Defying Gravity…

…And you can’t pull me down!

For those who have seen the musical Wicked, you may recognise the lyrics. I have not seen it but my wife and daughters have and, having bought the soundtrack and played it non-stop during the summer driving through France and Spain, I now know the songs just as well.

Every time I hear or read about market performance and particularly the FTSE 100 climbing through 7,000 points, I can hear this song playing in the back of mind. It does feel like markets are defying gravity; so what can ‘pull them down’?

It does not take one long to assemble a list of events that might cause markets to correct. Theresa May’s inference of a ‘hard’ Brexit, one which sacrifices access to the single market to take back control of immigration, has caused the pound to tumble further.  A loss of confidence in the UK will eventually take its toll on the share prices of domestic firms, particularly the banks.

Despite the release of damning, if not exactly surprising, evidence of Donald Trump’s opinion of women, he remains well supported and has a chance of becoming president. His economic plans do not appear to add up and whilst he is at the extreme, he sadly represents a growing disillusionment with globalisation in the western world and a move back towards nationalism and protectionism.

Britain fired the starting gun in Europe by voting to leave the EU, but most countries have well supported Nationalist parties. There are difficult elections looming in France and Germany where the notion of free trade and free movement of people will come under threat. Add to this the continued troubles in the Middle East, the continued slowdown in China, a potential monetary tightening in the US and the headwinds against equities begin to mount.

Dividend paying shares, particularly those with a good track record, are in high demand.

What is driving markets however is the fact that 8 years on from the crisis, interest rates remain at historic lows. Couple this with slow GDP growth and investors search for yield drives up the price of any asset which is generating an income. Thanks to quantitative easing, it now costs investors to lend to Western governments; corporate bonds prices are at all-time highs as the search for yield moves up the risk scale.

High yield bonds have historically low yields, forcing investors to hold more and more equity in the quest for an income. Dividend paying shares, particularly those with a good track record, are in high demand. This effect has been turbo-charged in the UK as companies paying Dollar or Euro dividends look even more valuable given Sterling’s decline.

This disconnect between the wider political and economic climate and the fundamentals driving markets could continue for some time. Even if the US eventually raise interest rates, there will continue to be a dearth of income yielding assets which should continue to support equity markets.

The headwinds are likely to ensure that even if markets avoid a fall down to earth, we could be in for a bumpy ride. The positive in this situation is that volatility provides investment opportunities and whilst on the lookout for these our investment managers are also keeping portfolios well diversified. Having exposure to foreign currencies may yet provide further returns as Mrs May begins our journey out of the EU.

It is important therefore to hold your nerve and not be tempted to time the market. Diversification has made sure portfolios have benefited from non-sterling exposure and that same diversification should soften the landing if markets fall. If you have any questions or concerns, please do get in touch.