomberg

Sterling was volatile again in November, as Mrs May agreed a Brexit deal with the EU, but faced a growing crisis of confidence in the UK, as Parliament seemed set to reject the deal, leaving open the possibility of a no-deal Brexit. A reasonable mid-term election performance saw the Republicans lose control of the House, but retain the Senate, much as expected, allowing President Trump to claim a good result, and the Dollar remained steady. The Chinese Yuan gained some ground against western currencies as there was no further escalation in the tariff war with the US.

Source: Bloomberg

The flight to safety in Europe saw a continuation of the trend in previous months, as investors moved into French, German and ECB bonds. Italy and Spain also saw their bond yields reduce slightly during the month with the yield on Greek bonds edging slightly higher. US bond yields ticked lower, leading some sensationalizing commentators to predict a full inversion of the yield curve and imminent recession, though the economic data does not support this. Buying support continued for UK debt, as the outlook for rate rises remained weak amid the Brexit-related uncertainty.

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

The Oil Price’s Remarkable Reversal

In a world where many investors have been searching for the positives, the recent remarkable reversal of oil prices offers some good news at least for some investments. The critical question is whether the weakness in oil prices is sustainable. We suspect they are.

One of the remarkable turnarounds in recent months has been the fall from grace of the oil price. From the lofty heights of US$86.74 when oil was up 30%, oil is now in a bear market. At the beginning of October, Brent Crude, the leading price benchmark for over two-thirds of the world’s internationally traded crude oil supplies, hit a near four year high. However, by November WTI oil prices have fallen by more than 30% from their peak.

Chart 1: WTI Oil price

The source of price weakness is multi-faceted.

OPEC now a price influencer, not a price setter.

OPEC no longer has control of a market it used to dominate. OPEC now faces the requirement in their December meeting to think about the need for production cuts. Such cuts would represent yet another reversal of policy. Remember it was only recently that OPEC was under pressure from President Trump to increase production to bring prices down.

Maybe more disconcerting for the oil markets have been mutterings from analysts of a potential break up of OPEC. Indeed, Saudi Arabia even admitted recently that it had asked one of its think tanks to study the possible effects on oil markets of a break up of OPEC. OPEC’s concerns relate to legal opinions in the United States that OPEC might be deemed to be acting as an illegal monopoly and be subject to anti-trust investigation. A few months back the OPEC President wrote to all members asking them to desist from talking about the level of oil prices per se and only allude to the need to minimise the volatility of oil prices. Qatar’s recent decision to quit OPEC only adds to this sense of failing cohesion.

US production continues to climb

The expansion of US oil production has challenged the omnipotence of OPEC’s supremacy in the oil market. US crude oil production has risen to a new peak as shale oil output has continued to climb and the US is now the worlds’ largest producer of crude oil. Also, there are signs that some of the pipeline bottle-necks are starting to be relieved with more pipelines due to come on-line in early 2019. The focus on the crude oil production numbers ignores the steady growth in the US of other sources of oil supply, such as NGL (Natural Gas Liquids), a by-product of shale gas output. This is further additional US oil supply into an already oversupplied market.

Chart 2: US Oil Output Still Rising

Diluted sanctions pose less of a challenge to supply

Although President Trump has talked a tough story on Iranian sanctions, the actual implementation has been relatively muted. Crucially, several countries including India, Italy, Japan, Turkey and South Korea, received temporary six-month waivers allowing them to continue to import Iranian oil. The prospect of a sudden collapse of Iranian export volumes has now evaporated

Positive consequences of the fall in oil price

There have been some immediate winners from the fall in oil prices. Firstly, India as a major oil importer. Delhi petrol pump prices, for example, have fallen 14% in 8 weeks, much to the relief of the local population. Indian asset markets and the rupee have recovered sharply from previous losses. The threat of rises in interest rates to control inflation has abated. Also, some of the political pressure on the government has eased lifting hopes of a win for Narendra Modi in next year’s general election.

Gasoline prices below US$2 at the pump will be of great benefit to the US consumer, as it simply translates into more dollars in the pocket to spend during the festive break. However, the dramatic fall in the WTI price has led to worries in the US high yield bond market, as creditors become concerned about the ability of overleveraged oil fracking companies to repay their debts. The future stability of these companies, in turn, threatens to put jobs at risk and sours local business activity and sentiment.

The fall in the oil price also appears to have taken off some of the pressure for further increases in US interest rates. Although the Fed tries to look through fluctuations in commodity prices and its impact on headline inflation the previous spike had the potential to only reinforce some of the inflationary pressures that had led the Fed to signal they were minded to increasing rates by a further 75bps over the coming 15 months. The sheer size of the US onshore drilling industry and its supply base means that from a total economy perspective, falling oil prices are now more of a mixed blessing.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

Market Commentary October 2018

Global stocks fall, led by US tech giants
The US market fell during the month, with the so-called ‘FAANG’ stocks leading the way. Netflix shares fell by almost 20% on a second quarter of disappointing subscriber growth.

UK markets continue to await clarity on Brexit terms
Rumours of an imminent deal announcement caused volatility in Sterling at various times during the month, though no details have been published. The Irish border appears, from comments, to be the sole issue that is now holding up an agreement.

• Italian budget rebuffed by EU
The proposed Italian budget deficit of 2.4% of GDP was rejected by the European Commission, leading to an increasingly heated debate between Italy’s new government and the EU.

Bank of Japan retains optimistic outlook
The outlook from the Bank of Japan, released on 31 October, remains relatively optimistic. The BoJ sees Japan continuing to grow, amid a virtuous cycle of income and spending growth in both the household and corporate sectors. Inflation expectations were reduced slightly.

Brazil bucks emerging market weakness
The election of Jair Bolsonaro to the presidency of Brazil saw Brazilian stocks rise 10.2% in October (as measured by the BOVESPA in local currency terms). He is perceived to be more market friendly than Fernando Haddad, of the opposition Worker’s Party.

During the month, the best performing major markets were the UK and USA, both of which fell by 4.8% in Sterling terms according to the FTSE Country Indices. Asian markets saw large falls, with Hong Kong being the worst of these, losing 9.7%. Japan was helped by a stronger Yen and fell by only 6.7% in Sterling terms. Emerging markets continued to be weighed down by a strengthening Dollar and among these, Mexico was the largest faller, recording a loss of 15.6%. The exception was Brazil, which rose by 19.8% as the markets warmed to the new President. USA +0.3% +1.

European markets in October extended losses from the previous month, with no market achieving a gain. The core markets, Germany, France and Italy all fell heavily as Angela Merkel resigned as leader of the CDU but remained as Chancellor, and Italy had its budget rejected by the EU. Peripheral markets, on the whole, fared better. The worst return came from Belgium, which lost 9.5% and the Nordics also had a weak month after holding up well previously. Year-todate Finland has lost only 2.2%, with Sweden flat and Norway up by more than 11%.

News flow from the Brexit negotiations, as we approach the November deadline for a deal, caused Sterling to have a volatile month, with the Pound ending mostly down against other major currencies, with the exception of the Euro, which also had a poor month. Mrs Merkel’s political difficulties and the Italian budget led to a lack of support for the currency. Continued strong economic data, and hopes for an agreement with China over tariffs, as well as a flight to safety, saw the Dollar continue to strengthen ahead of the mid-term elections.

Strong economic data saw US bond yields move higher again in October, despite President Trump expressing concern over the Fed’s tightening policy. In the UK, with little prospect of a rate rise in the next six months, and weakening data, buyers emerged for UK debt, leading to a good month for bonds and a decrease in the yield. Peripheral European bonds continued to weaken as the Italian budget weighed on sentiment and investors switched into ECB and core EU bonds.

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

THE HUNT FOR (the causes of) RED OCTOBER*

*with apologies to Tom Clancy

October is often perceived as a potentially challenging month for stock markets; we had the Wall Street Crash of Oct 1929, the Oct 87 crash, the Great Financial Crisis is generally regarded to have started in Oct 2008 and now we have ‘Red October’, when the S&P500 fell -6.9%, the FTSE All-share fell -5.4%, Europe -5.9% and the Nikkei also dropped -9.1%, though it had been the strongest market the previous month. The S&P gave up all its gains year to date, whilst the FTSE All-Share closed the month -7% lower than at the start of the year.

Dissecting a broad market sell off– and identifying and grading the various catalysts – is tricky given the complexity of modern markets, but there seem some obvious starting points.

The initial trigger does seem fairly clear. US Treasuries had been selling off all summer, but some very strong economic data and bullish comments from the US Federal Reserve Chairman in early October fanned fears of a faster pace of interest rate hikes and sent US 10-year yields up sharply to an eight year high of 3.26%.

The ferocity of the move in the US Bond market was probably made worse by events in the money market. The persistently strong US Dollar has made hedging costs for overseas buyers of US Bonds too expensive and once this cost is taken into account, the real yield on US bonds for foreign buyers is less attractive. With the rising US budget deficit (post the Trump tax cuts) leading to increased issuance and foreign buyers stepping away, we had a situation where there were more sellers than buyers and as a result US Yields were moving higher. Unlike previous equity corrections, US Bond Yields rose during the month. US bonds remain highly volatile and may no longer be the default ‘safe haven’ that many investors have assumed in recent years. The equity market’s prior assumption that the Fed will ride to the rescue when equities sell off, seems to no longer apply.

This bond sell-off then bled into Equity markets, especially the high-flying technology stocks that had powered much of the rally. Other factors were also involved, such as the sense that the tech rally was overdone, trade tensions, rising short term interest rates making cash a viable asset again, worries over the Fed’s balance sheet shrinkage and concerns that it was as good as it gets for US corporate earnings. Many US tech stocks were priced for earnings ‘beats’ and ‘upgrades’, but some were offering ‘in-line’ and no change to estimates.

A gradual decline in US stocks suddenly turned into an unnerving late afternoon slide on Oct 10th – the day after US Treasury yields peaked – when the S&P fell -3.3%. Computer-powered, algorithmic investment strategies reacted to this surge in volatility, which added to the selling pressure. The growth in passive investing in recent years along with regulatory changes has resulted in a thinning out of equity liquidity in markets, which in turn adds to the influence of these high-speed algorithmic traders.

An additional factor has been the poor performance of traditional long/short hedge funds, which increasingly had crowded into tech stocks and collectively got their fingers burnt as the month progressed and delivered one of the worst monthly performances for their investors since the 2008 Financial Crisis. Selling pressure from the Hedge Funds added to the downward pressure on markets.

Towards the end of the month, some of these selling pressures eased. US economic data continued to be strong and corporate earnings offered reassurance – the bargain hunters were able to come in and markets staged a modest late month rally.

There were obviously other localised factors at play – Brexit in the UK, the Italian budget standoff in Europe - but the events in the US were replicated across all major markets.

Looking back over October, US Economic data remained very robust, but European macro numbers are going in the opposite direction. The US trade dispute with China shows no signs of resolution and there remains little signs of progress on Brexit. Merkel’s decision to step down as President of her party may yet result in a German Federal election next year. The US Dollar continued to strengthen, which remains a headwind for emerging markets and for non-Dollar denominated global investors.

Within the market correction, we have seen weakness in smaller companies and an end to the onward and upward march of growth stocks and the so-called US ‘FANGS’. The volatility that we saw earlier in the year has returned and investors are now more conscious of the downside in both equity and bond markets.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

Market Commentary September 2018

Brexit tensions escalate as Chequers Plan is rebuffed by EU
Increasing talk of a no-deal Brexit, as Mrs May’s Chequers proposal is dismissed by the EU, followed by a strong performance at the Conservative Party conference

US stocks hold up ahead of Mid-term elections
Trade wars, the Kavanaugh enquiry, allegations of tax dodging against the President and uncertainty over November’s mid-terms balance against strong economic data to keep equities steady

Italian budget places emphasis on higher growth
Italy’s new government agrees a budget deficit of 2.4% of GDP, creating tension with the EU Commission. The figure is much higher than the previous forecast of 0.8% and the Economy Minister’s proposed 1.6%, and can only be justified by faster GDP growth

Trade Wars intensify
China was hit by an additional $200bn in tariffs from the Trump Administration as trade wars between the US and China drag on. China struck back with $60bn in tariffs of its own, and cancelled talks which had been scheduled to take place with Treasury Secretary Mnuchin

Japanese economy accelerates
Japan’s GDP grew at 3.0% year on year in the second quarter, the fastest pace in the past two years, and higher than initially estimated. Recent Japanese data has been strong across a number of metrics including retail sales, household spending and unemployment. This is reflected in the Japanese equity market, which rose close to 5.0%, as measured by the Topix Index in Yen terms, in September

During the month, the best performing major market was Japan, which rose by 2.6% in Sterling currency terms, with US flat and UK slightly up. Japan’s Nikkei 225 index hit a 27-year high, driven by a weaker Yen. The emerging markets that have been problematical of late, Turkey and Brazil, rallied strongly, but emerging markets as a whole were dampened by falls in China and India. The latter was the weakest market in September, falling 10% in Sterling terms and the former was hit by the escalation of the Sino-US trade war. The strong Dollar and rising oil price continue to provide a headwind for emerging markets generally.

September was a gloomy month for most of Europe, with falls in more than half of the EU equity markets in Sterling terms. Brexit talks and political stresses saw Greece fall by 9.8%, with Italy the best performer among the major markets, rising by 2.7%, despite being the source of much of the wider European gloom. UK and France were also positive, with Turkey rebounding from its recent falls to gain 19.8%, helped by a rally in the Lira on expectations of a rate-rise.

Sterling had a better month in September, as, both sides in the Brexit negotiation seemed committed to finding a solution to the current deadlock, however, it gave back larger gains after Mrs May’s Chequers proposal was rejected, and she reiterated the possibility of a no-deal Brexit. The Euro fell, as Italy’s government agreed a deficit target of 2.4% of GDP – well above the 1.6% proposed by the Economy Minister and the 0.8% predicted by the previous government. Italy is the third largest economy in the Eurozone. Despite strong Japanese economic data, the Asian currencies were weaker against the Dollar and Pound as a function of the latter’s strength.

US bond yields tracked higher in September after the Fed raised its target range by 0.25% to 2.00-2.25%. UK yields moved up after a surprisingly strong inflation figure of +2.7%, vs expectations of +2.4%. Wage growth also reached +2.9%. Italy and EU peripheral markets saw yields fall, as the latest data showed confidence falling and retail sales and industrial production also down. The ECB is about to start reducing its bond-buying programme and ending QE.

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

10 Reasons to be positive about the US economy

The US economy is growing strongly, whilst Europe and Japan have seen their growth rates slow as the year has progressed, the US grew at +2.9% in the 2nd Quarter of 2018 and an even faster rate of growth is expected for the third quarter.

We have been monitoring these developments closely and this is reflected in the construction of the investment models, which reflect our approach to controlling and spreading the risk through the asset allocation and fund selection process. The US, in terms of size, is over half of the FTSE World Index and we are always conscious of the inherent risks associated in building models based on the composition of the benchmark.

Our exposure to the US, whether in equities or fixed interest, reflects the combination of a positive view on the economy alongside those portfolio construction and risk management parameters.

Here are 10 reasons to be positive on the US for the rest of this year and into 2019.

Business Confidence – US businesses are very optimistic and have been so ever since the election of Donald Trump. Prior to November 2016, business confidence and activity were the missing pieces of the US recovery jigsaw. But a combination of tax reform, deregulation and sense that the President was a businessman rather than a politician, has boosted business confidence to levels even higher than under Reagan. This then feeds through into our second reason. The most recent monthly survey of Non-Manufacturing Activity, which covers 80% of the US economy, was the highest reading since the survey began in 2000.

Business Investment –strong business confidence is feeding through into much higher levels of Business investment and Capital Expenditure and this is coming through both in survey data on business intentions, but also the ‘hard data’ such as Industrial Production and Fixed Capital Investment.

Deregulation – Under the previous administration there was a huge increase in regulation and whilst there may have been sound political and environmental reasons for such legalisation, it was very unpopular with business. That is now being rolled back and is one of the factors driving the increase in business confidence and investment.

Inventory – the upswing in business activity has resulted in low levels of inventory across the economy. Strip this factor out and the underlying growth rate was even higher in the second quarter. We are due an inventory rebuild that will boost the economy even more.

Employment – The US continues to create jobs at an unprecedented rate with the weekly levels of unemployment claims back to levels last seen in the late 1960’s. If we strip out the effect of the Vietnam War draft, the rate drops to levels last seen when Eisenhower was President. We are now seeing increasing levels of job ‘quits’, as workers feel confident to move to secure better terms and prospects and the participation rate is finally picking up as ex-workers return to work.

Shale Energy – The huge increase in Shale Oil and Gas activity is not only boosting the economy but also moving the US towards the strategic goal of energy independence, as well as helping reduce the Trade Deficit.

Consumer confidence – Consumer Confidence is at record highs, reflecting the benefits of a buoyant job market as well as the one-off boost from tax cuts. Retail sales are strong and there is little sign that the political events in Washington, nor concerns over trade policy is impacting either consumer or business confidence.

Consumer debt – unlike the years ahead of the Great Financial Crisis, US consumers are not piling on the debts to fuel their spending. Credit Card default rates are at multi-year lows and family balance sheets are in better shape than they have been for a while.

Inflation – inflation has picked up, mainly due to the price of oil. But there is little sign of inflation getting out of control and wage growth has been far more subdued than would have been expected given the tight labour market.

Fed raising rates – this may seem a strange reason to be positive, but the US Fed is raising interest rates because it can, rather than because It needs to. The economy is strong enough to adjust to higher rates and it’s quite possible that a year from now US rates will be at 3%. This not only gives the Fed room to cut rates at some point in the future should it need to, but it also reflects the fact that the Fed is currently the only Central Bank able to embark on a policy of ‘normalisation’ of interest rates.

Disclaimer: FOR PROFESSIONAL USE ONLY.


This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

Market Commentary August 2018

Increasing talk of a ‘No Deal Brexit’
As the October meeting of the European Council draws closer, the new Brexit Secretary, Dominic Raab, remains outwardly confident that a good deal can be negotiated. Other commentators, however, are starting to talk more and more about Britain’s lack of a credible bargaining position, and the real possibility of no deal being agreed.

FAANG stocks begin to falter?
Whilst Apple became the first company to hit a $1tr stockmarket valuation, and Netflix showed some recovery from its low in July, Facebook and Alphabet both headed lower during the month

Emerging markets led lower by Turkey and Brazil
Although the argument for EM investing remains generally strong, country-specific problems continue to damage returns as Brazil is hit by weak Q2 economic data and Turkey sees confidence fall and inflation rise further.

• Peripheral EU debt under pressure
Peripheral EU debt markets were noticeably weaker at the end of the month as concerns over fiscal loosening led credit rating agency, Fitch to reduce its outlook on Italy’s BBB credit rating from ‘Stable’ to ‘Negative’, hinting at a possible downgrade. Moody’s made a similar move back in May.

• Indian economy accelerates
Shrugging off trade tensions, economic growth in India accelerated to 8.2% (annual) in Q2’18, up from 7.7% in Q1’18 and the highest figure since Q4’11. Robust economic growth was driven by the construction and manufacturing sectors.

During the month, the best performing major market, once again, was the US, with Turkey again the major faller, down 27.3%. Returns from the emerging markets were poor once again. Despite positive fundamentals, country-specific problems affecting Turkey and Brazil were compounded by weak returns from wider Asia, as concerns over the escalating Sino-US trade war remained in focus. The same fears also led many European markets to record losses, as, despite a more conciliatory tone from the White House of late, the EU remains a potential casualty of the spat between the US and China.

During the month, the best performance within Europe came from Ireland. The worst was Turkey, -27.3%, The pan-EU indices were mostly flat for the month, as Turkey is not part of the EU, but it was the Nordic countries that once again proved most robust. Trade war fears, and growing concerns about the possibility of a No-Deal Brexit, damaging to both parties, weighed on markets ahead of the October meeting of the European Council.

Movements between the major currencies were more muted in August, although the weakening of Sterling and strengthening of the Dollar continued, providing a mild headwind to performance relative to the World Index. Sterling saw a short-lived blip upward late in the month, when Michel Barnier spoke of an ‘unprecedented deal’ being offered to the UK, but the Pound quickly fell back when no further comment was forthcoming.

UK rates rose in the wake of a fully-expected 0.25% increase in the BoE base rate early in August. Bond yields in the peripheral European markets were the main story during the month, however, as Fitch followed Moody’s example and changed its outlook on Italy’s BBB Government rating from ‘stable’ to ‘negative’, potentially paving the way for a further downgrade of the credit rating, citing concerns over fiscal loosening.

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

The Outlook for Emerging Markets

In recent months, and particularly in August, global headlines have turned increasingly sour on emerging markets, with terms such as “contagion”, “bear market” and “sell-off” making a regular appearance. Year to date emerging market equities have fallen 3.4%, while developed markets (led mainly by the US) have risen 9.1%, in Sterling terms, according to MSCI indices. Emerging bond markets have been similarly hit, with most measures of emerging market bond indices down over 5%.

In this context its worthwhile taking a step back to consider the circumstances of emerging markets and review the case for broad emerging market investment.

Why are emerging markets selling-off?

Some of the challenges confronting emerging markets are clear. These being the rise in the US Dollar, tightening from the Federal Reserve and the Trump Administration’s Trade Policy. As US interest rates rise, emerging market sovereigns and corporates are forced to compete for funding with safer US fixed assets (including Treasuries). Rising rates also create upward pressure on the US Dollar, negatively impacting those corporates and sovereigns which have debt denominated in USD. Trump’s Trade Policy is a further challenge in this context as emerging markets (most notably China) face the prospect that a key export market (the US) becomes more difficult to access. Certain emerging markets, notably those with current and capital account deficits such as Turkey, will be particularly negatively impacted due to their reliance on external funding.

Arguably however, the headline narrative on trade wars and quantitative tightening here is misleading. The current distress in emerging markets is attributable to several factors. To illustrate:

▪ Argentina’s need for financing from the IMF is, at least partly, attributable to the poorest harvest in a decade, hampering the economy and exports

▪ Problems in Turkey, and the precipitous decline in the Turkish Lira, are not helped by a certain disdain for traditional economic policy shown by Erdogan, or the dispute between Ankara and Washington over the arrest of a US pastor. The pastor is accused by Ankara of carrying out activities on behalf of organisations behind the failed 2016 coup

▪ Our conversations with Asian and emerging market fund managers suggest that China’s actions to tighten monetary policy, to rein in debt and promote financial stability, may have had a greater market impact than external political/monetary factors. This is a realistic possibility given that retail investors account for close to 90% of trade volume within the domestic China A shares market

If not for these specific issues, the situation in emerging markets would likely be less negative than it is today.

Short-term concerns, Long-term opportunities

In the short-term, markets are driven by sentiment, and investors may be hard pressed for optimism at the moment. The nature of asset allocation means that if investors are worried about emerging markets, there is a likelihood they will divest from them all together, rather than discern between strong and weak countries. Outflows from emerging markets have been substantial, with investors pulling some USD 15.2bn from emerging markets in the three months ended July’18, according to Morningstar.

However asset price contagion and economic contagion are two different matters. Risks are high through a tightening cycle, but financial stability in most emerging markets does not appear to have been compromised. To illustrate, China’s foreign exchange reserves, a key watchpoint for capital outflows, have remained stable, at slightly over USD 3trn throughout the year. Meanwhile, Central Banks in India, Indonesia and The Philippines, have prudently hiked rates to maintain financial stability and support their currencies. Even Argentina’s recourse to the IMF can be viewed in the context of sensible economic decision-making.

In this context, long-term opportunities remain in emerging markets, from which patient investors can benefit. A notable long-term theme has been consumption growth, which is unlikely to be derailed by recent events. In China, in Q2’18, disposable income for urban households grew over 8% y-o-y, at much the same rate it has for the past few years. This income growth continues to drive strong retail sales in the country. India too has experienced rapid growth in consumption, with Q2’18 GDP data showing a rise in private consumption of 7.9%, year on year.

This growth translates into real earnings for companies, where feedback from our active managers has been helpful in cutting through the noise associated with sentiment. Their on the ground discussions and analysis of companies has indicated that many are meeting, or even exceeding operating expectations. Often companies are raising wages alongside their improved earnings, for example Yutong Bus, a Chinese bus manufacturer, is raising wages by some 15%. Positive fundamentals are also reflected in forward earnings estimates for the MSCI China Index rising notably year to date, even as the index has dropped.

For some, the arguments above may sound a bit like old news, and that may be because little has changed fundamentally for most emerging markets in the year to date. If emerging markets didn’t have the vulnerabilities outlined above, they would possess a lower growth profile, be more mature in their development, and perhaps be considered as developed markets. Investors should remain mindful that Emerging Markets have been through periods of stress before, and often these are accompanied by painful (though useful) economic lessons. It is perhaps not coincidence that some of the greatest emerging market wealth generators Alibaba (1998) and Tencent (1999) were founded in the aftermath of the Asian Financial Crisis. We therefore remain cautiously optimistic towards specific emerging markets, albeit conscious of the implications should conditions deteriorate further.

Disclaimer: FOR PROFESSIONAL USE ONLY.


This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

Market Commentary July 2018

Speculation of a No-Deal Brexit increases

UK stocks saw a rotation back towards large, overseas earners in July, as fears that no deal may be reached in Brexit negotiations led to further weakness in Sterling.

European stock markets rise on easing trade tensions

Major EU nations saw their stock markets rally after President Trump said that the US and EU would “Work together towards zero tariffs”. Gains were partly offset by poor performances from the weaker nations.

Emerging markets rally on easing of US/EU trade tensions

Whilst President Trump remained focused on imposing further tariffs on Chinese exports, his conciliatory visit to the EU eased fears among emerging markets, leading to a bounce, led by Brazil, +12.3%.

Japanese government bond yields rise on BoJ statement

The Bank of Japan pledged to implement “Continuous, Powerful monetary easing” for the foreseeable future, in its July statement. The Bank also raised the yield cap on 10-Year JGBs from 0.1% to 0.2%, resulting on 10-year yields moving up by 0.06%.

Chinese currency falls markedly against the Dollar

The PBoC allowed the Yuan to weaken further; concerns over the increasing trade tension with the US led to further weakness and short selling in the Yuan. A modest slowdown in Chinese economic data also contributed to the fall.

During the month, the best performing major market was the US, with Turkey was once again a major talking point, down 6.6%. Investment performance was thus dominated, once again, by the US market, but the slowing in the appreciation of the Dollar allowed a small recovery in emerging markets. The Bank of Japan indicated further monetary easing going forward, and equities saw a small rally. China continued to track lower, albeit more gradually.

During the month, the best performing market was Poland, +11.7%, adding to the year’s gains, driven by consumer spending and a tight labour market. The worst was Turkey, -6.6%, where Erdogan consolidated his hold on power in the recent election. Major European markets were broadly positive, whilst weaker performances from Southern Europe saw a more neutral performance for the region as a whole. Germany rose on a more stable political outlook.

Trends seen in the second quarter were broadly continued during July, as the Dollar continued to appreciate, albeit more slowly, and Sterling weakened further, driven by the looming October EU meeting and perceived lack of progress towards a Brexit deal. The Chinese Renminbi weakened markedly as President Trump’s uncompromising stance on tariffs was seen as increasing the likelihood of a full trade war between China and the US.

Across the Eurozone, bond yields continued to settle back towards the levels seen prior to the the Italian election, which saw yields rise significantly among the weaker EU nations. In the UK and US, yields increased slightly, as the market began to price in the expectation of a rate rise from the Bank of England in August. Japanese yields remained roughly unchanged.

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

Does Brexit matter in the longer term?

The effective ‘deadline’ for agreeing a Brexit deal that can be ratified by the EU is fast approaching, with politicians, journalists and investors becoming increasingly fixated on what universally acceptable form of words Theresa May’s government can come up with by October. There is no shortage of articles in the press right now, speculating on what state Britain may be in under various scenarios post its exit from the European Union, and very little in the way of undisputed facts upon which to base the headline-grabbing doomsday, or goldilocks projections.

In the UK, we have reached a point where a second referendum, offering a deal/no deal/remain set of choices may be a possibility, and of course, after the last vote in 2016, politicians have little credibility when it comes to predicting whether the UK would be better-off within or without the EU. This month, we thought it might be worth stepping back from the sound and fury, and looking at some longer term data that might offer some clues to try to answer that question, and consider the outlook for both the EU, and the UK outside of the EU, over the next 5-10 years.

It is clear that there will be a number of headwinds facing both the EU and the UK over the coming years. In a 2012 interview with the FT, Angela Merkel said:

“If Europe today accounts for just over 7 per cent of the world’s population, produces around 25 per cent of global GDP and has to finance 50 per cent of global social spending, then it’s obvious that it will have to work very hard to maintain its prosperity and way of life …. All of us have to stop spending more than we earn every year.”

This is certainly true, but the EU as a whole, and particularly the poorer nations to the South, face some very tough challenges if it is going to maintain its current standard of living.

First of all, there is the growing power of China as a trading entity. China is focusing on two major initiatives: the ‘One Belt, One Road’ project, which will see $900bn of planned infrastructure spending to link China to many of its less developed trading partners, and the ‘Made in China 2025’ project, which specifically targets ten key industrial sectors across the world, that will threaten Europe as a whole and especially Germany. If anyone doubts the determination and capability of China to wrest market dominance away from other nations, one need only consider the solar panel market. In 2000, Germany led the world in solar panel production, as generous feed-in tariffs guaranteed solar power producers a fixed price for 20 years. However, in May 2017, after years of erosion by cheaper Chinese competitors, the web site Cleanenergywire.org ran a headline: “Last major German solar cell maker surrenders to Chinese competition”. In 2018, seven of the top ten solar panel manufacturers are Chinese, with only one, Canadian Solar, being outside Asia. A similar story is playing out in the global battery market, where China already controls half the world’s supply of lithium, and is set to dominate the electric car battery market within the next couple of years. Overall, according to a study by Oxford Economics, by 2030, seven of the top ten cities by contribution to global GDP will be in China. The other three are Los Angeles, New York and London – none will be in the EU.

As great as the threat from Asian competition may be, the rise of automation and artificial intelligence may prove even greater for the EU. Whilst all countries will be affected, to a greater or lesser extent, by the advance of technology, a number of studies have pointed to the fact that the EU countries, other than the major Western nations, will be highly vulnerable. In general, the more industrial a country’s economic backbone is, the more exposed it is to automation, and potential job losses. Studies have estimated that Portugal and Romania have up to 60% of their industrial jobs vulnerable to automation. According to a recent OECD report on the subject, jobs in Germany and Southern and Eastern Europe are the most at risk, not primarily because of their different economies, but because jobs in the English-speaking countries, the Nordics and Netherlands are already being done in different ways; China, Korea, UK, US and Western Europe are already embracing new technology. China is also investing between two and four times as much as the EU in artificial intelligence research.

The third major headwind for the EU is debt. Of the 28 EU nations, there are 21 whose debts are larger than the ‘60% of GDP’ limit, set out in the Maastricht Treaty. Five have debts greater than 100% of GDP. This is a higher level of debt than before the financial crisis ten years ago, and the ECB’s balance sheet has grown by 50% since 2012, driven by QE. However, aside from this widely publicised data, there is another unexploded bomb in the EU’s finances, in the form of off-balance sheet debt – specifically unfunded pensions. The UK and the Netherlands each has more pension savings than the whole of the other 26 nations combined (The UK has more than all 27 others). After the UK and the Netherlands, the figures decrease alarmingly quickly, with Italy, only in 5th place out of the 28, but still having an estimated total unfunded pension liability of some 350% of GDP.

Mrs Merkel appreciates all of this, hence her statement that the EU will have to work hard in order to maintain its standard of living. And there is the real problem. The only ways to counter these threats from China, automation and debt are population growth and productivity improvements. According to a UN report, between 2015 and 2020, exactly half the nations of the EU will experience natural population growth, i.e. excluding migration. Half the populations will decline.

However, when we adjust these figures to take account of population sizes, and express the projection simply in terms of thousands of people, the picture is even more worrying.

Migration within the EU will not affect these figures overall, so only migration from other parts of the world into the EU, or an unexpected upturn in the birth rate, can turn the situation around. Figures from the UN Population Database predict that Europe will be the only region in the world experiencing absolute population decline between 2010 and 2050.

In addition to falling populations, the countries of the EU are also seeing their workforces ageing. The dependency ratio is set to rise, with fewer workers supporting more retirees, and hence exacerbating the pensions problem. According to UN World Population Prospects 2017, between 2015 and 2030, the median age of some EU countries is set to rise by as much as seven years. Even the major western nations, Germany, France and Italy will see rises of two, two and five years respectively. Only the UK, Luxembourg and the Nordics will see a modest one year increase. This is a major headwind for all developed countries, but especially those poorer nations in the EU
.

OECD figures suggest that one third of GDP growth comes from growth in the labour force, whilst two thirds comes from productivity gains. However, for the EU, it seems that more than 100% of any GDP growth will need to come from gains in productivity. Automation may make the Southern European nations more efficient, but if it does so by destroying jobs, this will not help the situation, and will not grow GDP. A recent Conference Board analysis, published in the FT, showed that productivity in the Eurozone rose by 1% in 2017, and is expected to rise by 1.1% this year. This is below, but within reach of the 1.4% growth seen in the region before the financial crisis, suggesting some light at the end of the tunnel. Europe as a whole was behind the other major economies in productivity (defined as GDP per capita) last year, but ranks a lot higher when we consider the projected productivity growth of 1.8% per annum over the next three years, as the chart below shows:

Of course, these are trends that will be played out over a long period of time. There will still be opportunities for European companies to do well, as well as under-researched market niches and pockets of value that active managers will be able to exploit. However, it is worth keeping some perspective when the markets are panicking over where Britain will be on 1st April 2019. On the face of it, Britain seems better placed both financially and demographically to weather the storms that lie ahead, but, in the face of adversity, the biggest advantage for the UK will be the ability to change policy and execute decisions as the situation demands. In this regard, the UK might be likened to a speedboat, pulling away from the EU super-tanker, that will take far too long to turn away from impending problems.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

Market Commentary June 2018

• Brexit talks become more stressed as deadlines approach
• European and Asian markets hit by trade war fears
• China enters a bear market
• Little net movement in major market bond yields
• Dollar strength continues to hit emerging markets
• Erdogan consolidates power in the Turkish election
• Japanese unemployment is now at 1992 levels

During the month, the best performing market was Mexico, +9.6%, and the worst was Ukraine, -9.5%. Investment performance was dominated by the US market and the continued strengthening of the Dollar, which led to a poor return from emerging markets and the smaller Asian nations. China officially entered a bear market according to the Shanghai Composite Index. Japan managed a small gain, but this was offset by Yen weakness for UK investors. The potential threat to global growth that a full trade war would represent has not yet dented confidence in the US, where all data continues to point in the right direction.

During the month, the best performing market was Malta, +4.7%, and the worst was Turkey, -3.8%, where Erdogan consolidated his hold on power in the recent election. European markets were once again weaker overall, as fears of a trade war with the US weighed on sentiment. Emerging European markets provided a drag on the overall performance of the Eurozone, as did the stresses between Angela Merkel’s Christian Democrats and one of their coalition partners, the Christian Social Union (CSU), over immigration, which, at times, seemed likely to spell the end of Mrs Merkel’s leadership.

The major themes in the currency market were the strength of the Dollar, the general weakness of Sterling and EM currencies, including China. Fears over the outlook for the Eurozone, amid German political difficulties and the prospect of a trade war between the US and China, also bringing in Europe, saw money continue to flow into the Dollar as the reserve currency, which continued to gain against most other currencies. The continued lack of progress in Brexit talks saw further declines in the Pound, which reached 1.32 against the Dollar. This helped to mitigate losses from overseas funds for the UK investor.

Eurozone bond volatility settled down in June, with the sovereign bonds of Italy, Spain and Greece closing in against the Bund, after widening substantially in May. With little in the economic data to suggest an urgent rate rise anywhere among the major markets, and uncertainty over the effect that trade tariffs might have on economic growth, 10-year yields in the major global bond markets were mostly unchanged.

Trade Wars

The Financial Press has been awash with stories about trade “wars” between the USA and China, the EU and even Canada. Allowing for the expected media hyperbole (trade ‘disputes’ or ‘disagreements’ sounds far less alarming), what is clear is that financial markets are upset by such developments.

What started off as a US v China dispute has escalated, both in size and scope and we have now reached the stage where the retaliatory levels are at the U$200bn level. The origins lie in Trump’s successful election campaign, which tapped into fears amongst the voters about losing out from globalization. Interwoven within the dynamics of the trade agenda, are further complications associated with Chinese intellectual property theft. In Trump’s own words “China has… long been engaging in several unfair practices related to the acquisition of American intellectual property and technology. These practices… harm our economic and national security”.

Once the dispute with China started (and probably smarting from the lack of support from his allies), Trump has also turned his ire towards long simmering trade disputes with other countries. For example, Canada sets domestic production quotas and imposes tariffs of up to 270% on dairy products, to keep prices stable and ensure a stability of income for Canadian farmers. In isolation, this seems an extreme form of protectionism, but domestic political considerations make it extremely difficult for the Canadians to admit this, let alone do anything about it. The EU also has high external tariffs on agricultural products and bans US GM food products on some convenient health regulation grounds. It also charges a 10% tariff on cars, verses just a 2.5% tariff in the USA. Equity markets have reacted badly to the headlines, with the Chinese equity market hitting a 2-year low during June, though the US market has held up.

Chinese threats to impose tariffs on agricultural imports are already impacting US agricultural commodities. The price of US Soybean futures has fallen sharply, which puts pressure on US rural communities, which have been staunch Trump supporters (which is why the Chinese have done this).

Germany has long been the industrial powerhouse of Europe, deriving over 50% of its GDP from exports and is the world’s third largest exporter of merchandise. Unsurprisingly therefore its main equity index (DAX) sold off heavily on the additional tariff announcements. Germany is also in the firing line for the US over their failure to honour NATO defence spending pledges, their 10% tariffs on car imports and its large current account surplus with the United States.

It is also important to consider the differentiation of company size in the US (and indeed globally). Those towards the mid and lower end of the market capitalisation scale, will be much more influenced by domestic economics (fiscal reform, deregulation etc) when compared to their large-cap, Dow Jones cousins. For these smaller companies, by many measures, the outlook remains optimistic and performance year-to-date has been strong.

The challenge here is how to reconcile the Trump approach with international trade negotiations and the attitude of the Chinese and Europeans.

Trump thinks bi-laterally, not internationally. He wants immediate actions and solutions, not endless rounds of negotiations. He expects the other side to accept his proposals to eliminate what he regards as obvious tariff inconsistencies and he has little regard for their domestic political considerations, or the historical (and very slow) protocols for resolving these kinds of issues. The media has so far tended to focus more on his tactics and less on the actual tariffs that have so stoked his ire.

So what happens next?

Chinese imports from the US are only a quarter of the value of their exports to the US, but there is more than one way to skin a cat. We could see state-organised boycotts of US products – a tactic the Chinese have employed previously with Japan. They could stop buying US treasuries, or even start selling some of the U$.118tn that they currently own. Alternatively, the Chinese government may decide simply to flex their significant political muscle to leverage influence in key geopolitical issues of major US interest, such as N Korea or Taiwan. Domestic considerations make compromise from the likes of Canada or Mexico difficult, whilst the EU’s approach to tricky decisions has always been to kick the can down the road. Even if the EU was minded to amend some of its protectionist trade policies, getting all 27 EU counties to agree is a very time consuming operation.

With the US economy performing strongly and the rest of the world less so, Trump will feel that he has timed his rhetoric well. Markets don’t like uncertainty, disruption or change to long held agreements and perceptions of how the world works and the perceived wisdom is that raised tariffs (1930 Smoot-Hawley Act) was a key factor in turning the 1930s recession into the Great Depression.

US tariffs have been very modest for several decades, particularly when compared with the rest of the developed world. This is most striking when we compare tariffs on agricultural products between the USA and the EU.

Trump represents a challenge to all these beliefs, which is his intention. Many of the tariffs and trade practices that he has highlighted are hard to justify, but that is no guarantee that they will be negotiated away. A summer of adverse headlines about trade and tariff disputes seems inevitable. Some of the investment trends that we have seen in recent months seem, therefore, likely to continue. The US, particularly small and mid-cap companies, seem well placed. Trade worries can be added to an ever-growing list of challenges for Europe and many of the positive long term structural trends that underpin Asian consumer growth remain in place.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

May 2018 - Market Commentary
 

• Fears escalated over the prospect of a Brexit with no deal. Sterling weakened against most other currencies during the month

• Italy’s 5-Star Movement and the League party formed a new populist/anti-EU coalition

• More tough rhetoric from the US revived fears of a trade war with China

• Oil Prices fell as Russia and OPEC discussed increasing exports.

• Japanese equities were weak, led by financials and poor growth figures

• Rising US rates exposed weakness in some emerging markets

• Asian markets were generally resilient, compared with weaker emerging markets elsewhere

During the month, the best performing market was Israel, +9.2%, and the worst was Greece, -16.9%. May was a mixed month for equity investors across the major markets, with strong returns coming from North America, whilst Europe and Japan performed poorly. A mixed return was seen from emerging markets. South America fared particularly badly, led lower by a truckers’ strike in Brazil, a decline in the oil price and falls in the shares of oil companies on the continent. Russia and China conversely saw strong rises as their currencies gained against the Dollar.

During the month, the best performing market was Portugal, +1.7%, and the worst was Greece, -16.9%. European markets were weaker overall, with the political uncertainty in Italy, where a new populist/anti-EU coalition has been formed, sending ripples of unease through the weaker nations of the Eurozone. The better returns during the month came from the Nordic countries and the UK, with relatively minor falls in the main European markets. Emerging European markets provided a drag on emerging markets funds.

The major themes in the currency market were the strength of the Dollar, and the weakness of Sterling. Fears over the outlook for the Euro, and the prospect of a trade war between the US and China, also bringing in Europe, caused a flight to the reserve currency, which gained sharply against Sterling and the Euro. The continued lack of progress in Brexit talks saw a decline in the Pound, which boosted returns from overseas funds for the UK investor.

The political upheaval in Italy was also reflected in sharp movements in the bond market, as investors switched from riskier Italian, Spanish and Greek bonds to the perceived relative safety of French, German and ECB issues. The spread between the stronger and weaker economies’ sovereign bonds widened dramatically. Meanwhile, yields in the UK and US contracted slightly as pressure for further early rate rises appeared to recede, benefiting some long-only bond funds.

Why are US Bond Yields rising?

The big event in world markets so far this year has been the move in the US 10yr Bond Yield (Yields rise as Bond prices fall) to 3%. The US Bond market is the biggest and most liquid market in the world so what happens here influences other investment markets across the globe. US Bond Yields were 2.40% at the start of January and have been rising faster and further than most commentators expected. So why are US Bond Yields heading higher?

There are many factors at play here, but let’s concentrate on four of them.

Firstly, the US economy is performing strongly. Growth has been modest in recent years, mainly due to consumer spending holding up. What has been missing has been Business confidence and Business investment. Confidence rose with the election of President Trump, who was perceived as being more business friendly than his predecessor. But it was the recent tax reforms that have driven Business confidence and investment higher, which is starting to come through in the economic data.

Secondly, the more that there is of something, generally the lower the price. In the short term, the Trump tax reforms means a big increase in the US budget deficit, which will have to be funded by increased selling of US Bonds. Adding to the selling pressure is that the US Federal Reserve is no longer buying some of the Bonds that it was issuing, and it also used up a lot of its reserves to fund last years’ deficit. Put simply, compared to last year, there’s a lot more Bonds about.

Third, Bond markets don’t like inflation and particularly if they appear to be more worried about inflation than the authorities. (when you hear people talk about the Fed ‘being behind the curve’, this is what they mean.) There is little sign of inflation rising to a level that would cause the authorities concern. But you can see inflation in the Oil price. Despite rapidly growing US OIL production, the oil price has been rising in recent months due to strong demand, worries about the Middle East and falling output from Venezuela. Some investors may be getting concerned that the rising Oil price could start to feed through into the inflation figures further down the line, most obviously via the Gasoline price.

Finally, Bond Yields have been at historically very low levels ever since the Financial Crisis. This was due to the concern that economic growth going forward would be much lower than previously seen. Under more normal economic conditions, Bond Yields should track or be slightly above the growth in Nominal GDP. (that’s the sum of the inflation rate and the GDP growth rate) But in recent years, it has been significantly below that. But better US GDP growth and modest increases in the inflation rate have combined to produce a steady increase in the rate of nominal GDP growth – a sign of a return to more normal economic conditions in the USA. This has acted to lift up US Bond Yields back towards more normal levels. Though as this chart shows, there is still some way to go to get Bond yields back above Nominal US GDP (currently 4.8%)

Bond Yields are rising for good reasons (better economic growth), rather than bad ones (inflation) and this shouldn’t necessarily threaten Equity Markets. Several months ago, US Bond Yields looked too low given the better economic data that we were seeing. This view that Bond Yields were set to rise (and therefore Bond prices set to fall) was a key factor behind the construction of portfolios that were designed to avoid an asset class that was traditionally regarded as a safe haven but was to our mind fundamentally miss-priced. With stronger economic growth and subdued inflation, those factors remain in-play.

Disclaimer: FOR PROFESSIONAL USE ONLY

This report was produced by Purple Strategic Capital Ltd (“PSC”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While PSC uses reasonable efforts to obtain information from sources which it believes to be reliable, PSC makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this update are provided by PSC for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the update. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. Purple Strategic Capital Ltd is authorised and regulated by the Financial Conduct Authority. Purple, PSC and Purple Strategic Capital are trading names or Purple Strategic Capital Ltd, registered in England and Wales No. 06864342 Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

April 2018 – Market Commentary

Equity investors, who had seen a volatile start to the year, found some comfort in April, as markets rallied to some extent, after the falls they recorded in February and March. In the UK, shares were boosted by the diminished prospect of a base rate rise in May, following a weak GDP figure. At the end of the month there was further good news for investors as Sainsbury, the number two grocer in the UK, announced a merger with Asda, the number three. European markets were mixed, but Greece was a highlight, as the prospect of an end to the EU bailout this summer appeared much more likely. Shares on the Athens Stock Exchange rose by 10%, whilst Greek Government debt traded closer to German Bunds, as investors warmed to the prospect of an end to eight years of austerity. In the US, strong economic fundamentals once again drove the US Treasury Ten-year bond yield up, this time reaching 3%, but a more sanguine market did not react as negatively as some market commentators feared. Meanwhile, the Bank of Japan appeared to abandon the expectation of reaching the target 2% for inflation next year, though the equity market continued to perform well. Emerging markets saw a wide dispersion of returns, ranging from India, which returned more than 6%, driven by strong corporate earnings, to Russia, which fell by more than 8% on US sanctions against oligarchs and their interests.

UK

The key economic news in April was the much weaker than expected 1st quarter GDP growth rate, which came in at just +0.1% versus the previous quarter and +1.2% when compared to a year ago, both lower than expectations. There were some one-off factors (such as the weather) and it is possible that the number could be revised up in the coming months. However, there is no denying that this was a disappointing number, doubly so when one considers the better economic news that has been coming out of the USA and Europe. The chart below shows the annual change in UK GDP and helps to illustrate the slowing rate of growth in recent years.

The immediate impact of the weak GDP number was that the probability of a May UK interest rate rise fell back sharply. The recent strong wage growth data had seen markets pricing in a 0.25% increase in interest rates, but the Bank of England had already started talking down the possibility of a rate rise as the latest inflation data came in lower than expected.

The last few days of the month saw political and the company surprises. Amber Rudd resigned over inconsistencies in her statements over the Windrush affair. Her departure might prove significant in altering the delicate balance within the Cabinet particularly over the question of what form, if any, of customs union may be put in place after Brexit.

The big company news was the announcement of the proposed merger between Sainsbury and ASDA. The whole process could take over a year, but if the deal were to go ahead, the landscape of UK food retailing could be significantly altered. In the medium term it could also lead to further downward pressure on the UK inflation rate if the merged group cuts food prices. Sainsbury shares were up nearly 30% over the month.

Europe

A broad recovery in global equities during April saw most European markets higher over the month, with Germany, France and Italy returning +4.3%, +6.8% and +7.0% respectively. Large cap stocks outperformed their smaller counterparts as the Stoxx 50 Index gained 5.2%, compared with a rise of just 4.1% in the MSCI Europe Small Cap Index. Greek equities made a particularly strong showing, returning +10.0%, as Eurozone finance ministers agreed that the EU bailout of Greece should end in August. The end of the bailout will leave the Greek government free to set its own economic policies, after eight years of austerity measures, and Greek shares continued to ride a wave of optimism on the outlook for the country’s economy. The euro weakened by 1.8% against the US dollar, which also helped European stocks to advance, but was steady against sterling.

German Chancellor, Angela Merkel and French President Emmanuel Macron both visited the US for talks with President Trump, aimed partly at gaining some assurances over his plans for steel and aluminium tariffs that would affect European producers. Whilst Mr Macron appeared to have a much more cordial relationship with the President than the German leader, there was no clear sign that there will be any change of policy on the tariffs, which are due to come into effect on 1st May, though the President has yet to make his final ruling on exemptions, and has until 12th May to do so. The EU, along with Canada and Mexico are currently temporarily exempted. The tariffs, if they do apply to the EU, will ultimately have limited effect on German producers, which export just 5% of their steel to the US, with the overwhelming majority of exports going to other EU nations.

French rail strikes, were joined by a strike at Air France, where pilots and cabin crew commenced industrial action over a pay dispute. Air France shares fell by more than 10% during the month, as the company was forced to cancel around one third of its services at a cost of €250m, with flights grounded in both France and Germany. It is unclear how long the current unrest will continue, or how it may spread which may create a headwind for businesses across the EU.

As in other markets, European bonds were mixed, with both government and corporate bonds giving a small negative total return overall. Longer dated bond issues managed to achieve a marginal positive return, despite rates edging slightly higher at the longer end, in anticipation of continued strong growth and resultant rate rises in the future. Greek sovereign bonds saw their spread over the German Bund contract on optimism over the country’s improving economic fundamentals and the proposed end of the EU bailout; the ten-year Greek bond moved from yielding 3.79% over the Bund in March, to just 3.28% over in April.

In terms of economic data, unemployment remained at a low level in France and Germany, and the headline figure across the EU continued to trend lower, moving from 8.6% to 8.5% in February, as employment data from some of the weaker economies continued to improve. Inflation returned to 1.3% in March, after a dip to 1.1% in February, whilst wage growth data has not yet been published for Q1 2018. Business confidence, measured by a survey of managers’ appraisals of order books, tapered off in April, reaching its lowest level since last August. Meanwhile, business confidence in Greece strengthened.

US

In the 1st quarter of 2018, the UK economy grew just 0.1% over the previous quarter, but in the United States that figure was +0.6% and close to +3.0% on an annual basis. That faster rate of growth is one of the factors behind the big move up in US bond yields. The 10-year US Treasury bond yield started the year at 2.40% and during April it breached the 3% level, before settling back to 2.95%. The US Federal Reserve has been making encouraging noises about the strength of the US economy. US interest rates are expected to rise further this year and next as the authorities continue their policy of moving interest rates back up to historically more normal levels. Compared to other advanced economies, the US is much further down this road.

With the Trump tax reforms now firmly in place, companies have visibility on their future tax liabilities and this is one of the factors driving a big pick up in Merger and Acquisition (M&A) activity. Global M&A deals announced so far this year is already ahead of the previous peak of 2007, after just 4 months. As a result of the new US tax laws, some of the biggest US companies are also starting the process of repatriating large amounts of cash previously held overseas and that is helping to finance some of the take-over activity that we are seeing. The oil price continued to move higher, with Brent crude up 7% to U$75/bbl. This was despite the remorseless rise in US oil production as the shale oil revolution continues apace. There seem to be three key reasons for the recent strength in the oil price – global demand is very strong, Venezuelan output continues to fall away and the oil market is also conscious of the impact should President Trump cancel the Iranian Nuclear deal. The oil price is now over 40% higher than a year ago.

Asia Pacific and Emerging Markets

Japan


Japanese equities moved higher in April, with the TOPIX returning 3.6% (in yen terms), ahead of other developed markets. Increases were led by more cyclical areas of the market with the major banks Sumitomo Mitsui, Mizuho Financial and Mitsubishi UFJ Financial rising as investor sentiment towards cyclicals improved following a sharp sell-off in February and March. Larger cap stocks outperformed smaller cap, likely driven by the yen which weakened against sterling, the US dollar and the euro. Currency weakness occurred as woes for the Government mounted following the release of several polls highlighting an ongoing decline in Shinzo Abe’s approval rating amid the continuing fallout of a cronyism scandal. Investors may be mindful of the risks for Japanese Government policy given an upcoming leadership vote in September. In monetary policy news, the Bank of Japan (BoJ) retained its key policy settings in its late April meeting. Interestingly however, the BoJ lowered its inflation outlook for 2018, and removed any mention of reaching the 2% target around 2019. The shift potentially signals the BoJ pushing out its expectation of when the 2.0% target will be reached and a continuation of highly accommodative monetary policy.
 

 

Source: Morningstar, Japan Institute of Labour, Japan Statistics Bureau

Emerging Markets

Emerging market equities rose 1.2% during the month, as measured by the MSCI Emerging Markets Index, in a month that was marked by political risk and substantial dispersion in returns. Indian and Korean markets were the leaders with the NIFTY 50 rising 6.2% and the KOSPI 200 up 2.8%. Indian markets were buoyed by heavyweights Reliance Industries (+9.1%) and Tata Consultancy (+24.0%), which both rose prior to announcing positive earnings reports in the second half of the month. The KOSPI was driven by Samsung (+7.7%), which comprises over 20% of the index. Samsung rose in advance of announcing record operating income on the back of robust demand in its memory segment and strong sales of the Galaxy S9. Other market giants Tencent (-5.2%) and Taiwan Semiconductor (-7.7%) struggled. Tencent continued its downward slide triggered on 22 March after Naspers announced it would sell a 2.0% stake in the company, while Taiwan Semiconductor failed to meet analyst earnings expectations in its Q1 results released on 19 April. However, the greatest surprise for the month was reserved for investors in Russian equities with the MICEX down 8.1% on the business day following the introduction of new US sanctions. The sanctions were imposed against a number of Russian oligarchs, government officials and related companies. The sanctions include freezing of assets and prohibit US persons from having any dealings with the sanctioned parties. The implications were particularly acute for Rusal, the world’s second largest aluminium company, which halved following the sanctions announcement as many investors were forced to sell their shares and the company warned of the potential for a technical default. Interestingly, by the end of the month the impact of sanctions was most felt through the ruble which fell over 10%. Local currency investors in Russia had an easier ride, as the MICEX quickly recovered from its loss to end the month up around 1.0%.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance.

ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

March 2018 – Market Commentary

March was another poor month for global equity markets, with the major markets all experiencing further falls to add to their losses from February. Whilst economic data remained broadly supportive, investors were nervous as President Trump’s campaign rhetoric turned into trade tariffs aimed at China, with a scattergun approach that also affected the US’s European and other allies. Fears of a global trade war led the US market lower and this was compounded by sharp falls in the technology stocks that had racked up huge gains in 2017. In the UK, further progress was seen in Brexit negotiations, but a number of high-profile profit warnings, particularly in the retail sector, saw the major indices come under pressure. Across Asia, the consumer-facing sectors continued to outperform other areas of the markets, and as a whole, smaller company shares performed better than their larger counterparts as investors sought safety in more domestically-focused stocks.

UK

Brexit negotiations took a step forward in March with agreement on the transition period, as well as on the post-exit financial settlement and citizens’ rights. The broad sweep of economic data remains unchanged, with strong export and manufacturing data, helped in part by the economic recovery in Europe. After a period of 12 months when wage growth was below inflation, there was better news on real wage growth, with the latest inflation number dropping to +2.7% and average wage growth of +2.8%, as the following chart shows.

Real wages grew steadily until the Financial Crisis in 2008. We then had a period of several years when inflation grew faster than wages. Real wages have again been falling over the last 12 months, but any potential recovery in real wages is unlikely to lead to a recovery in retail sales, which have been very weak of late and help explain the succession of disappointing trading updates from the likes of Carpetright, Debenhams and Prezzo. Although the outlook for real wages is beginning to improve, food inflation remains high at +3.3% (in part due to the weakness of the Pound, post the referendum, against the Euro as well as the Dollar) and disposable incomes are likely to remain under pressure. Consumer confidence remains subdued and this is reflected in the weakness in the sales of big ticket items such as cars and houses. As a result, we remain cautious on the short-term outlook for the UK economy.

Having fallen around 4% in February, equities were down again in March as global markets were unsettled by rising US/China trade tensions. The FTSE 100 was down by 2.4%, with slightly smaller falls in the mid- and small-cap indices. The FTSE 100 Index is down 8.2% year to date, and down 10% since the market high on 12th January. UK 10-year Gilt yields fell from 1.50% to 1.35% and this helped defensive ‘Bond Proxy’ sectors such as utilities and pharmaceuticals to hold up better. Banks and retailers were noticeably weak, the latter reacting to a stream of profit warnings. In terms of individual moves, Micro Focus fell 52% on a large profit warning, following its disappointing acquisition from Hewlett Packard.

The pound ended the month above US$1.40 and is now around 12% higher against the US dollar than it was a year ago, though this is more a reflection of US dollar weakness, rather than Sterling strength. Against the Euro, Sterling was barely changed over the month.

Europe

Given the fall in the US market, it was no surprise to see the stock markets of Europe following suit during March, with investors experiencing a bumpy ride as shares headed lower. The major markets, Germany and France fell by 2.7% and 2.9% respectively, whilst Italian shares fared somewhat better, losing only 0.9%. The latter market continued to be buoyed, to some extent, by bargain-hunting, as investors bought up banks and other stocks that had been weak ahead of the Italian election. Across the Continent, small-cap stocks proved more robust than their larger peers, with the MSCI Europe Small Cap Index losing only 1.7%, compared with a fall of 2.3% for the Euro Stoxx 50. Government bond yields across Europe fell over the period, as investors considered the likely negative effect on growth of a possible global trade war. Eurozone government bonds returned a healthy +1.6% overall, as investors sought safety in Sovereign debt, outstripping more risky corporate bonds, which mostly failed to make gains.

In a month when stock markets provided so many of the headlines, it was easy to lose track of the evolving political landscape across the EU. Germany, which had been without a government since last September’s inconclusive election, had its first full month under a new ‘Grand Coalition’ between Angela Merkel’s Christian Democrats and the Social Democrats, with the latter having control of the finance and foreign ministries. Meanwhile, Italy’s general election saw the populist Five Star Movement win 32% of the vote; not enough to claim outright victory. Negotiations to form a government are likely to be difficult, and possibly lengthy, leaving the EU’s third-largest contributor and one of its most indebted nations without a government in place for the time being.

In France, President Macron’s attempts to overhaul SNCF, the state-run railway system, resulted in strike action. Negotiations with the rail union have proven difficult in the past, with Alain Juppé in 1995, being forced to withdraw proposed reforms to the retirement age, and elimination of jobs in the industry. The 1995 dispute was supported by the Paris metro workers, postal workers, teachers and others and spread from Paris to cover the entire country, leading to an eventual climb-down by the Government. The current dispute looks set to continue for a while, as strikes are planned for two days out of every five for the next three months. It is hard to imagine that prolonged disruption, or a repeat of the widespread strikes of 1995 would not have a negative effect on productivity and the investment markets. However, the rail reforms are a part of Macron’s larger pro-business reform package aimed at modernising the economy and reducing workers’ rights. The successful implementation of these plans would be seen as providing a significant boost to businesses and the economy.

In other political news, EU nations were on the receiving end of President Trump’s steel and aluminium tariffs, which, despite being aimed at China, did not exclude the US’s allies, and despite diplomatic representations from the EU, there has not yet been any exemption granted. In a worst-case scenario, the EU could find itself involved in a full-blown trade war, and this was one of the concerns that weighed heavily on the markets during the month. Whilst no action has yet been taken, the EU has signalled its willingness to consider tariffs of its own on American imports.

US

There was further evidence of the robust growth in the US economy in March. Consumer and business confidence figures were particularly strong, with US small company confidence the highest since 1983. The forward lead indicators (which take a blend of economic data points to provide a guide to the short term economic outlook) were also elevated. The fear of wage inflation, which contributed to the market falls in February, abated somewhat when the latest wage inflation data showed a moderation in the rate of pay settlements from +2.9% to +2.6%. Markets seemed to take this news in their stride, maybe due to their attention being elsewhere. Overall, the US labour market remains strong, with steady falls in unemployment and rising vacancy rates, but little sign of actual wage inflation.

If we are looking for some evidence of moderation in the pace of growth, then some of the regional business activity surveys have come off their recent highs. This is best shown by the Chicago PMI survey, which measures manufacturing activity and confidence in the Greater Chicago area. Any reading over 50 signals expansion. But overall, the broad sweep of US economic data remains very positive.

Rising US/China trade tensions led to proposals by President Trump to implement tariffs against Chinese steel and aluminium imports. Later he extended this to cover U$50bn of Chinese imports in response to allegations surrounding Chinese actions towards US intellectual property.

The US equity market reacted badly to the news flow on tariffs, with the S&P down 2.7%. Unauthorised use of personal data by Facebook and highly critical comments by the President relating to Amazon’s tax and business practices saw many of the leading tech stocks give up some of their recent gains. NASDAQ fell 2.9%, with Facebook down 10%. US small-cap companies performed better due to their focus on domestic exposure, where the impact of US business tax cuts is more relevant than the US/China trade dispute.

After a steady rise in bond yields in recent months, US 10-year bond yields fell back from 2.86% to 2.74%. This helped utilities and pharmaceuticals, which had performed poorly, to regain some of their recent ground. The first meeting of the US Federal Reserve under their new Chairman, Jerome Powell, declared that “the economic outlook has strengthened in recent months” and raised US interest rates by 0.25%. Another two interest rate rises are expected during 2018. Having previously expected two further rate rises in 2019, the Fed is now expecting to raise interest rates a further 3 times next year, as the US authorities pursue a policy of returning to historically more normal interest rates.

Asia Pacific and Emerging Markets

Japan


March was a poor month for Japanese equities, with the TOPIX falling 2.0% (in local currency terms), slightly better than global markets. The sell-off was concentrated in large-cap stocks with the large-cap index falling 2.6%, compared to a decline of 1.2% for small-caps and 1.8% for mid-caps. Softbank was the poorest performer, falling 10.4%, continuing a decline from February when earnings came in below expectations. Cyclical sectors such as basic materials and industrials fell more than defensive sectors such as utilities and real estate. In the latter half of the month, political issues weighed on markets as Abe’s approval ratings hit new lows, following additional information becoming public regarding a long running cronyism scandal. Economic data was of some comfort with GDP coming in higher than expectations early in the month at +1.6% year-on-year. Household spending also surprised on the upside. However, the manufacturing sector appears to have cooled somewhat with the flash manufacturing PMI index coming in lower than anticipated, driven by lower job creation and growth in new orders. The Bank of Japan retained its key policy settings as inflation (National CPI, +1.5% year-on-year) edged slightly closer to the 2.0% target.

Emerging Markets

Emerging markets fell 1.9% in local currency terms during the month (as measured by the MSCI Emerging Market equities index), faring slightly better than developed markets. Declines were driven by the large-cap segment of the market, with small and mid-caps outperforming. There was divergence within emerging markets on a regional basis with Korea and Taiwan, two of the largest constituents, generating positive returns as other markets fell. Both markets were supported by technology hardware manufacturers such as Samsung, SK Hynix and Taiwan Semiconductor, potentially suggesting some easing of negative sentiment in this segment of the market that was sparked by negative broker reports in late 2017. Russia was the weakest performing major emerging market, declining 3.7% in USD terms, giving back some of the solid performance generated in January and February as the Rouble fell amid a series of US-led sanctions that were introduced during the month. Consumer staples generally held up well, however more cyclical sectors such as materials and consumer discretionary underperformed. Trump’s tariff announcement shook Chinese markets, with the Shanghai Composite falling 2.8% on the day following the announcement. Investors should be conscious of the fact that direct trade with the US is only a small part of the Chinese economy, with exports to the US equating to roughly 3.5% of GDP.”

Disclaimer: FOR PROFESSIONAL USE ONLY. 


This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance.


ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

February 2018 – Market Commentary

During February, world markets saw the correction that many commentators have been expecting for some time. The downturn in global equity and bond markets was triggered by US wage inflation data that triggered a rise in the ten-year US bond yield to 2.86%, sparking fears of more and faster Fed rate rises. Falls were spread over a few days in early February, with the US market reaching technical correction territory (more than 10% of its high) at one point, though shares were quick to recover some of their losses, and the overall returns on the month were generally in the -2% to -6% across major markets. Emerging markets fared similarly badly, led by the Asian economies, which had been strong performers in recent times. Russia managed to produce a positive return over the month.

In the UK, headlines were dominated by political concerns as Brexit talks ran into difficulties once again, highlighting the fractures within the Conservative party over the strategy. Meanwhile, EU politics was more inward-looking, as the Germans and Italians faced the prospect of a new government. President Trump became more vocal on the subject of import tariffs to be implemented shortly, prompting suggestions of trade wars, whilst in China, the communist party opted to remove presidential term limits, allowing President Xi to run for a third term.

UK

The lack of positive news flow around Brexit and the transition deal has been somewhat disappointing in recent weeks as the delicate task facing Mrs May of keeping the Cabinet united on an agreed stance, whilst facing the complex challenges of the negotiation process, becomes ever more apparent. It is perhaps no surprise that the Pound gave up some of its recent gains, drifting lower through the month and ending at U$1.38.

The economic data continues to reflect the divide between strong company order books and weaker consumer spending. Wage growth is starting to accelerate and the latest data showed whole economy wage growth at +2.5% for the prior 3 months. Dig a little deeper into that data and we find that the latest private sector monthly wage growth data is up 2.8% on the prior year; within touching distance of the CPI inflation rate of +3.0%. However disposable incomes are still being squeezed as Food Inflation remains persistently high. As a result, the UK high street remains very tough with many retailers and restaurant chains reporting poor results. Uncertainty over Brexit is also having a dampening effect on major purchases such as housing transactions, which remain below the pre-2008 levels, as the chart below shows.

The UK equity market was not immune to the falls in global equities during February. The FTSE 100 was down around 4%, with similar falls for mid and small caps. UK ten-year Gilt yields were broadly unchanged over the month, but they did peak at 1.65%, before ending the month at around 1.50%. Whilst a market sell-off normally drives investors towards the traditionally defensive sectors, this one was rather different. The rise in bond yields, as well as some disappointing trading updates from individual companies, has meant that sectors such as Utilities, Beverages, Food Producers and Tobacco have remained out of favour. Reckitt Benckiser had a disappointing set of results and the shares fell by 15%, Standard Life was down 13% on news of the ending of their investment relationship with Lloyds Bank. The long running Sky bid story took an unexpected turn when US media company Comcast launched a hostile bid and the shares rose by 27%.

Europe

February was a difficult month for European equities, as the turbulence seen in world markets also affected the markets of the EU to varying degrees. There was no clear division between major and peripheral markets, but all turned in negative returns for the month. Among the worst performers were Poland, -6.6%, Spain, -5.8%, and Germany, -5.7%, whilst Luxembourg, which has been a poor performer of late, fell by only 2.7% and both France and Belgium lost 2.9%. Both growth stocks and value stocks were equally out of favour. Overall, the Euro Stoxx 50 Index fell by 4.7%, whilst the more broadly-based Euro Stoxx 600 lost 4.0% and the MSCI Europe Small Cap Index managed a slightly better return of 2.9%. Large-cap utilities, tobacco and consumer staples companies – the so-called ‘bond proxies’ were particularly susceptible to profit-taking, as noted in the UK.

February provided a political lull before the storms seen in early March, with the Italian election, German coalition vote and President Trump’s trade tariffs. The spotlight was primarily on the state of Brexit negotiations, where the Irish border continued to be a concern, and there was division within the Conservative party as to Britain’s future membership of a customs union. Hard-line Brexiteers, led by Jacob Rees-Mogg, point to the fact that membership of any such union would make Britain subject to EU trade rules and hence rule out any trade deals with other nations, effectively negating one of the main points of Brexit. Others, however, see a better deal for Britain within a customs union with the EU, than outside, seeking to create trade deals from scratch with other nations.

Returns from the Government bond markets were modest, but positive, with the S&P Eurozone Government Bond Index rising by 0.2%. Across the individual markets, returns ranged from +0.1% from the Netherlands to +0.3% from France. Political paralysis in Germany has led to less immediate fear of a rate rise from the ECB, whilst concerns over rate rises had, to some extent, already been factored into investors’ thinking, due to the strong economic growth seen in the region in recent months. The ECB, meanwhile, has been preoccupied with currency wars and the prospect of trade tariffs from the US. Index-linked bonds fared slightly better than their conventional counterparts, rising by around 0.30.4%, while corporate bonds were broadly unchanged over the month.

Unemployment continued to edge lower, driven by improvements in the labour markets of Greece and Spain, whilst inflation also continued to recede from its November high of 1.5%, recording just 1.2% in February. Meanwhile business confidence, particularly in the manufacturing sector, measured by a European Commission survey of 22,950 companies, remained strong, as GDP growth (up to Q4 2017) remained robust, helped by healthy foreign demand.

 

The Euro gained 1.3% against a weaker Pound, but was otherwise lower against Asian currencies and fell by 1.8% against the Dollar. This trend may well continue if expectations for US rate rises are fulfilled and appear faster than rises in Europe.

US

The US economy continued to grow strongly in February, with a range of macro data points posting positive numbers. Regional manufacturing surveys such as the Chicago PMI, Dallas Fed and Philadelphia Fed all posted strong numbers, suggesting manufacturing activity remained very strong. Consumer and Business confidence surveys remained very elevated, particularly for small businesses, as the impact of the Trump tax reforms starts to take effect.

The US Equity market had been going up steadily and consistently, with the S&P 500 up each and every month since October 2016. It is historically un-heard of to avoid ‘down months’ for 15 months in succession. Additionally, market volatility has been very low. However, this came to an end in February, with the S&P 500 falling by 3.9%.

The trigger for the market fall was the US Department of Labor Wage data, which came out on 2nd February. It was ahead of expectations at +2.9% (the highest reading since 2009) and the previous month was also revised upwards. With the job market as tight as it is and the economy growing strongly, it should be expected that some of the benefits would drop through to workers. A pickup in real wage growth on the back of a stronger economy and better company profits could be viewed as positive, providing it does not lead to higher prices. US Inflation measures remains relatively benign, with US Core inflation (which strips out food and fuel) running at just 1.8%.

However, the unexpected rise in the Dept of Labor wage data heightened market concerns over wage inflation leading to higher price inflation. This caused a sharp selloff in both equities and bonds, with the US 10yr Bond yield rising from 2.70% to 2.86% during the month. Commodities were also weak, with the Oil price falling by 5%.

There are other US wage data points out there. The Atlanta Fed Wage Tracker also points towards +2.9%, but their wage data is trending DOWN, not up. However, the market was paying attention to the higher profile Department of Labor data (blue line in the chart below), not the Atlanta Fed data (red line).

As in the UK and Europe, so called ‘bond proxies’ were weak, with Consumer Goods, Telecoms and Property REIT’s noticeably poor. Technology was far more robust, with Apple +6% and Cisco +8%. Walmart disappointed the market with poor e-commerce sales and the shares retreated 16%. GE continued to under perform, falling a further 13% this month on the re-stating downwards of prior year earnings. The weak oil price saw a broad retreat across the Oil and Oil services sectors, with Exxon down by 13%.

Asia Pacific and Emerging Markets

Japan

February was a poor month for Japanese equities which fell 3.7%, roughly in-line with other developed markets. Declines were led by the financial services sector which dropped 5.9%. Mitsubishi UFJ Financial Group, the largest Japanese bank, fell 6.7%, after reporting financial results which, although strong in absolute terms, disappointed relative to market expectations. Some respite was found in the healthcare sector which actually rose 1.1%, driven by strong performance from several pharmaceutical and medical instruments firms. Unhedged investors in Japanese equities would also have been supported by a rise in the Yen, which appreciated 2.4% against the US Dollar, and 5.0% against Sterling. On balance economic data was weaker than anticipated, with industrial production, retail sales and housing starts coming in below expectations. The first estimate of fourth quarter GDP was also slightly lower than expectations at +0.1% (compared to +0.2% expected). Nonetheless there were hints of price pressure, with National CPI rising 1.4% year-on-year, bringing the Bank of Japan slightly closer to its 2.0% inflation target.

Emerging Markets

Emerging markets largely erased January’s gains in February, falling 3.9% in local currency terms, slightly underperforming developed markets. The sell-off was concentrated in Asian emerging markets, with those in South America and Eastern Europe faring relatively better. Mega-cap Chinese stocks were among the worst hit with Tencent (-7.2%), Alibaba (-8.9%), China Construction Bank (-9.2%) and ICBC (-7.9%) giving back most of their quarterly gains. Baidu (+2.2%) bucked the trend, bouncing back after announcing strong fourth-quarter operating profits and positive forward-guidance. Russia was again the strongest performing major market, with the MICEX rising 2.7%, led by Sberbank, which rose 3.0%. Russian equities have been viewed as relatively cheap, especially in light of the recovery in oil prices. Arguably the most important news during the month was the Chinese Communist Party’s decision to abolish presidential term limits, effectively giving Xi Jinping the ability to run for a third term. This move further emphasises the strength of Xi’s position in the Chinese Communist Party and suggests agreement within The Party for his policy agenda, or at least an unwillingness on the part of dissenters to speak up. Economic data was mixed across major emerging markets, but remained in expansionary territory. China trade data, although potentially skewed by the Lunar New Year holiday, came in particularly strongly with import growth of +36.9% year on year, suggesting strong domestic demand.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance.

ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

January 2018 – Market Commentary

January saw another positive month for most major equity markets, but with the UK once again lagging, as the FT All-Share Index lost -2% during the month. The collapse of Carillion and a major profit warning from Capita combined with renewed Brexit uncertainty continued to undermine investor confidence. In the US, markets reacted well to President Trump’s new corporate tax package, and yields on the ten-year US Treasuries rose above 2.70% as economic data continued to point to an ongoing recovery. European data followed the same pattern, leading to further strength in the Euro. Inflation in the EU appeared to have peaked in November, removing some of the concerns that early rate rises might be necessary. Japanese inflation continued to move slowly higher, with the headline rate hitting 1.0%, which is encouraging, but still well below the Bank of Japan’s target rate of 2.0%. Further weakness in the US dollar saw it fall to more than 1.40 against Sterling, reducing US gains for UK investors. Conversely, however, this added to gains in the emerging markets, which benefit from a weaker Dollar due to their large exposure to US$ denominated debt.

UK

After the progress made in the Brexit talks in December, the New Year saw a return to the sense of drift in terms of how the EU negotiations were playing out, with little further progress being made. The perception of a badly handled cabinet reshuffle, the cancellation of non-emergency operations by the NHS through part of the month and the high-profile collapse of Carillion all added to the political pressure on the Prime Minister. Yet despite this, the opinion polls hardly changed, with the average of the polls year to date still showing a small sub 1% lead for Labour. Sterling was strong against the US Dollar, rising from U$1.36 to U$1.41, but this was more a reflection of Dollar weakness.

The UK macro data continues to reflect a tale of two economies, with very strong order books for services, manufacturers and exporters, in part due to the improving global economic outlook. Business and consumer sentiment remains weak, but maybe not as bad as the previous month, with retail sales showing some resilience. The chart below compares the buoyant CBI current order book survey with the weaker GFK measure of UK consumer confidence.

UK 4th quarter GDP came in slightly ahead of expectations at +1.5%, which represented a slowing from the previous figure of +1.7%. This rate of growth remains sluggish when compared to the rapidly improving rates in Europe and the USA. This may be due to the perceived slow progress and uncertainty on Brexit, along with the squeeze on real wages. This trend is set to continue into 2018, with the UK expected to be towards the bottom of the range in terms of Developed Economies growth rates.

Labour market data remains strong, with the January ONS labour market report showing the employment rate of 16-64 year olds at 75.3%, the highest since records began in 1971. Wage growth remains subdued, but there is some evidence that the pace of wage settlements seems finally to be picking up. UK wage growth edged higher to +2.4% (from +2.3%), still below the current 3.0% inflation level. But the gap is beginning to narrow.

Although there was little change in the economic data in the UK, bond yields rose significantly, in line with the trend globally. The yield on UK 10-year gilts went from 1.29% to 1.51%, which in the context of the Gilt market, is a significant move. Rising global bond yields and the weak US$ (which reduces the sterling value of US$ profits) acted as a drag on the FTSE100, which fell by -2%, with most of the fall in the second half of the month.

Rising bond yields and the weak US dollar made defensive dollar earners unattractive to investors, so sectors such as Utilities, Beverages, Food Producers and Tobacco performed poorly. M&A remained strong, with bids for GKN and UBM. Having already had a profit warning in December, Capita had an even bigger profit warning in January and the shares fell by nearly -50% as it cut profit guidance, cancelled the dividend and announced an emergency rights issue, as the outsourcing model that the company had based the business on came unstuck.

Europe

European equity markets were strong once again in January, and, as we saw at the end of 2017, it was the peripheral nations that led the charge, with Greek equities gaining +9.5% and Italian stocks rising by +7.6%. The core markets, Germany and France, rose by a more muted +2.1% and +3.2% respectively. Overall, the Euro Stoxx 50 Index of large pan-European companies gained +3.0% during the month, outstripping the MSCI Europe Small Cap TR Index, which managed a rise of only +1.9%. Investors favoured value stocks over growth at the start of the year, perhaps reflecting a more cautious tone, although the Economic lead indicators remain strongly positive for the coming year. Industrial and automotive equipment provided the biggest gains in the market, with water stocks being the only sector to produce a major loss, as Suez announced disappointing results and cited the independence struggle in Catalonia as one reason. Suez claims to have spent an extra $18.7m in 2017 to protect its interests in the region.

Government bonds in the Eurozone returned -0.4% overall, ranging from -1.1% from Germany to +0.4% from Italian issues, which continued to benefit from the recent electoral reform and upgrading of the nation’s credit rating by Standard & Poor’s. This performance was mirrored by the index-linked market, where German bonds returned -1.5% and Italian inflation-linked bonds gave +0.4% on the month. Overall, bond yields rose slightly, reflecting the expectation of QE tapering and possibly even a rise in the base rate this year.

Economic data continued to provide support for the markets, with GDP growth remaining strong and inflation and wage growth appearing to stabilise at a modest level. Unemployment also remained in a gentle downward trend. This combination helped to strengthen the Euro and the currency rose by +3.4% against the Dollar, creating a potential headwind for the region’s exporters.

European politics was dominated by the ongoing failure of German politicians to form a coalition. Angela Merkel spent much of January in discussions with Martin Schultz’s SPD and other parties, but by the end of the month, an agreement was yet to be reached on a new coalition Government for the EU’s largest economy. This inability to form a Government, four months after the general election, sees Germany in a state of political paralysis, which could potentially delay Brexit talks and Eurozone reforms, as both the UK and France regard German support, or acquiescence, as vital for the UK’s desire for a bespoke Brexit deal and President Macrons’ proposals for reform of the EU.

US

The economic data continued to surprise on the upside in January. Manufacturing, current order books, business confidence and investment surveys were particularly strong. Even when the economica data came in below expectations, such as the 4th quarter GDP, the underlying picture looked much stronger than the headline number.

Business confidence has continued to remain strong as the full impact of the Tax Reform Bill starts to feed through into the economy. We are seeing capital expenditure and business investment levels picking up after being subdued for a number of years. Domestically focused US corporations should see a material uplift in earnings and cashflows because of the tax cuts and we are already seeing examples of this uplift being passed on by companies such as Walmart to workers in terms of higher salaries and benefits. Analysts are rather slow in upgrading their earnings forecasts to take accounrt of the tax cuts, but these are now beginning to come through. Inventory levels remain very low by historical standards and the strong new order levels being registered by US surveys would suggest that an inventory rebuild is needed.

US 10-year treasury Yields closed 2017 at 2.46% (close to the highest point of the year), but the buoyant data both in the USA and globally, drove bond yields higher as the market began to price in further interest rate hikes and expected inflation increases. Yields went from 2.46% to 2.70% in just one month. More surprising was the weakness of the US dollar across the board, which surprised many investors given the strength of the US economy and the rise in US bond yields. But this may simply be a reflecting of the fact that economic expectations are rising faster in other parts of the world. The weak dollar was one factor which helped push the oil price to new recent highs. Brent briefly touched US$70, but the fundamentals remain supportive with solid global demand growth, falling inventories and OPEC extending its production cuts.

US equity markets continued their progress, with the S&P500 up +5.6% for the month. The S&P 500 recorded positive returns for each month since Oct 2016, the longest winning streak on record. Defensive sectors linked to bond yields, such as utilities were firmly out of favour. Proctor & Gamble fell by -6% on fears over its price-cutting strategy, GE was weak again, down -7% on a SEC investigation into its accounting and the admission that it expects its tax charge to rise, despite the tax reforms. Boeing rose by +20% on strong results, but Netflix did even better, rising +40% on much better than expected subscriber numbers.

Asia Pacific and Emerging Markets

Japan

January was a reasonable month for Japanese equities which returned +1.3% in yen terms. Although performance was below that of other developed markets, Japanese equities peaked at over 24,000 on the 23rd January, a level not seen since the early 1990’s. Market gains were led by larger-cap stocks with Toyota +5.6%, and Keyence +5.2%, the key contributors. Weakness in more interest rate sensitive segments of the market, for example, utilities and consumer staples, hindered stronger market performance. Economic data remained robust, with the Bank of Japan’s Regional Economic Report (a comparable document to the Fed’s Beige Book), signalling moderate expansion across Japanese regions and a “virtuous cycle” between income and spending, in the context of tight labour markets. In monetary policy, although inflation has continued to inch up over the course of the past year, readings on core inflation which rose +0.7% year on year, continue to be well below the Bank of Japan’s 2.0% price stability target. Unexpectedly, the Bank of Japan also slightly reduced its purchases of long-term government bonds, leading to a rally in the yen, and uptick in yields over the course of the month.

Emerging Markets

Emerging market equities had a strong start to the year, generating returns of +6.8% in local currency terms, around 3.0% ahead of developed markets. The Shanghai Shenzhen CSI 300 index was up +6.1% and whilst there was little new economic news during the month, Chinese consumer confidence remains very high by historical standards. January also saw an interesting shift in market leadership with value stocks, for example China Construction Bank (+25.0%) and the Industrial and Commercial Bank of China (+20.4%) recording solid gains, interrupting the outperformance of growth stocks which has been led by technology giants such as Tencent and Alibaba. Russia was the strongest performing major market, benefitting from the robust performance of energy stocks such as Gazprom (+9.9%) as oil prices rose. Brazil also had a positive month, with the BOVESPA Index rising 11.1% in local currency terms. The Brazilian market rose amid positive economic data with retail sales, industrial production and jobs data exceeding market expectations. Korea and India were the weakest major markets. Korea was impacted by a fall in the price of Samsung (which makes up over 25% of the market), following negative broker reports for the stock.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance.

ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

December 2017 – Market Commentary

December saw a strong end to the year from major equity markets, as investors prepared their asset allocations for 2018. Continued optimism following the re-election of Shinzo Abe in October, the passing into law of President Trump’s tax bill in late December and the last-minute agreement on the Irish border issue that was holding up Brexit negotiations all combined to provide the hoped-for ‘Santa Claus rally’, and markets closed in good spirits ahead of the new year celebrations. European politics was dominated by the failure of Angela Merkel to form a coalition government, three months after the general election, eclipsing, for the moment, the Catalonian independence question in Spain. Economic data published during the month pointed to steady and improving global growth, with wage growth in many areas appearing not to keep pace with inflation. The focus for the coming year, as in 2017, is likely to be on these data points, and their implications for monetary tightening in the major economies.

UK

December saw progress in the Brexit talks, with an outline agreement covering future UK budget contributions, the rights of EU citizens living in the UK and the border between the UK and the Republic of Ireland. This allowed negotiations to move to the next phase involving future trade agreements, which the equity market is anxious to see progress on, hence the positive reaction. Despite no firm date for these discussions to commence, markets reacted positively, both in terms of the FTSE100 and the equity prices of domestic-related assets. UK macro data continues to reflect a tale of two economies, with very strong order books for services, manufacturers and exporters, but weak business and consumer sentiment and signs of slowing business investment. This may be due to the perceived slow progress and uncertainty on Brexit, along with the squeeze on real wages. The two charts below highlight the two-speed nature of the current state of the UK economy.

UK wage data tends to be rather backward looking, often expressed as changes over a 3-month period, so more recent changes in the pace of wage growth take time to show up. That said, UK wage growth inched higher to +2.3% (from +2.2%) and the most recent data on private sector wage growth suggests a figure above +2.5%, but still below the current 3.1% inflation level.

This negative real wage pressure is currently dominating sentiment around the domestic part of the equity market and economy. But the Bank of England in its latest report, highlighted that "recruitment difficulties had intensified" and that "wage settlements were expected to be between 2.5%-3.5% in 2018". The latest data on EU migration into the UK showed those arriving looking for work (as opposed to those with a definite job) were at the lowest level for several years. This probably reflects a combination of apprehension over Brexit and the muchimproved labour markets within the EU. This will place increased pressure on the already tight UK labour market.

If wage growth moves towards 3% next year and inflation falls back towards 2% as sterling's depreciation effects annualise out, (sterling is currently 10% higher against the U$ v a year ago), then we could see the return to real wage growth, which should have a positive impact on consumer confidence and will then feed through into retail sales.

Having lagged global markets for most of the year, the FTSE 100 rallied strongly in December, up +4.9%, to close the year at 7687.8, a rise of +7.1%. M&A was strong, with bids for Ladbrokes, IWG and Regus and we had profit warnings from Saga and Capita. The strong global macro background helped drive commodity prices higher (Copper rose by 7%) and this was reflected in the very strong performance of the Mining sector.

Europe

The overall theme among the European equity markets during December was one of recovery among the smaller economies, led by Greece, which rose by 8.4%. Hungary, Portugal, Ireland, Austria, Luxembourg and the Netherlands also provided positive returns, in contrast to France, Germany, Belgium, Italy and Spain, which all fell during the month. Overall the Euro Stoxx 50 Index ended the month 1.8% lower, though small cap stocks, as measured by the MSCI Europe Small-cap Index rose by 2.4%, with investors seeking out growth opportunities among the region’s smaller companies. A rising oil price and encouraging economic data saw the mining companies sector index gain more than 10% to be the best performing equity sector, whilst the malaise in utilities continued, with telecom equipment manufacturers losing more than 18% and energy suppliers falling by more than 12%. Pharmaceuticals also performed poorly as investors took profits and these falls impacted incomeoriented portfolios.

Sovereign bonds, as measured by ‘All Stocks’ bond indices, across the Eurozone gave negative returns, ranging from -0.5% in Germany to -1.7% from Italian bonds, which had performed strongly in November, buoyed by electoral reform and the upgrading of Italian Government debt by Standard & Poor’s. Across the EU there was no clear pattern to be seen in bond spreads between the core and peripheral European markets. Index-linked and corporate bonds also performed poorly in December. The effect, if any, of the expected tapering of the European Quantitative Easing programme is hard to predict, but it is unlikely to be positive for fixed income markets in Europe. Since its inception in March 2015, the European asset purchase programme has grown to just under €2tn.

 

Although tapering is expected to start in January, asset purchases will continue until at least September, hence the ECB’s balance sheet will continue to expand for much of 2018. The ECB has also indicated that it will maintain rates at the current level. Low interest rates and easy availability of capital led to a supportive environment for equities during 2017, and this seems likely to continue into 2018. The strength of the Euro and relatively subdued inflation will help with this, though the Eurozone economy seems to be recovering well and corporate earnings growth is being reported. Investors may find plenty of cause for continued optimism, but it may be that continued improvements in growth lead, in due course, to talk of interest rate rises.

In European politics, Germany will enter the new year without a government and Angela Merkel’s CDU will shortly embark on a week of talks with their old coalition partners, Martin Schultz’s SPD aimed at piecing together another ‘Grand Coalition’. If this fails, the remaining options are a minority government involving the Bavarian Christian Socialists (CSU) or fresh elections, which would not be the favoured option for Mrs Merkel. The main point of difference that could scupper any chance of a deal in January is still migration. There are also other ‘pet projects’ of the SPD and CSU, such as healthcare reform and pensions, that could prove to represent insurmountable differences.

US

Most of the economic data points in December came in ahead of expectations, reflecting the depth and breadth of the US recovery. Adding to this, we saw the passage of the tax reform measures, the first major Trump success on policy, which will add momentum to an already strong US economy. Last month we commented that consumer, manufacturing and business confidence were already on multi-year highs and some of these data points have moved higher as shown by the chart below.

The Tax reform bill should encourage a further recovery in capital expenditure and business investment levels. Unlike the Reagan tax cuts of the 1980’s, this measure is firmly focused on the reform of corporate taxes. Domestically focused US corporations should see a material uplift in earnings and cashflows as a result. We are already seeing examples of this uplift being passed on by companies such as Walmart to workers in teams of higher salaries and benefits.

The Federal Reserve responded by raising interest rates and signalling further rate rises in 2018. We leave 2017 with US 10-year treasuries at 2.4% (close to the highest point of the year). Despite the buoyant economic data, there is little sign from either the consumer price or wage inflation data that the US economy is overheating. Core inflation remains subdued at just 1.5%, wage inflation – as measured by the Atlanta Fed Median Wage Tracker – rose by only 3.2%; but crucially, both these measures of inflationary pressures are running materially lower than a year ago.

US equity markets continued their steady progress, with the S&P500 up 0.98% for the month and 18.4% for the year. The S&P 500 recorded positive returns for each and every month in 2017, which is the first time this has happened in the 90 years of recorded data. Freeport-McMoran was the best performer, up 36% on the back of stronger metals prices and the resolving of a long running dispute at its Indonesian mine. Rising commodity prices and growing US oil production helped oil service giant, Halliburton, rise 17%. Having disappointed investors last month, GE remained under pressure, falling a further 5%.

Asia Pacific and Emerging Markets

Japan

Japanese equities ended 2017 in positive territory, returning 1.6% for the month and delivering a 22.2% gain for the year, in Yen terms. The market was led by financials and industrials stocks which rose by 2.8% and 3.0%, respectively. In corporate news, Sumitomo Mitsui Financial, Japan’s second largest bank, rose 6.6% following the Basel Committee’s decision to finalise regulatory capital requirements. Subaru Corp, surprised markets on 19th December, falling 7.0% after announcing lapses in final inspections for domestic vehicles, the automaker later recovered and ended the month down a modest 2.3%. Economic data exceeded expectations with GDP, inflation, retail sales and household spending figures all beating consensus estimates. Estimates of Q3 GDP growth were revised upwards to 0.6% (vs. 0.4% expected), with new data indicating that private demand was stronger than initially anticipated. Forward-looking data, also remains upbeat, with measures of business conditions in manufacturing and services remaining at, or near, five-year highs. In its final policy meeting for 2017, the Bank of Japan left its policy settings unchanged, maintaining the -0.1% interest rate on bank reserves and purchases of Japanese Government Bonds and ETF’s at an annual rate of ~¥80trn and ~¥6trn, respectively.

Emerging Markets

Emerging market equities had a solid December, generating returns of 2.6%, rounding off an annual return of 30.6% for 2017, in local currency terms. Larger capitalisation stocks generally underperformed mid and small capitalisation, as larger technology companies such as Tencent, Samsung and Alibaba underperformed broader emerging markets. Financial services had a good month, however, with China Construction Bank (+7.6%) and the Industrial and Commercial Bank of China (+4.7%) generating strong returns. In terms of country-specific equity markets, Taiwan was the weakest major market with iPhone suppliers Hon Hai Precision Industry (-4.8%) and Largan Precision Co (-21.8%) declining on reports iPhone X sales could come in weaker than anticipated. On the economic front, most data was in-line with expectations, however the stand-out was Chinese trade data, with both exports (+12.3% year-on-year) and imports (+17.7% year-on-year) coming in substantially ahead of expectations. In other news, the People’s Bank of China, in a surprise move, very modestly hiked money market interest rates (+5 basis points) shortly after the Federal Reserve also hiked interest rates, to signal its continued emphasis on reining in excessive credit growth.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance.

ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

November 2017 – Market Commentary

November was a mixed month for equities around the world. US equities continued their ascent, with optimism over the Republican tax plan, and Japanese stocks moved relentlessly higher following Shinzo Abe’s successful electoral gambit in October. The UK and Europe, in contrast, struggled with a weak energy sector and political problems that overshadowed the equity markets. Concerns over the lack of progress towards an agreement on the early preconditions of Brexit talks saw investors remain on the side-lines in the UK, whilst in Germany, Angela Merkel looked no closer to forging a coalition and providing the country with a stable government, two months after September’s inconclusive election. Economic data around the world remained supportive and attention continues to move steadily to the unwinding of QE and the return to ‘normality’ in interest rates. The UK saw a long-awaited rise in the base rate – the first in more than ten years, and the stock market took the news in its stride, whilst rates around the other developed markets remained unchanged.

UK

The UK saw its first rate rise since July 2007, which was entirely expected and had little impact on the bond market. However, the dovish statement that accompanied the announcement suggested that the next rise may be some time away, and this caused a short-term drop in Sterling, which it subsequently recovered. In the UK it has been noticeable that economic data points have rebounded somewhat from a lull in the summer, with most data points coming in ahead of rather muted expectations. Whilst manufacturing and export activity is strong, retail sales and consumer confidence is weak. This may be due to the perceived slow progress on Brexit, along with the squeeze on real wages.

UK wage data is very backward looking and changes in the pace of wage growth take time to show up. That said, UK wage growth for the September quarter was c. +2.2%, still below the current levels of inflation. This negative real wage pressure is currently dominating the news and sentiment around the domestic economy and equity market. But the Bank of England in its latest report, has highlighted that "recruitment difficulties had intensified" and that "wage settlements were expected to be between 2.5-3.5% in 2018". If wage growth moves towards 3% next year and inflation falls back towards 2% as sterling's depreciation effects fall out of the calculation after twelve months, then we could see the return to real wage growth.

In the November budget, the Office for Budget Responsibility's (OBR) gloomy forecasts for UK productivity growth dominated the headlines, with the OBR effectively downgrading the UK long term growth rate from +2.0% to +1.6%, which had significant impact on future tax revenues. The forecast date for the elimination of the deficit was yet again pushed further out. The budget did bring encouraging headline announcements on infrastructure and housing, but not the dramatic change of policy that some had predicted.

We had movement on Brexit at the end of November, with a broad agreement on the cost of exit seemingly agreed. We will see if the other issues associated with Ireland and the European Court of Justice are ironed out before the EU summit in a few weeks' time. The breakthrough on the Brexit divorce costs led to sizeable moves in the FX and bond markets, which flowed through to the mix in the equity market. The size of these moves shows how polarised the market is on the Brexit issue.

The FTSE 100 fell 2.2%, which was a sharper fall than either the mid or small cap indices. It has traded sideways for several months now. Sterling was strong, up 1.8% vs. the US Dollar, which weighed heavily on the FTSE, where the big Dollar-earning consumer staples sectors performed poorly. Concerns over a cash crisis at the MoD saw defence stocks under pressure. Centrica warned over poor performance in their US business and customer attrition in the UK. Tesco got the go-ahead for its acquisition of Booker and the shares rallied from their lows. A stronger oil price and a confident trading update saw Shell move higher towards the end of the month.

Europe

The European markets retreated in November, giving back some of their recent gains. The pan-European Euro Stoxx 50 Index fell by 2.8%, although small-caps were slightly more robust, losing only 1.8%. Whilst food retailing and diversified industrials were the most positive contributors. Health care and computer services also performed poorly, as did sectors exposed to discretionary retail spending. Across the individual nations, the worst of the developed equity markets was Spain, falling 3.7%, with Ireland at the other extreme, losing just 1.5%. Vestas, the world’s leading manufacturer of wind turbines, announced disappointing results, citing strong competition and price pressure within the wind energy sector. The company, which had been a stock market darling, missed the consensus analyst estimate for third quarter earnings by 15% and, in keeping with recent market reaction to poor results, the shares were immediately marked down by 21%, continuing to fall during the rest of the month.

Government bonds across Europe gave an average 0.3-0.4% positive return, whilst corporate bonds across the region lost 0.1%. Index-linked returns were in the range +0.6% to +1.3% as annual inflation appeared to resume its mild upward trend with a November CPI figure of 1.5% vs. 1.4% a month earlier. The best returns in both conventional and inflation-linked bonds came from Italy as Italian sovereign bonds continued their recent rally, having been upgraded from BBB- to BBB by Standard & Poor’s. The country’s bonds were also buoyed by the passing, in October, of an electoral reform bill that seems designed to prevent the populist Five-Star movement from gaining power in next year’s elections. The new rules, a mixture of proportional representation and ‘first-past-the-post’ are seen by supporters as making Italy more governable by encouraging coalition-building, particularly among smaller parties. However, other electoral experts have expressed concern that the new system will not produce a clear winner in next March’s election, based on current opinion polls.

Elsewhere in European politics, Germany’s Angela Merkel continued her struggle to form a coalition after September’s inconclusive election. With the AfD highlighting the fact that Germany has gone almost two months without an effective government, Mrs Merkel has been pressuring her former coalition partner, the SPD to form a new coalition, with talks scheduled for early December. The SPD leader, Martin Schultz, is also, allegedly, facing pressure from within his own party after rejecting the idea of a continued coalition partnership with the Christian Democrats. Unemployment in the Eurozone continued to edge lower, reaching another new multi-year low of 8.8% in October. The overall figure continues to be distorted by the high rates of particularly youth unemployment in Spain and Greece, but improvements in these countries are also contributing significantly to the improvement seen in figures for the EuroZone.

The Czech Republic has the lowest rate of unemployment at just 2.7%, whilst the rate in Germany is 3.6%. GDP growth, last reported in September, remains robust at an annualised 2.5%, up from 2.3% in Q2 and 1.9% a year earlier.

US

November saw a continuation of the strong sequence of economic data being seen globally, with the US leading the way. As the two charts below show, US consumer confidence and manufacturing sentiment are close to 20-30 year highs.

3Q17 GDP growth was upgraded to 3.3% and the composition was good, with less reliance on the consumer and a big pick up in business investment. The vast majority of economic data points came in ahead of expectations, reflecting the depth and breadth of the US recovery. We also had some progress on the Tax reform bill, which if passed could have a positive impact both on markets and the economy, particularly on capital expenditure and business investment levels.

Turning to oil, OPEC agreed to extend production cuts. We have seen material upgrades to global oil demand growth this year (and also for 2018), driven by the synchronous global GDP growth (with a major influence on oil demand being the economic recovery in Europe). We are also seeing a lower-than-expected growth rate from US shale producers, partly linked to higher cost inflation in that area but also because of less access to capital and a greater focus on returns versus growth on the part of operators. Shale is growing quickly, but not as quickly as some had forecast. However, progress on reducing the huge levels of crude oil inventory in the States remains muted, as non-conventional supplies of oil continue to increase.

US equity markets were very strong, with the S&P 500 Index up +2.8%. The S&P 500 has now recorded positive returns each and every month YTD, which is the first time this has happened in the 90 years of recorded data. Stronger than expected retail sales during Black Friday saw a strong rally amongst the retailers, with Wall Mart up 12%. House Builders were strong on the back of supportive macro data. GE, once the biggest company in the world, fell 10% on a poor set of results and a large cut in their earnings guidance. They also cut their dividend for the first time since the 1930’s.

Asia Pacific and Emerging Markets

Japan

Japanese equities rose in November, with the TOPIX Total Return Index increasing 1.5% in yen terms, slightly behind the MSCI World. The result marked a milestone in the Nikkei 225 which closed at its highest level since 1992 on 7th November. Market gains were led by Consumer Services (+3.8%) and Consumer Goods (+2.6%). Sony was among the biggest movers, rising 17.9%, on the back of strong results and bigger than ex
pected upgrades to earnings guidance. Economic data remained solid, with GDP rising 0.3% quarter on quarter, leading to Japan’s 7th straight quarter of growth, the longest since 1999/2000. Growth in the economy was driven by net exports and a rise in inventories, with private consumption and government spending detracting.

Emerging Markets

Emerging markets equities were negative in November, returning -0.8% in local currency terms. The decline was driven by large emerging technology companies, with Samsung (-7.8%), Taiwan Semiconductor (-7.0%) and Alibaba (-4.2%) all recording negative returns. Samsung was particularly impacted by a downgrade from Morgan Stanley, who argues the technology giant’s profits may suffer as demand for memory chips pulls back from cyclical highs. At a country level, the decline was broadly based however Russia’s MICEX bucked the trend, rising 2.85%, as the energy-heavy index benefitted from a rise in oil prices as OPEC agreed to extend production cuts until the end of 2018. Economic data in emerging markets was mixed. In India, industrial production and GDP came in below expectations, while the Nikkei Services PMI signalled a slowdown in growth of the services sector. Chinese data on industrial production (+6.2% year-on-year) and retail sales (+10.0% year-on-year) also fell short of expectations, however PMI data in the services and manufacturing sectors continues to indicate a relatively positive outlook. A recent trend of note in the Chinese manufacturing sector has been a widespread crackdown on polluting factories, coinciding with the Chinese Communist Party Congress in October, in which President Xi Jinping signalled greater prioritisation of environmental goals. This trend is being observed from a top-down perspective in producer price inflation, as the rationalisation of polluting industries (e.g. cement), appears to have contributed to higher quality, environmentally-compliant firms gaining additional pricing power.

Source: China National Bureau of Statistics: Producer Price Indices for Industrial Products reflect the trend and degree of changes in general ex-factory prices of all manufactured goods during a given period, including sales of manufactured goods by an industrial enterprise to all units outside the enterprise, as well as sales of consumer goods to residents.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance.

ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

October 2017 - Market Commentary
 

October saw equity markets across the world continue their ascent, with strong performances in most areas and the UK, once again, pulling up the rear as Brexit negotiations continued to provide a cloud over investor sentiment. In the Eurozone, Catalonia held a referendum on independence from Spain. The vote, declared to be illegal by the Spanish Government and accompanied by violence from the Spanish police, appeared to show strong support for the independence movement, and was followed by a formal declaration of independence, which has not been recognised by world governments. In Germany, Angela Merkel is struggling to pull together a coalition Government, following her election victory in September, whilst in Japan, Shinzo Abe is also settling into another term in office after his snap election win on 22nd October. The Japanese equity market is now at a 25-year high, whilst the UK and US markets have reached new all-time highs. Fixed income markets were mildly positive with the exception of the UK, where expectations of the November rate rise weighed on bonds. Hints were also given that the next rate rise would not happen for some time also hit Sterling. The global economic recovery appeared to continue on-track, with steady GDP growth being indicated, particularly in the US, whilst consumer activity, as measured by monthly retail sales, remained erratic in many markets.

UK

Brexit negotiations continued, but with little real sign of progress. EU Chief Negotiator, Michel Barnier, made some more conciliatory noises about wanting to make progress and David Davis alluded to further movement from the UK with regards to Teresa May’s implied offer of GBP20bn from her Florence speech.

It is now virtually certain that insufficient progress will have been made to allow progress onto trade talks in December. The UK Government is still trying to engage the EU on the territory of mutual economic benefit, whereas Brussels remains firmly focused on the political imperative that any deal with the UK makes it manifestly clear as to the economic ‘price’ of leaving the EU. As a result, the prospects and implications of a ‘no-deal’ departure are gaining increased comment and debate.

The economic news flow and the tone of the accompanying media coverage remains subdued and in marked contrast to the flow of better macro data across the world. Hope lies with an improved labour market, which is essentially the Bank of England’s focus, as it ponders the first interest rate rise in a decade. Growth remains sluggish, with the broad sweep of data moving in a sideways direction.

The labour market data continued to be at the more resilient end of the spectrum. Whilst real wages continue to fall against both CPI and RPI measures, employment and hours worked continue to grow, so overall the consumer is in a reasonable position, even if consumer confidence continues to drift lower. Retail sales data remains very volatile, and core inflation remains stubbornly high at +2.7%, just a fraction below CPI at +2.9%.

Following a dip in September, equity markets rallied, with the FTSE 100 index rising 1.6%, mid-caps up 1.8% and small caps up 2.1%. There were several profit warnings, led by one of the less well-known FTSE stocks, the medical products manufacturer, Convatec, which fell by 30%. Merlin Entertainments (owners of LEGOLAND amongst other attractions) fell 16% on weaker current trading and IWG (Regus) was down 32% on a major profit warning. Poor numbers from Glaxo, GKN and Barclays were not received well. Conversely, there were bid approaches for Millennium Hotels, Spire Healthcare and Aldermore. The rising oil price and some good results from BP made the oil sector the biggest contributor to the index rally and mining stocks also gained further ground.

Bonds did very little, with the UK 10 Gilt Yield drifting marginally higher to 2.38%. Sterling moved lower, from U$1.34 to U$1.32. Oil continued to grind higher on concerns over events in Kurdistan and signs of a further extension of the OPEC production cuts. It closed the month above U$60/bbl.

Europe

European stocks enjoyed another positive month in October, helped by a slight weakening of the Euro, which had begun to prove problematical for large-cap equities after its recent strength. The Euro Stoxx 50 Index of the largest pan-European companies rose by 2.2%, whilst small-cap stocks gained a similar 2.1%. French and German equities were among the strongest, gaining more than 3%. Technology stocks were among the top returning stocks during the month, whilst the telecommunications sector as a whole lost more than 13% after Nokia announced third quarter sales down 9% on the previous quarter and saw operating profit of €4.8bn vs analyst expectations of €5bn. Nokia shares lost more than 15% on the announcement, emphasising the trend seen in recent months for companies that miss their forecasts, even slightly to be severely punished by investors.

Fixed income markets were similarly buoyant with Government bonds across the continent returning +1.1%, slightly ahead of corporate bonds, whilst index-linked issues also saw small gains of less than 1%. Interest rates and the yield curve remained unchanged over the period.

In terms of economic data, the current state of the Eurozone appears favourable as unemployment continues to trend lower, reaching 8.8% in September. This figure is inflated by the high levels of unemployment, and particularly youth unemployment in Greece and Spain, and some further improvement seems likely as these markets recover. GDP growth continues to trend strongly with growth in the third quarter at 2.5%, up from 2.3% in the second quarter of 2017. Inflation, however, tailed off slightly in October, falling from 1.5% to 1.4%, and the consumer still seems reluctant to participate, with negative real wage growth in many areas and retail sales falling for the second successive month in August.

In Germany, Mrs Merkel’s attempts to form a coalition Government without her former allies, the Social Democrats, seem to be proving predictably difficult. Having seen the country lurch at least in a small way, to the right as the AfD share of the vote in September’s election grew, Mrs Merkel is now seeking to stitch together a coalition of more moderate parties. The foremost of these is the Free Democrats, and the Greens are also most likely to be involved. However, there are a number of issues that stand in the way of a deal being done. Firstly, the business-friendly Free Democrats are keen to get their hands on the Finance Ministry, whist Merkel’s conservatives are not keen to let it go. Secondly, Mrs Merkel’s national policy of moving Germany rapidly towards complete dependence on renewable energy sources is not a priority for the Social Democrats. The next step in this policy – the closure of the country’s coal-fired power stations, requires urgent attention, as the reduction of CO2 emissions is a key part of Germany’s commitment to the Paris climate deal. Hence it seems as though political horse-trading may extend into 2018 before a new Government is formed. Migration is also a point of disagreement between the parties and Merkel has lost support due to her handling of the migrant crisis.

Elsewhere in Europe, the issue of Catalonian independence persists. Catalonia is the richest part of Spain, but would inherit a large amount of debt if it were to secede. In addition, it would not initially be a member of the EU and would find itself negotiating trade arrangements and joining a waiting list for membership – which would need approval from all 27 states, including Spain. On balance, a breakaway by Catalonia seems unlikely, but the situation continues to develop away from the front pages, and the elections at the end of December will be a major determining factor as to how it is resolved.

US

The most recent US real economy news flow indicates that the US expansion remains alive and well. The Chicago Fed’s National Activity Index – the best available indicator of US economic momentum which has 85 separate inputs – improved sharply last month to a slightly above-trend level, and the anecdotally-sourced Fed Beige Book stated: “Reports from all 12 Federal Reserve Districts indicated that economic activity increased in September through early October, with the pace of growth split between modest and moderate”. Importantly, too, wage and price pressures were reported to be limited “despite widespread labour market tightness”.

Another data-point deserving of comment is the preliminary US GDP report, which showed a stronger-than-expected annualised gain of 3% and a YoY gain of 2.3%, the latter the most robust showing seen for two years. It’s also worth noting that the Philadelphia Fed monthly capex intentions response remained at an historically elevated level in October, which pushed the 6-month moving average to a new, multi-year high. In the past this index – albeit based upon a regional manufacturing survey – has proved a useful leading indicator of nationwide business investment, as the following chart shows.

On this basis, the extra-ordinarily buoyant survey capex readings seen in recent months suggest that US business investment will strengthen substantially further. Regional manufacturing surveys suggest elevated business confidence levels and investment intentions. Given that the consumer has done all the heavy lifting so far, it is encouraging to see US companies now joining the party. Despite a very tight labour market, there is little sign of inflationary pressures building up in the system. US core inflation rose by only 1.3% YoY in October – a very considerable way short of the Fed’s 2% target.

This positive economic backdrop, with minimal inflation along with positive updates from the earnings reporting season from US corporates has helped drive the US equity market to new highs. The S&P500 was up 2.2% and has now recorded positive returns in every month YTD, which is the first time this has happened in the 90 years of recorded data. We are now looking at 12 months of consecutive positive returns, which equals the records of 1935/36 and 1949/50.

The perceived predictability of the short-term interest rate outlook alongside low inflation meant that Bond Yields hardly moved, with US 10-year bond yields moving up from 2.33% to 2.38% and the yield curve steeping very slightly.

Asia Pacific and Emerging Markets

Japan

Japanese equities were again higher in October, with the TOPIX Total Return Index rising 5.5% in Yen terms, 2.9% ahead of other developed markets. The rally was led by Technology (+8.4%), and Industrials (+7.8%). Softbank (+9.5%) was the strongest performing company in the top 10, on speculation that Sprint Corporation (in which Softbank holds a majority stake) would merge with T-Mobile. However, political events dominated the news headlines with the general election occurring on 22nd October. The ruling coalition, led by the Liberal Democratic Party (LDP), achieved strong results, gaining almost 50% of the total vote and just over two-thirds of available seats. The results represent a decisive win for Abe and the LDP, and may provide the ruling coalition with the support required to change Japan’s pacifist constitution. The results also suggest a continuation of “Abenomics” which has sought to reflate and grow the Japanese economy. By several measures, Abenomics has been a success, Abe’s leadership has been marked by a steady decline in unemployment and an increase in the number of jobs to applicants, as well as robust growth in corporate earnings and a depreciation of the Yen.

Emerging Markets

Emerging market equities were positive in September, returning 3.9% in local currency terms, around 1.6% ahead of developed markets. Continuing the trend observed earlier in the year, technology companies such as Taiwan Semiconductor (+12.2%) and Alibaba (+7.1%) drove the performance of emerging markets. At a country level, India and Korea were the strongest performers, rising by 5.6% and 5.5%, respectively. Both countries appear to have benefited from solid economic data, with industrial production in India and overall GDP growth in South Korea, exceeding market expectations, despite the tensions with North Korea. However political events in China were the highlight of the month as the Chinese Communist Party held its 19th Party Congress between 18th and 24th October. Xi Jinping was re-elected General Secretary of the Communist Party and a new line-up of leaders was unveiled, with five of China’s top seven leaders in the Politburo Standing Committee being replaced. The event appears to have solidified Xi Jinping’s position as paramount leader of The Party, as “Xi Jinping Thought”, a body of work encompassing Xi’s political theories, was incorporated into the Party’s Constitution.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

September 2017 – Market Commentary

September was dominated by political events: The German Bundestag elections, Brexit, the calling of a snap election in Japan and the ebb and flow of US/North Korean tensions. Theresa May made her all-important speech in Florence to try to re-start the stalled Brexit negotiations, whilst, elsewhere in Europe, Germany became the latest EU nation to see an increase in the populist/nationalist vote, although Angela Merkel’s CDU did retain its position as the largest party. Sorting out a new coalition without the SDP, CDU’s former partner, may be a long job, and may introduce some uncertainty into German politics. Japanese centre-right Prime Minister, Shinzo Abe, saw a sharp bounce in his hitherto poor approval rating as the opposition fell into disarray, and took the opportunity to call a snap election on 22nd October. Equity markets across the world were mostly positive, with the notable exception of the UK, where sentiment is increasingly being affected by the weak position of Theresa May as Prime Minister and the lack of progress over Brexit, with the uncertainty that this generates for businesses. Meanwhile, a generally more hawkish tone from central banks saw fixed income markets weaker during the month.

UK

The major news during September was Theresa May’s speech in Florence, in which she attempted to build bridges with other EU leaders with the aim of securing a favourable trade deal after 2019. The general consensus of opinion seems to be that Mrs May probably did enough to restart the stalled negotiations, but not enough to push them beyond the current sticking points of the ‘Divorce bill’ and citizens’ rights. In her speech, Mrs May requested a two-year transition period to allow new trade arrangements to be put in place smoothly, and she conceded that during this period, Britain would continue to be subject to EU rules, including the jurisdiction of the European Court of Justice. Mrs May also offered to pay enough into the EU to ensure that no member state will have to pay more (or receive less) during the current budget round ending in 2020. She did not mention a sum, but it seems likely to be about €20bn (£18bn).

Just hours after the Prime Minister’s speech, the credit-rating agency, Moody’s, cut its rating for UK sovereign debt from AA2 to AA1: its lowest ever credit rating. Moody’s stated the belief that Brexit will be negative for the country's medium-term economic growth prospects, and that growth will not recover to its historic trend rate over the coming years. In addition, the agency said that it expects significantly higher Government spending levels than currently predicted, leaving the UK budget deficit stuck between 3% and 3.5% of GDP, compared with a Government target of <1% in five years’ time. S&P, the other major ratings agencies, have yet to react.

Latest figures showed unemployment continuing to edge lower, reaching 4.3% and inflation returning to the 2.9% level seen in May. However, second quarter GDP growth was revised downwards from 1.7% to 1.5% and wage growth remained stuck at 2.1%. Whilst this figure is not helped by the lack of bargaining power of workers in the ‘gig economy’, the recent removal of the cap on some public sector wages may well have some effect over the coming months. Retail sales recorded their third successive monthly gain, rising 1% from July to August.



Source: Office for National Statistics

Equities sagged during the month, with the FTSE 100 losing 0.8%. Some comfort was found in the mid-cap space where the Mid 250 Index managed a gain of 0.4%, driven by value investors fishing for bargains in a generally weaker market. Investors’ attention was focused on Ryanair, as the company announced a failure to plan for pilot holidays, which necessitated the cancellation of up to fifty flights per day over a six-week period, leading to a fall of more than 9% in the shares, despite a 10% increase in traffic in September. Oil stocks led the market, gaining more than 17% as the oil price recovered by 7.7% over the month.

The pound jumped past the $1.36 level mid-month and hit a 15-month high of $1.3611 after Mark Carney was quoted as saying the probability of a UK rate increase had “definitely increased”, following the rise in inflation noted in August. Mr Carney subsequently reined in his enthusiasm, saying that rate rises were likely to be gradual, and settle at a level significantly below those seen before the financial crisis. Sterling retraced some of its gains, but still turned in a strong performance against all major currencies over the month, gaining 3.5% against the Dollar and 4.5% against the Euro, as expectations reflect a 75% chance of a rate rise in November.

Bond markets reacted predictably badly, with long-dated gilts returning -4.0% and their index-linked counterparts -5.0%. Corporate bonds in general recorded a loss of 1.9% according to the iBoxx UK Corporate Bond Index and Sterling High Yield bonds, those of poorer quality and more speculative in nature, returned +0.1%, being the only part of the fixed income landscape to remain above water during September. The UK yield curve steepened slightly on the change in base rate expectations.


Europe

September marked the best performing month for European equities this year, with stellar performances from the Dax, up 6.4%, EuroStoxx 50, up 5.1% and the Eurostoxx 600, up 3.8%. The rally was led by various key sectors such as basic materials, industrials and financials. In particular the banking sector performed well on the expectation of a tighter monetary policy going forward. Spanish equities lagged their counterparts gaining 0.8%, as performance was hindered by the upcoming referendum vote in Catalonia, which led to clashes between the Spanish Government and referendum voters. The biggest laggard from the region was Greece with the Athex Composite Index down 8.5%. Concerns around the country entering its final bailout review has worried market participants, who are now weighing whether the country can stand on its own once the bailout ends and how the final review will be conducted by the IMF.

In terms of economic data, business conditions remain robust. Euro Area Manufacturing PMI increased to 58.1, with output and new orders continuing to expand across Europe and the recovery looking very broadly based. Faster growth increases were registered in Netherlands and Spain, while slower but still strong growth was seen in Germany, France, and Italy. Notably, Greece saw its biggest expansion since June 2008. However, consumer confidence and retail sales from the region remain negative and inflation remained unchanged at 1.5%.

On the political front, we finally saw the German elections come to a close, with Angela Merkel marginally wining her fourth term as chancellor. Marked as the worst election for the CDU party since the 1950’s, Angela Merkel faces a number of challenges ahead to form a strong Government. Firstly, Mrs Merkel will need to form a coalition Government with the Greens and the liberal Free Democrats party (FDP), the negotiations for which could lead in to next year. Secondly, she will need to overcome the differences within her own block between the Christian Democratic Union party (CDU) and their long term allies the Christian Social Union (CSU) on potential upper limits on migrant numbers. Merkel’s reluctance about placing limits on refugees in the past has been one factor cited for her losing votes to the extreme far right party - alternative for Germany (AfD).

French president Emmanuel Macron also scored an important victory last month by signing the new labour reform bill. The bill is designed to cap severance payments and make it easier for companies to lay off and hire workers and in turn should improve overall competitiveness in the labour market and increase growth over the medium to long term. The controversial bill was expected to see mass street protests during the Summer, though in fact, only the hardline General Confederation of Labour union called for a strike in September, describing the bill as a ‘Declaration of war’. French law makes it mandatory for the government to consult all unions before reforming the labour market.

US

September in the US was a month of turbulence, both politically and meteorologically. Tensions between the US and North Korea continued to escalate after Pyongyang claimed to have tested a hydrogen bomb, and after a second ICBM test that weapons experts said could even bring New York within striking range of North Korean missiles. North Korea accused the US of declaring war, following an inflammatory tweet by President Trump.

The Graham-Cassidy bill, the last GOP healthcare bill (for the foreseeable future, at least), failed to get through the Senate. In fact, this fourth Obamacare repeal bill did not even make it to the vote, being withdrawn a few days before the 30th September deadline. The bill, which had seemed to be gathering momentum, ultimately fell in the same way as its predecessors as Republican Senators baulked at the prospect of reforming US healthcare in such a haphazard process, especially given the proposals to reduce Medicaid cover and remove protection for people with pre-existing conditions.

Elsewhere, a succession of bad weather events devastated the US’s Caribbean neighbours and did substantial damage to various areas of the US mainland, particularly Florida, Texas and Southern Georgia. Hurricanes Harvey and Irma did however bring a bonus for shares in the automotive sector as consumers in hurricane-hit parts of the country, particularly Southeast Texas, rushed to replace flood-damaged cars. Both retail and fleet sales leapt in September, providing car manufacturers with their first monthly sales gain this year, though this was from a depressed level in August when the hurricanes were being anticipated. Oil stocks also performed well as the oil price rose steadily during the first three weeks of the month with WTI crude climbing back above $50. Outside the automotive sector, consumer stocks were less favoured, with housewares faring poorly and food and drink stocks also losing close to 10% from their share prices. Overall, equities were positive, with the S&P 500 Index climbing 1.9% and the Dow Jones US Small Cap Index rising by 5.2% during the month.

Fixed income markets were weaker over the month, as a more hawkish tone from the Federal Reserve saw yields at the longer end rise by around 0.13%. Long-dated Treasuries returned -2.3% and their index-linked counterparts lost 1.3%. Corporate bonds were similarly lacklustre, with the exception of high yield bonds, which managed a positive return of 0.9% as investors continued to seek out any remaining opportunities for a positive return.

Wage growth is expected to reach 3.58% by the end of the third quarter. However, unemployment rose unexpectedly in August, from 4.3% the previous month. Inflation also exceeded expectations, rising to 1.9%, compared with 1.7% in July and forecasts of 1.8%, and retail sales dipped in August, falling 0.2% from their July level. It remains unclear whether the consumer is yet ready to join in the recovery and figures for September will be distorted by the unusual weather patterns seen during the month.


Source: US Census Bureau

On the foreign exchange markets, the Dollar lost 3.5% against a stronger Pound, which was boosted by talks of an early rate hike from the Bank of England. Against the Euro, it achieved a modest 0.8% gain.

At its September meeting, the Federal Reserve said that it would start to reduce the $4.5tr balance sheet that is the legacy of six years of quantitative easing. Some action on this issue had been widely expected, and did not cause undue concern, though it is worth noting that such actions in the past, have often resulted in recession: an outcome that the Fed will wish to avoid.

Asia Pacific and Emerging Markets

Japan

Japanese equities were sharply higher in September, with the TOPIX Total Return Index rising 4.3% in yen terms. The rally was led by more cyclical sectors with financials (+6.4%) and industrials (+5.5) outperforming more defensive sectors, for example healthcare (+3.0%). Toyota, Japan’s largest company, had a particularly strong month, rising 13% as part of a broader global rally in consumer cyclicals. Japanese equities continued to benefit from positive net flows with monthly inflows of $US 7.2bn into Japanese equity ETF’s, based on Morningstar figures. Year to date Japanese equity ETFs have experienced inflows of $US 42bn. It was a relatively sparse month for economic data, however year-on-year GDP growth came in below expectations at +2.5%. News later in the month was more positive with exports and industrial production rising more than anticipated. In monetary policy, the Bank of Japan left its policy settings unchanged, while lowering its inflation forecasts to 1.1% (from 1.4%) for the current fiscal year. The resignation of Japanese opposition leader, Renho Murata, appeared to leave the main opposition party in some disarray, and Prime Minister Shinzo Abe called a snap election for 22nd October, seeking to capitalise on a rally in his previously sagging approval rating. Abe’s popularity had fallen as low as 20% in July, following a number of scandals, but rose to 50% after recent North Korean provocations and nuclear tests. Whilst the election is not a foregone conclusion, polls seem to suggest that Abe’s gamble could pay off.


Source: Morningstar

Emerging Markets

Emerging market equities were marginally positive in September, returning 0.4% in local currency terms. September saw reasonable dispersion in terms of country performance as India and Taiwan fell, by 1.3% and 1.9%, respectively, while Brazil (+4.9%) and Russia (+3.1%) rose. Taipei-based Hon Hai Precision Industry (also known as Foxconn), the largest assembler of Apple’s Iphones, fell around 10%, as investors were disappointed by Apple’s latest round of new products, and pre-orders for the Iphone 8 came in substantially lower than for its predecessors. Samsung appears to have benefited from the same event, rising 10.7%. Brazilian stock markets were buoyed by data showing that GDP has grown for the first time in almost three years, however ongoing corruption charges for President Michel Temer risk hampering much needed reforms and derailing market sentiment. Russia’s MICEX stock index was propelled higher by rising oil prices, with Brent Crude closing the month at $57.5, up from $52.4 at the end of August. In upcoming political news, China’s Communist Party is set to meet on October 18, for its 19th Party Congress, an event which will be closely watched by markets due to the anticipated transition of leadership from several members of the powerful Politburo to a new generation of leaders.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance.

ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

August 2017 – Market Commentary

August is a traditionally quiet month in terms of news, with many market participants absent. Last month saw broadly neutral returns from equities. Bond markets were able to offer positive returns, in light of relatively benign economic data. The major themes of Brexit and US/North Korea were largely ignored by investors. The Jackson Hole Economic Conference produced no headlines and, thus far, the forthcoming German election looks set to go in favour of the incumbent Christian Democrat party. Japanese economic data exceeded expectations and inflation achieved a small, but welcome, tick upwards, offering hope that Abenomics is indeed starting to work. UK

August saw little progress in the UK’s Brexit negotiations with the European Union, with the same sticking points of the free movement of people and the ‘divorce bill’ being rehashed in the press on a daily basis. These points are reported to be holding up the very substantial talks that will be needed to work out the fine detail of what the relationship will eventually look like and it seems the longer the current posturing continues, the more speculation about a ‘hard’ Brexit will be heard.

July’s inflation figure remained stuck at the 2.6% figure that it had fallen to in June, and with retail sales continuing at a subdued 0.3% in July, and June’s data showing just 2.1% wage growth, there is still little to suggest that the British consumer is ready to join in the recovery. Consumer confidence, represented by the GfK Consumer Sentiment Index, which has averaged -8.96 over nearly four decades, stands at -10: a little above its recent low of -12, but still looking very sickly in comparison with the level of -1 a year ago. The Index measures households' expectations over the next 12 months regarding their personal finances and the economic situation. By contrast, the CBI Business Optimism Index stands at +5, compared with +1 during the second quarter, and against a long-run average of 3.4. Low unemployment has yet to lead to significant wage inflation, and industrial production is trending upwards from its low in April of this year, hence there is little reason for gloom in the corporate sector. With the Pound weakening by upwards of 2% against all major currencies, the outlook for Britain’s large-cap exporters continues to be relatively benign.

Investment markets were typically quiet during August, with few outstanding features. The FTSE 100 Index recorded a gain of just 0.8%, ending the month at 7430, despite reaching 7531 early in August, less than 20 points below its all-time closing high. Miners were the best performing sector, driven by improving forecasts and increased production, whilst technology was the major laggard as profit-taking continued in a sector that was at the forefront of global equity market performance during the first half of the year. There were few individual stock stories of note, but Provident Financial, the FTSE 100 doorstep lender, saw its shares fall by a further 57% over the month, after a second profit warning saw a one-day fall of 66%. The shares had already fallen by 15% in July, on the first indication that their move towards app-driven lending and re-organisation of doorstep collections was running into problems.

UK fixed income markets performed well, with conventional gilts returning +1.9% overall and up to +3.4% at the longer end. Corporate bonds gave a slightly lower +1.3%, with high-yield bonds offering only +0.7%. Index-linked gilts also rebounded, giving a +4.7% return overall, with +6.1% from the over-fifteen-year stocks. Across the curve, yields softened on comments from Mark Carney suggesting that a rise in the base rate is unlikely this year, reversing comments made earlier in the year.

Europe

European equities declined during August with the Euro Stoxx 600 Index down 0.45%. Economic data remained robust, but the strength of the Euro during the month presented a headwind for shares. The biggest laggard was Spanish equities, where the IBEX was down 1.93%. This was due, in large measure, to the terrorist attacks in Barcelona and Cambrils.

Looking at this in more detail, Eurozone GDP growth came in at +0.6% in the second quarter, up from 0.5% in the first quarter. This was supported by faster expansion from the likes of Spain, Netherlands and Austria, whereas France was unchanged and Germany slowed. In terms of business conditions, the manufacturing PMI index rose to 57.4 in August from 56.6 in July, suggesting ongoing growth momentum boosted by domestic demand and rising new export orders. However, the services PMI continued to slow due to fewer jobs being created and a pickup in input and output prices. Inflation over the last month had picked up to higher than expected 1.5% from 1.3% in July.

Overall the region continues to show signs of stable growth with the recent Economic Sentiment Indicator increasing to 111.9, its highest level since July 2007.

Given the stronger data, investors were also looking ahead to the ECB’s policy meeting in September, where market participants are looking out for any signals on the tapering of the quantitative easing programme. It had been thought that some clue might be given by Mario Draghi’s speech at the Jackson Hole conference, but this turned out not to be the case.

Within the equity market, the top performing sectors were transportation, utilities and mining, underlining the broad economic recovery. However, the poorer performing sectors were mostly consumer-facing: Food retail, media, financial services and leisure, adding weight to the idea that the consumer is proving to be a drag on the recovery. Retail sales reported in July saw a month-on-month fall of 0.3%. Fixed income markets remained buoyant with sovereign bonds returning +0.8% and investment-grade corporate bonds giving +0.6%, as the market anticipated no early increase in interest rates. August also saw campaigning begin in earnest for the German elections in September. Following the 2013 election, the 631-member Bundestag is governed by a coalition led by Angela Merkel’s Christian Democrats (311 seats) and the Social Democrats (193 seats). The opposition comprises the Greens and The Left Party. All signs point to a comfortable win for Angela Merkel, who is personally popular, and polling well ahead of Martin Schultz, the SDP leader, at present. There is a possibility that the CDU may end up in coalition with one or more of the other parties, but the expectation overall is for no change. The nationalist AfD has a widespread but small support base, and the best outcome that they could hope for would be to form the main opposition party, though this is just one of many possible outcomes.

US

The Jackson Hole conference, billed as the event to watch in August, turned out to be the proverbial damp squib. Paul Mortimer-Lee, Chief Market Economist at BNP Paribas summed up the proceedings, saying “It looked as if ECB President Draghi and Fed Chair Yellen had competed to see who could produce the speech least relevant to monetary policy. We call it a 0-0 draw” (http://blogs.marketwatch.com/capitolreport/2017/08/25/jackson-hole-fedconference-live-blog-yellen-draghi-on-tap/). Instead, most media attention during the month was centred around the continuing escalation of tensions between the US and North Korea. Despite this, investment markets remained largely unmoved during the summer period. The S&P 500 Index managed a rise of 0.1%, whilst smaller companies, as measured by the Dow Jones Small Cap Index, were a little weaker, falling by 1.1%. A Bank of America survey, published mid-month, suggested that only 33% of money managers expect corporate profits to improve from here, compared with a figure of 58% in the same survey at the start of 2017, and we have seen in recent weeks how the broadly-based market uptrend has been accompanied by savage markdowns for companies that disappoint even slightly in their earnings. In July, O’Reilly Automotive fell by 20% on announcing sales growth of just 1.7% versus expectations of 3-5%, and in early August, travel group Priceline had its shares marked down by 8% after it reported second quarter gross bookings of $20.8bn, versus expectations of $21.05bn.

The same Bank of America survey saw a record 46% of managers expressing the view that equity markets are overvalued, although positioning among US managers still seems to be pro-risk, and the S&P 500 Index is still trading just above 21 times trailing 12-month earnings – around 23% above the ten-year average.

President Trump’s handling of the North Korean crisis has been criticised for his attempts to use economic measures to exert influence on other Asian nations, particularly China, threatening to cut off trade with any country that does business with North Korea. Previous Presidents have managed to separate security issues from trade issues and co-operate on the one, whilst competing on the other. Mr Trump’s determination to link the two is a departure from historical US policy and it is unclear how the US stands to benefit from it, given that more than a quarter of US exports go to Asia.

Meanwhile, economic data points to a continuing recovery in the US, with inflation rising from 1.6% in June to 1.7% in July, and retail sales exceeded forecasts of +0.4%, with a reported figure of +0.6% in July: an increase on June’s figure of +0.3%. Industrial production also pushed further ahead in July, with a year-on-year increase of 2.2%, compared with 2.1% in the previous two months. August also saw significant increases in both consumer and business confidence, with the former rising from 63.4 to 96.8 and the latter from 56.3 to 58.8. The retail sales data saw a short-term rally in the Dollar, leading to rekindled speculation about further Fed rate rises this year. However, over the month the US currency weakened against both the Yen and the Euro.

Fixed income stocks all offered positive returns over the month, with long-dated conventional Treasury bonds gaining 3.4% and their index-linked counterparts rising by 3.3%. Investment-grade corporate bonds rose by 0.8%, whilst high-yield bonds managed a small gain of 0.2%.

Asia Pacific and Emerging Markets

Japan


Japanese equities were flat in August and broadly in-line with other developed markets. Negative returns were realised in the financials sector which fell 3.9%, led by Mitsubishi UFJ Financial (down 4.9%). Positive performance was generated by the industrials and consumer goods sectors. Keyence Corporation, one of Japan’s largest technology companies, was particularly strong, with returns of 12.2% in August following positive financial results released in late July. Economic news was mostly positive with GDP rising 1.0% (quarter on quarter), the strongest result in two years. In addition, industrial production rose 2.2% over the past month (vs. 1.6% expected) and inflation increased to 0.5% year on year. In political news, Prime Minister Abe appeared to recover somewhat from a series of scandals over the past few months which have called into question the stability of the Abe Government and implementation of the “Abenomics” economic reform agenda. Following a cabinet reshuffle in late July which brought in a new team of ministers, Abe’s approval ratings have ticked up and the Liberal Democratic Party backed candidate achieved a solid victory in the Ibaraki prefecture election.

Emerging Markets

Emerging market equities were positive, yet again in August, returning 2.1% in local currency terms, compared to flat returns in developed markets. Emerging market equities continued to experience positive inflows. August saw a lessening of the influence of emerging tech giants in aggregate market returns and broader market participation from other sectors, notably financials, with ICBC, the world’s largest bank by assets, rising 7.1% in RMB terms, and China Construction Bank, the world’s second largest, rising 3.7%. Larger capitalisation companies slightly outpaced smaller and mid-size companies. Among specific countries, Russia and Brazil were the stand out performers with the MICEX (Russia) and BOVESPA (Brazil) indices returning 4.8% and 7.5%, respectively, in local currency terms. Both markets were supported by their largest constituents with Sberbank (Russia’s largest bank) up 11.5% following strong profit results and Vale (the world’s largest producer of iron ore) up 11.7% in-line with rising iron ore prices. South Korea was the laggard with the KOSPI falling 2% in Won terms as political tensions weighed on market sentiment following Trump’s promise to meet any North Korean threat to the US with “fire and fury”.

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

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