Market commentry |

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.

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.

“If I go there will be trouble” (The Clash)

So we have voted to leave – what happens next?

After months of campaigning, the UK has finally voted and whilst the result has been extremely close, many will be shocked at the decision to leave. Following on from Michael’s note last week, we have put together this short article looking at the consequences and potential impact of Brexit.

Market Reaction

Unsurprisingly, initial market reaction has been negative given that sentiment in the days preceding the referendum seemed to be swinging in favour of a Remain vote. As expected, the FTSE is down approximately 4% at time of writing and Sterling has fallen by approximately 6% versus the Euro and 8% against the Dollar.

It would seem that the prospect of protracted uncertainty across the UK and Europe means volatility will continue and coming weeks and months will be difficult for fund managers and small and mid-sized UK based businesses. However, it is important to remember that many of the companies listed on the UK Stock market, particularly those in the FTSE 100 are global companies and as such may be protected to a certain extent due to their relative lack of domestic economic exposure.

Political Repercussions

Statistically at 17.4m, the vote to leave was approximately 1.3m larger than the Remain vote. That said and even with a turnout of 72%, some 13m people didn’t vote which is 10 times the size of the Leave win.

Although the choice was binary – “yes or no,” there is no doubt that the possible consequences arising from the decision are far from binary. Already we have seen David Cameron resign, raising the prospect of a leadership battle within the Conservative party and all that may bring (could we see Boris Johnson finally make his play?); Alex Salmond call for a further vote on Scottish Independence and in Northern Ireland, we have heard Sinn Fein call for the opportunity to allow the population to vote for a separation from the Union and look towards a United Ireland.

Although these calls present risks, they are not unexpected and in reality any decisions regarding the future of the Union ought to be viewed as possible on a longer term, say 10-year horizon.

Economic Consequences

As already alluded to, the economic consequences of this decision are not clear. If we look specifically at the regions of the UK, the impact could be significant. Scotland can set its own tax rates, but we have already seen Wales asking for money to replace what it will lose from the EU. Northern Ireland is a net beneficiary of EU money and so that money will have to be found from somewhere either in the form of extra taxes or extra borrowing with consequences for the economy as a whole. Only time will tell what the impact will be as the shock of the decision dissipates over time.

Some commentators have suggested that the vote in favour of leaving (52% v 48%) is relatively narrow and allows the possibility that the UK will retain access to the single market through membership of the European Economic Area. However, this depends on negotiations with the EU and could mean free movement of labour would continue across the EU… plus ça change, plus c’est la même chose…(the more things change the more they stay the same).

We should remember that the Bank of England and other institutions have worked out their contingency plans in the event that the country voted to leave. This was particularly evident in Mark Carney’s speech earlier today when he explained the plans that have been put in place to protect the UK and UK business as far as possible from the potential fallout caused by a Leave vote.

Our Message

Whilst this decision is the most important in a lifetime, I go back to the point we made in a previous commentary. The sun has still risen this morning, Wimbledon will still begin on Monday and Northern Ireland will still beat Wales tomorrow afternoon. The move to divorce ourselves from the EU will take a considerable amount of time, with more becoming clear in coming weeks and months.

At Greenstone we advocate three key principles:

Have faith in the future – At the moment, the FTSE 100 stands at 6,038. However on the day I was born it was 149.76 (please don’t ask when. It was a long time ago!). There will always be some crisis or other around the world that impacts on markets, but if we believe they are broadly efficient and capitalism works, then the long term trend is upwards.

Have a plan and work it patiently for your lifetime and if appropriate, the next generation. None of us are in this for the short term.

Have patience – Have a plan and work it patiently for your lifetime and if appropriate, the next generation. None of us are in this for the short term.

Discipline – Avoid doing the WRONG thing. At times like this it is easy to be caught up in the broader sentiment. Keep a cool head and speak to us if you are worried about your investments.

As always, any uncertainty presents opportunities and we will continue to work with you to make sure your plan stays on course whatever happens in the short term.

However, we appreciate that you may have more questions about how this is likely to impact you personally, so do please feel free to contact us in coming days and weeks.

Brexit – “Should I stay or should I go?”

What Brexit will mean if we decide to ‘leave’ or ‘remain’

With just days to go until one of the most important decisions in a generation, we thought we would add to the mountains of commentary on the vote. Greenstone does not have a house view on which way people should vote and therefore this missive is not to sway opinion one way or another, rather to offer comment on the claims and look ahead to what the landscape might be on 24^th June.

The case for Leave (“If I go there will be trouble…”)

This is clearly the more vocal of the campaigns; one cannot help noticing the number of posters encouraging us to vote out. Their central case seems to revolve around three pillars; regulation, sovereignty and immigration. The belief is that if we were to leave the EU, we would be able to take control of our own destiny and cut the red tape which is holding British business back. It would also allow us to negotiate trade deals with the rest of the world which would boost exports and reduce our trade deficit.

The subject of immigration dominates debates however and is a key issue for the leave campaign. Many in the UK remember the claims regarding tens of thousands arriving from Poland and the new joiners in 2004 and the resulting 1million+ which came over has made many cynical of future immigration claims. The fact that the Polish in particular have integrated well into society and particularly the economy, seems a given but irrelevant for their argument. The fact is we had no control over the inflows.

The case for Remain (“…And if I stay it will be double”?)

As with the Scottish referendum, campaigning for the status quo is hardly the most inspiring message. It has been dominated by fear of the unknown and tales of perilous economic hardships if we leave. Their message is that the EU is a long way from perfect, but it is a case of better the devil you know. They also point out that it is better to be involved and try to reform it from within than sit on the side lines, still being affected by its decisions but having no say.

Whilst not saying that the UK is a lesser economic and military power than it used to be, it talks up the virtues of collective bargaining and that being part of a group of 500 million people adds weight at international negotiations. The main argument however surrounds the economy and the belief that a Brexit will curb demand of UK services, particularly in the financial sector, which are vital to our economy.

How to decide?

The problem with such an important decision is that it effects so much, it is impossible to quantify the costs and benefits of either option. There is more clarity around what a remain vote will bring, as effectively there will be little change. However, in our view the arguments for voting for or against are as follows:

Remain – You believe the EU has been good for Britain, Europe and the World. That the UK is stronger when working closely with our neighbours and there is better opportunity for trade by remaining part of the Single Market. The overriding reason however may be fear of the unknown or shorter term market volatility.

Leave – You believe the EU has not been good for Britain, that the EU’s free movement of people has caused a strain on housing and public services. That we are better off trading with the rest of the world and remain a big enough power to command bilateral trade agreements with India, China and the US. The overriding factor may be that you are concerned about immigration and wish to restore sovereignty.

Myths, half-truths and unknown unknowns

As we mentioned, it is nigh on impossible to say what the specific costs and benefits may be of either vote given that membership of the EU affects so many parts of our lives. Both camps have been guilty of making claims backed up with little evidence or worse, ignoring statements and official opinions of professional bodies.

As mentioned, the remain camp has been based largely on scaremongering and they have employed some ludicrously exact claims of a cost of exit. There was a precise figure of how much worse-off households will be in over a decade’s time, that unfortunately mixed up household income and national income per household. There were also figures on the increased cost of one’s holiday to Tuscany this year!

The leave campaign has had its share of questionable statistics, though its main tactic has simply been to ignore the official voices. Almost all financial and business institutions, from company owners to banks, central banks and organisations such as the IMF, have said Britain is better off in the EU. The leave campaign has simply retorted ‘they would say that, wouldn’t they’. This appears to be an effective argument as a large portion of the population is mistrusting of such official opinions. It has allowed the leave campaign to claim that there will be less immigration, even though most of our immigration comes from outside the EU; that it would stop Brussels setting so many new laws despite the fact that new legislation is largely home grown; and that we can have a trade deal with the US despite the American President himself denying such a claim.

What will 24th June look like?

Whilst it is easy to become caught up in the hype, come the morning of the 24^th June, the sun will rise, people will go to work as usual and England will no doubt be heading for an early exit from the Euros. It will be in the days, months and years that follow in which the true repercussions emerge. Below are what we think might occur in the weeks that follow either result.

Brexit – The FTSE 100 is likely to fall sharply as markets wake up to the news that uncertainty remains. The pound will also likely fall against most other currencies, though the fall against the Euro may be tempered by the Euro’s own fall in value as the EU as a whole looks less attractive to investors minus Britain.

It is likely that David Cameron would resign and as the party elects a new leader, gilts may come under pressure as international investors weigh up Britain’s economic future. This in turn would push up the cost of borrowing and could trigger a recession.

Longer term of course, we may negotiate a number of bilateral agreements with the rest of the world, allow only the best and brightest into the UK and cut red tape for business, generating a highly productive, exporting economy and a shrinking welfare bill, leading in turn to lower taxes. Of course, a vote to leave would still need to be approved by parliament and, although unlikely, it could be blocked if enough pro-EU MPs were prepared to go against the public will.

Remain – There may be a small relief rally in markets and Sterling could strengthen against major currencies. If it is a close vote there could still be a vote of no-confidence in the Prime Minister, putting pressure on gilts, but that is less likely. The housing boom may well resume as foreign investors who paused their purchasing plans start buying again. There may even be a bounce in GDP as companies deploy investment which they have held back in new machinery, marketing and employment.

Over the longer term the risk is that there is a wave of immigration which we cannot control and therefore puts further strain on welfare and public services. It may also be that increasing involvement from Brussels affects the competitiveness of our industry and service sectors which, combined with the pressure on the welfare state and increased taxes, tips the country into recession.

Conclusion

Over the longer term, no one can say which vote will lead to the most successful result. It is too big a decision with too many outcomes. We believe the vote will be much closer than the bookmakers would have people believe and the result is likely to come down to turnout. Those who will vote no matter what are more likely to be pro-leave, whereas the remain voters tend to be younger and more apathetic.

We continue to live in interesting times.