Category: Expert views

UK Election Summary

After years of Brexit stalemate, months of battling to agree to an election and weeks of campaigning, the day finally arrive when the UK went to the polls for the 3rd general election in 4 years. The polls in the lead up to the election pointed to a large Tory majority which was whittled away during the campaign however give the track record these in the Brexit vote, the last general election and the US presidential election, little faith was placed in these predictions. Then came the exit poll and it felt almost a disappointment, perhaps the polls were right this time?

A Conservative government was returned and with a majority that no one believed possible. Sterling made large gains on the news and markets moved higher during the day. This is less a comment on sentiment towards Brexit and more relief that we did not return a hung parliament or a very left-leaning Labour government. A Tory majority is the outcome which provides the greatest certainty going forward which is the reason for the market response.

We will have to wait and see whether this now unleashes the pent-up investment and corporate spending which was much talked about and if that does come to pass whether this offsets any negative impact of finally leaving the EU. Whilst Johnson will be keen to pass his withdrawal bill with his new majority, it is of course only the beginning of our departure. The real negotiations begin around how our future trading relationship will function which even with a stable majority at home will be anything but uneventful.

One silver-lining, in purely economic terms, is that with this comfortable majority Boris may be inclined to soften his talk of a hard Brexit and look to reach out to the remain side and seek to negotiate a softer Brexit which will be less disruptive for future trade.

That move to the centre ground seems even more important for the Labour party. After leading the party to three straight electoral defeats Jeremy Corbyn has said he will not stand as leader in the next one. Whilst Brexit clearly dominated the election this time around, many were cautious about their economic plans. Assuming this parliament lasts its full term, perhaps we will see a less radical Labour party at the polls next time, which given that the country would have had nearly 15 years of Conservative rule in which austerity was pushed through and a potential exit from the EU, it will surely be Labour’s to lose next time.

So what does this all mean for our clients? The continuation of Tory rule should mean that tax rates and rules remain broadly where they are and one should not fear a government grab for your wealth. As stated above, markets have reacted positively to this outcome but that is more on relief than strong endorsement of the regime. A negative financial outcome has been avoided but we are not out of the woods yet. A lot of spending has been promised and given that growth continues to soften, government revenue will need to be found somehow. Therefore continuing to tax plan carefully remains a top priority. Also important is the need to diversify. As we negotiate our exit the UK market is likely to remain volatile. Elsewhere in the world there are a number of trends and potential events which will cause unease in global markets and demonstrated time and again, the unexpected always occurs, even when you were told it would happen as in the case of this election!

“…This too will pass….”

Thoughts on recent market restlessness

What is it about October? As flooding in parts of the UK subsides and the clear up following Storm Callum continues, investors are also taking stock of the damage wrought in the financial market storm of the last two weeks. The press were quick to compare Callum to the ‘Great Storm’ of 1987. Thankfully, so far, the falls in markets have not been on the scale of those witnessed 31 years ago, on Black Monday.

The trouble this time is a rapidly growing US economy rather than a slowing one. The Federal Reserve raised interest rates in September to 2-2.25% range and the minutes released yesterday suggest that more are to come. We have been here before, most recently in January and February this year, where fears of rapidly rising interest rates caused markets to fall. The Fed has been communicating to the markets that it expects to raise rates again this year (most likely in December) and another three rate rises in 2019. The sell off this month, as happened earlier this year, is that there will be more rises or by greater amounts, than has been suggested.

This is a case of good news being bad for the markets. The US economy is growing at its fastest rate for decades – over 4%pa – unemployment is low and Donald Trump’s tax cuts and promise to slash regulation has boosted sentiment further. Wages are increasing which has led to inflation rising above the target level of the Fed and as a response, interest rates have been increased. Any data which suggests wages or the economy is growing faster than expected, good news more broadly, will be interpreted by investors as a sign that interest rates will rise more sharply and therefore be bad news for markets.

A growing economy and rising interest rates are part of a normal economic cycle and have been repeated time and again since the establishment of the market economy. What is making the process more painful this time is the base from which monetary policy is moving. Interest rates have been at historic lows for nearly 10yrs following the financial crisis; governments have taken on massive debts in order to stimulate their economies and Central Banks have engaged in quantitative easing, swelling their balance sheets to unprecedented levels. All of this needs to be unwound and the US, being the first into and out of the crisis in 2008-09, is leading the way.

It is also still the dominant World economy and despite growth in Emerging Market economies, a lot of their debt is priced in Dollars and by extension linked to US interest rates. Therefore a rising Fed rate does more than affect US businesses and consumers. It threatens to cause debt crisis in over-leveraged Emerging Markets and if the strong Dollar weakens US demand for imports, manufacturers in East Asia will be affected also.

So what happens next?
Given the underlying economy in the US is so strong, and the Fed and the Government are more sensitive to a potential downturn, it is unlikely that interest rate rises will tip the US economy into recession. Economic growth across the World is more divergent than it was in 2017, however most economies are growing and therefore the underlying drivers of market returns are robust, so a full-blown market crash looks unlikely. What is more likely is that markets will continue to be flat, as they have shown to be this year, as rising interest rates dampen expectations of that rate of future profit growth and that profit is valued less in todays terms and therefore prices will come under pressure. At the same time there will be plenty of volatility as fears around the rate of increases ebbs and flows, not to mention the countless political and geo-political tensions brewing. Expect Italy, Brexit, Turkey, US-China trade wars and the Middle East to continue to dominate the headlines this year and next.

What can investors do?
Given that market levels, even now after the recent sell-off, are at long term highs, and that alongside this, levels of volatility and uncertainty are also high, taking some risk off the table is probably sensible. The trouble in doing this is what ‘safe assets’ to move into? Gilts and Government Bonds are at risk of capital falls as interest rates rise, particularly given the low rates they are moving from. Quantitative easing and a decade of low interest rates means that anything with a yield has been in high demand and so bonds across the investment risk spectrum are also at historic highs. They are also more susceptible than in the past to interest rate rises because of this. Therefore managers have been focusing on shorter duration, where there is less interest rate risk and whilst they may not perform well in the short term (where shares and bonds are affected by rate rises), should there be a greater market sell off, interest rates will be cut and bonds will be back in favour as the traditional safe haven.

Other than bonds there are alternative strategies such as property and cash. Cash is a good short term tactical play, given it has little cost and has the greatest liquidity. The downside is that if held for too long it is eroded by inflation. Alternative strategies are expensive but with a good manager have shown themselves to have low correlation to financial markets. Finally property, whilst still exposed to economic cycles and the least liquid of these assets, has maintained good yields and capital values have been fairly stable.

The recent market falls seem to have abated and markets found a new level. Unless corporate earnings are much higher than expected, I do not see markets racing ahead from here and so it may be some time before the previous highs are reached.

A full-blown market crash looks unlikely but repeats of the recent falls are likely, though hopefully accompanied by subsequent recoveries. A sensible strategy to navigate this would be a more cautious one, however one which also has a good yield. Whilst market levels fluctuate, investors can still generate positive returns by way of income. Re-investing this income will benefit from pound cost averaging in these turbulent times also.

We are living through one of the longest recoveries in history, which means a future downturn is closer than the one we left we left behind. Having interest rates at a higher level and monetary policy more ‘normal’ will mean more can be done to manage the next downturn. For economies such as the Eurozone (0% interest rates) and Japan (-0.1% interest rates) it will be much more difficult to manage.

In Summary
As always, the trick is to remain patient, ride it out, and look through the noise and sensationalist headlines. Bear in mind that whilst these gyrations are painful, they are necessary. The quote at the beginning of this article is by Benjamin Graham. He was a British-born American investor, economist and professor and taught Warren Buffet, among others. Graham said, of a particularly turbulent time in investment markets “In the old legend, the wise men finally boiled down the history of mortal affairs into a single phrase: “This too will pass.”

At Greenstone, we advocate three key principles to help you achieve your financial goals.

1) Have faith in the future and keep perspective.
Market downturns can be upsetting but history shows that major stock markets such as the UK and US markets recover from declines and can still provide investors with long-term returns. For example, during the past 35 years, the US market experienced an average drop of 14% from high to low during each calendar year, but still had a positive annual return in more than 80% of the calendar years in this period*

2) Patience
Work out a plan with your adviser. Articulate your key goals and understand how they might be achieved. Be patient about achieving them and make sure you are comfortable with your whole financial situation. Your adviser will have helped you to put together a portfolio that takes account of your time horizon, goals, tolerance for risk and capacity for loss. Speak to him or her about that plan if you need to refocus.

3) Discipline
Avoid doing the wrong thing. Market timing is a tricky game to play. There have been numerous studies over the years into the effects of moving in and out of the market. In fact, it is virtually impossible to consistently predict when good and bad days will happen. If you miss even a few of the best days, it can have a lingering effect on your portfolio.

That said, market downturns may be an excellent time to carry out some tax planning. For example, if you haven’t used your ISA allowance as yet this year, now might be a good time to do so. Alternatively, if you wish to sell some holdings that have performed well, a down-turn may provide an opportunity for some Capital Gains or Losses planning. This could help your overall financial position.

As ever, if you have any questions about this article or your investments, do please contact us your adviser on 020 3931 0340 or, for more general queries, contact us at info@greenstonefp.co.uk

*Fidelity; “6 tips to manage volatile markets”; Fidelity Viewpoints 01/08/2018

Meet the Manager

In the first of our occasional Meet the Manager interviews, we spoke to Richard Philbin, Chief Investment Officer at Wellian Investment Solutions about Brexit and the impact of the Leave vote.

Following the US election result earlier this month, we thought it would be an excellent opportunity to ask the experts at LGT Vestra what they think are the threats to be aware of and the opportunities to be grasped.

Although this absolutely does not constitute a recommendation to invest in LGT Vestra (we are of course, independent and have relationships with a wide selection of firms), we thought you might like to hear their views following the vote and how they have positioned their portfolios now and into what it looks like may be, a turbulent 2017.

So we asked Phoebe Stone (PS), Model Portfolio Manager at the firm, a number of questions:

CG – How did your team position the LGT Vestra portfolios in the run up to the election and did you forecast a Trump win?

PS – The work that was done by the LGT Vestra equity research department concluded that a Trump win was very much possible. However, we didn’t expect the support for Trump to be as strong as it turned out to be. Because of the lack of clarity and detail in Trump’s policies throughout the campaign trail, it was difficult to get a good understanding of the impact that his election as President would have on global economies and nations.

In terms of positioning, gold exposure was added to portfolios. This was to act as our ‘insurance policy’ in case Trump was elected and the markets fell in response. This worked initially but since then gold has sold off in line with increasing implied US real interest rates and a surging dollar as investors have u-turned on Trump.

Gold remains an important asset in portfolio construction particularly at a time in which we could see persistent inflationary pressures as a result of fiscal stimulus by governments. In this type of environment, holding an allocation to gold is a prudent hedge.

CG – How are your investment managers taking advantage of the new uncertainty?

PS – The most remarkable thing we have seen since the Trump election is how quickly the markets have shifted. From initial falls in equity markets stemming from uncertainty over what an elected Trump would result in, the markets have undergone a massive rotation.

We saw investors in the days following the election fleeing bond markets as they expected the President-elect’s stimulus policies to generate strong US GDP growth and consequent inflation. In this scenario bonds are relatively less attractive than equities. With bond prices falling and corresponding yields rising, investors looking to achieve specific levels of income could start to view the fixed income arena as more attractive, without the equity risk of dividend income.

CG – In light of the vote for Trump, do you foresee any immediate portfolio changes?

PS – We are certainly in for a rockier ride than if Clinton had been voted in. In terms of portfolio positioning, we have been reducing our sovereign debt exposure over the past few months ahead of the US election. We were therefore sheltered from the falls in the bond market seen during November. This was triggered by the rotation out of bonds and into equity on the Trump rally. Following the election of Trump we increased our exposure to both US mid-cap equities and global value equities in the higher risk portfolios. Trump’s protectionist and US-centric policies are likely to most benefit US small-cap companies and cyclical stocks (held in global value strategies), as investors anticipate stronger GDP US growth ahead.

CG – What might the long term effects of a Trump Presidency be? Will this be positive or negative for investors?

PS – A lot of attention since President-elect Trump’s victory has been on fixed income markets. We have seen a consequent selloff in bonds across the globe. Many people have been predicting a reversal for bond markets after years of falling interest rates. Could this be the start of a much bigger move or a short term correction? Bond markets are driven by interest rate expectations and supply and demand. With many central banks targeting inflation, the path of interest rates is dependent on long-term inflation expectations.

Globalisation has kept prices low as manufacturing was able to move to the cheapest parts of the world. Trump’s indicated trade policy would be a retreat from this and would involve raising tariffs on imports. If the UK fails to make a good post-Brexit deal on trade with Europe, a similar effect will be felt here. These are potentially one-off effects but do remain a concern.

Another concern for markets is the influence on prices, supply and demand. Donald Trump, in his acceptance speech, only mentioned one real policy and that was to increase infrastructure spending, which would imply more government borrowing. Interestingly, at the Conservative party conference there was also talk of a relaxation of the previous Chancellor’s austerity measures, which could mean more supply in the Gilt market.

As for Trump, we will see how much US Congress will let him do in the months to come. In many ways there are still deflationary forces at work. Globalisation cannot be entirely reversed and internet price checks, automated production and an ageing population all mean that we are probably not in for a long-term higher inflation rate. Given the amount of gearing in the global economy, in both government and private sectors, any rise in interest rates will be a further constraint. Thus we believe that official rates will only rise very slowly in the UK and US despite short-term inflation threats. However bond markets may remain volatile as fears come and go.

 CG – Given the protectionist rhetoric we heard throughout Trump’s campaign, what do you think the biggest challenge will be for our clients over the next 4 years?

PS – Trump’s election is another catalyst for the increased levels of volatility that we have been experiencing in markets since last August. Initially triggered at that time by concerns over China’s GDP growth rate, and followed by the fall in the oil price there has been increased volatility in equity markets driven by macroeconomic events. Interest rate cycles and political events (Brexit, US Presidential Election) have all contributed. One thing that unites these events is the consequent uncertainty; we don’t know at this point how each will pan out, what the effects will be on the economy, society and on each other.

We believe the volatility we have seen permeating markets is here to stay, and this will therefore be the biggest challenge for clients. In portfolios we are specifically focused on managing the volatility, using absolute return funds for example, to provide ballast to the ship. This will smooth the path of return during a time when macroeconomic events continue to shake markets.

CG – Looking forward to the European political scene, a number of countries in Europe have important elections coming up in 2017.  What are LGT Vestra’s views on the political climate in Europe and how are you positioning your portfolios to take advantage of potential changes.

PS – After President-elect Trump’s success and following the ‘Brexit’ referendum over the summer, potential constitutional crises have never been more in vogue. With this in mind, the world’s attention will now shift to the upcoming referendum in Italy. On 4th December, the Italian electorate will go to the polls to vote on the fundamental changes to their country’s constitution. The referendum is also another opportunity for the populists, buoyed by results from elsewhere in the world, to land another blow against the established mainstream. In Italy this is led by the ‘Five Star Movement’, notably led by a comedian (literally, rather than the accusation levelled at other similar parties) and is highly Eurosceptic.

Next year will bring a Dutch general election and French presidential election in spring, with German federal elections to follow later. Anti-Europeans are doing well and will only gain more momentum if the Italian referendum is interpreted as another vote against the establishment.

In terms of portfolio positioning, we have reduced our exposure to Europe in light of the upcoming uncertainty. We are also exposed to Europe on a hedged basis which will allow the portfolios to benefit from a falling Euro versus Sterling (likely with the uncertainty surrounding the future of the Eurozone).

CG – What are the key points for clients to be optimistic about?

PS – We continue to see value in equity markets, the asset class that will drive portfolio performance over the next four years. We are selective in terms of exposure, for example in the UK equity space, choosing to use active fund managers who are able to get access to areas of the market in which there is particular value. The election of Trump has acted at a catalyst of sea-change. Despite there being a multitude of uncertainties ahead, this change has already thrown up a huge amount of opportunities and from an investment perspective, will generate new drivers of growth and prospects.

As ever, we appreciate that each client is very different, with widely varying circumstances.  This article is for informational purposes only. It is considered to be a general market commentary and does not constitute advice or a personal recommendation or take into account the particular investment objectives, financial situations or needs of individual clients. It is not intended and should not be construed as an offer, solicitation or recommendation to buy or sell any investments. You are of course recommended to seek advice concerning suitability of any investment from us.

Past performance is not a reliable indicator of future performance; and the value of investments, as well as the income from them can go down as well as up, and investors may get back less than the original amount invested.

The information and opinions expressed herein are based on current public information we believe to be reliable; but we do not represent that they are accurate or complete, and they should not be relied upon as such. Any information herein is given in good faith, but is subject to change without notice. No liability is accepted whatsoever by LGT Vestra or its employees and associated companies for any direct or consequential loss arising from this document. 

 

“Difficulties mastered are opportunities won”

An Investment Manager’s Perspective

“Difficulties mastered are opportunities won”. Winston Churchill famously uttered these words in a speech on 21st March, 1943, at the height of the Second World War. As we have seen, the UK has been thrown into a state of flux following Friday’s vote. However, as always, this also represents opportunities; the question is how to take advantage of those?

As many of our clients hold Wellian portfolios, we decided to speak to Richard Philbin, Chief Investment Officer at Wellian Investment Solutions earlier this week.

Although this absolutely does not constitute a recommendation to invest in Wellian (we are of course, independent and use a range of investment firms), we thought it might be helpful to hear their house view on the decision to leave and how that may impact decisions taken in relation to their portfolios.

So we asked Richard (RP) a number of questions:

Richard Philbin image
Richard Philbin, Chief Investment Officer, Wellian Investment Solutions

CG – Had you known the result in advance, how would you have positioned the portfolios?

RP – Hindsight is a wonderful thing. We are longer term investors and have been changing the shape of the portfolios for quite some time now – it is better to close the stable door BEFORE the horse bolts. We also build portfolios to be diversified across geographies, styles, asset classes and so on, whilst still being very mindful of the risk profile and investment objectives of the underlying client. We often use the following (potentially flippant) saying “if you’ve bought a toaster, you expect it to cook bread, you don’t expect it to change into a washing machine.”

We build and monitor our portfolios to meet defined risk boundaries as well, and had been aware that correlations and risks were rising in the UK, so we reduced UK exposure to a number of funds. In a couple of models we increased our cash weight too.

With perfect hindsight, you would be fully weighted in equity until Thursday night and then go short Sterling, and correspondingly long US Dollars (USD). You would have increased exposure to gold. Then, this morning (28th June) you would have gone back into the market….

I guess the question could also be phrased along the lines of “how far in advance would we have known the outcome?” Our models have performed very well over the past couple of days – our funds are not 100% exposed to the UK stock market, and even though we do have some exposure to the domestic market which has hurt, we have been increasing our international holdings and diversification which would have benefited from the currency weakness. A good example would be the purchase of Fundsmith Equity which we placed into a number of models almost 5 months ago. It accounts for instance 8% in the Growth model.

 

CG – How are investment managers taking advantage of this uncertainty?

RP – A very good question. I have been talking to a number of fund managers in the last couple of days; collating their views and thinking about the future, and the vast majority are talking about “caution.” The dust is far from settled – politically the Conservative and Labour parties are rudderless, Article 50 – the now famous Article 50 – has not yet been invoked, and there is no precedent regarding how a European “divorce” will happen. All we know is that it will take some time and not be painless.

Some indices have sold off dramatically – especially the Small Cap and Mid 250 indices, and within these there have been some large movements – stocks within the retail, real estate, construction sectors (and many more) for instance are down greater than 20%. Some approaching 50%. This means there will be opportunities – for domestic as well as international buyers (just think – US investors can now gain an extra 10% due to currency movement alone…)

In the large cap space, insurance and banking stocks have taken a beating – financial services is seen in the immediate term to likely be a large “loser” and that is not too surprising all in all. The fear of inflation, interest rates, corporate failure, bad debts and so on weigh on the mind of the market.

There will be opportunities – the market is both “a weighing machine as well as a voting machine” when it comes to share prices.

Liquidity seems to be fine (unlike 2008) which should give some comfort to market participants. I only know of one major “winner” – Crispin Odey – who runs a hedge fund – where his portfolio was up greater than 15% on Friday alone. But, his fund is still massively down on the year….

 

CG – In light of the decision, do you foresee any immediate portfolio changes?

RP – I don’t think “immediate” changes are on the cards – we will closely monitor the situation. I would imagine over the next couple of months though that we might increase our exposure to the UK due to the benefits already gained from the weakening currency and the recent stock market sell-off. We do not know if the sell-off witnessed on Friday and Monday is a knee-jerk reaction or the start of something greater. Fortune favours the brave, but I don’t think it is our job to be super “brave” at the moment.

Our portfolios are diverse and we will have had some funds deliver excellent numbers as well as some that have disappointed. But, we are happy with this approach and aim to deliver outperformance over the medium to long-term.

 

CG – The biggest casualty to date seems to be Sterling.  How have portfolios been affected by this?

RP – It is very interesting to see that Sterling has been the main “casualty” of Brexit. The Bank of England is independent and has the ability to print money. Over the past 12 months or so Sterling has weakened against most currencies – the Euro and the US Dollar especially. Of course our funds would have taken some impact from having UK holdings, and to a certain extent, the old “pound in your pocket” saying still remains. We have been increasing our international holdings over the past couple of months, and the translation effect of Dollars to Sterling or Euros to Sterling will have positively impacted returns.

It is (sorry for sounding like a stuck record here) still very early to say whether the short-term weakness in Sterling will become long-term weakness, but companies that export will be beneficiaries and the UK does operate within a global marketplace. Japan has been trying for years to weaken their currency and would love to see the Yen fall to such an extent.

 

CG – Looking forward, what are the key points for clients to be optimistic about?

RP-

  • The UK stock market has a great deal of businesses that are both inward and external looking when it comes to revenues, profits and therefore there will be winners in this recent “turmoil”. We have global leaders in many market segments and there will be opportunities.
  • When markets sell off, dividend yields rise (although you need to be mindful of pay out ratios.) With interest rates low, inflation muted (but this could change if Sterling remains weak) and yields on gilts touching less than 1% yesterday for the 10Y Treasury, sometimes taking risk when others are taking cover could provide a very timely investment return.
  • Interest rates could fall at the next BoE meeting (July). Low interest charges can be translated into higher profits.
  • The UK is very entrepreneurial in spirit. (Potentially) less legal constraints due to Brexit can free up innovation
  • The UK is still 0:00 on GMT. We speak the global language of business and have some of the best laws in the world. London is a global city and will always attract foreign money – whether that be for business, property or leisure spend. It’s now 10% cheaper to come… Maybe the leisure industry will be a big winner.

 

Although we are going through a turbulent time, it is precisely these moments that can create opportunities. It is important though to make sure you are as comfortable as possible with everything that’s going on – remember your plan and work it patiently.

We are always happy to answer any questions you may have and to discuss any concerns you or your friends and family may have.