Going global

Written by: David Burrows Posted: 25/08/2017

Global feature illoDespite political and economic uncertainty around the world, it appears that stock markets have enjoyed a rising tide in the past year. This article was edited on 24 August 2017

With Brexit, the Trump effect, and uncertainty pretty much on a global scale, you’d think that stock markets would be in freefall, but they’re not. So, just why have markets risen in the past year when you’d expect them to have been flat or fallen?

According to Mike Farley, Head of Zedra’s Fiduciary Investment Services department, low interest rates have been the biggest factor. “Central banks have maintained their accommodative stance on low interest rates, which makes a major recession unlikely and is good for both consumers and businesses,” he says.

He also points out that low rates for savers have made equity investment more attractive, which has kept interest in the stock market especially keen.

Michael Bull, Investment Manager at Quilter Cheviot, agrees that despite high levels of uncertainty across the globe, the economic climate hasn’t had a detrimental effect on equities. “The Trump effect, so far at least, hasn’t been damaging. His tax ideas were business-friendly – though he hasn’t been able to push things through as quickly as he thought. There are some good signs – Q1 earnings in the US were strong and supported stock valuations, and the S&P Index is still making record highs. It’s now grinding higher, but there are still signs of growth.”

Robert Lea, Head of Global Equity Research at Ashburton, is inclined to agree that the Trump factor has had limited impact. “Trump’s presidency has been beset by multiple problems, but investors shouldn’t forget that the President’s core policies are pro-job creation and pro-growth. While we’re doubtful Trump will succeed in getting many of his reforms through Congress, the prospect of superior US growth is still welcomed by the markets.”

He also believes the market reacted positively to Trump’s more conciliatory stance towards China, following his earlier protectionist statements. As a result, the markets have been willing to overlook the US’s political uncertainty, choosing to focus on the positive outlook for economic growth and corporate profitability.

Andrew Robins, Senior Private Banker at Nedbank Private Wealth, agrees that notwithstanding uncertainty around the UK election result, Brexit and Trump (which so far haven’t damaged equity markets), there have been positive events, especially in Europe. “The market got the results it wanted in both the Dutch general election and the French presidential election,” he explains.

“Another supportive factor for a long time has been central bank policy, which continues to suppress interest rates across the curve. This has forced investors towards other asset classes, as the main alternatives [cash and bonds] are quite unattractive.”

Certainly, market numbers are highly supportive of a bias towards equities. The MSCI All Country World Index was up 12.44 per cent for the year to 15 August 2017, the Dow Jones up 13.3 per cent in that period, and the FTSE 250 up 9.8 per cent.

Few areas of weakness

Broadly, the picture is positive, but have any global regions done better than others? The US, UK and Europe have all performed strongly, according to Bull. “Europe is recovering from a very low base, but there are signs it’s coming back on a sure basis, with improved earnings figures from European companies. Asia and emerging markets have also done well this year.”

This point is supported by the fact that the Hong Kong’s Hang Seng Composite Index rose a remarkable 24.4 per cent in the year to 15 August. Indeed, equity markets have been stronger pretty much across the board.

There have been a few areas of weakness though. Investment grade bonds have struggled and energy and commodity stocks have underperformed in the year to date, due to the decline in oil price and general downturn in commodity pricing.

Lea says the Russian stock index has fallen more than 10 per cent, due to concerns about the domestic oil-intensive economy, as well as general geopolitical concerns. 

In terms of volatility, through 2017 the VIX Index has hit a multi-year low. However, this should be read with a degree of caution. As Bull stresses: “It’s important not to lie back and just think all is fine. Currencies have acted as something of a release valve for the US, UK and Europe.”

Given that Brexit hasn’t happened yet, and Trump has more than proved he’s the loosest of cannons, are we likely to see increased volatility going forward?

Bull thinks not. “I don’t think we’ll see excessive volatility. Q1 earnings in the US and Europe were the strongest since 2013. More value is being pushed into these stock markets.” 

He adds that positive numbers need to come through over the following quarters, though, to show Q1 was no fluke. As for Brexit itself, the feeling is that it in no way spells disaster for the UK equity market. “I think currency is going to bear the brunt of Brexit,” says Bull. “And if you look at the huge number of foreign earners in the FTSE, that’s going to negate a lot of the ‘pound’ effect.”
 
Heading for a fall?

Talk of the market being over-valued has led to speculation that we’re heading for a fall. Clearly, markets correct from time to time but, as the gold market has proved in recent years, hitting historic highs doesn’t necessarily mean you’ve reached a peak.

Farley doesn’t believe stock markets are perilously over-valued. “I think we’re probably in the final stages of a bull market but it could run for some time yet. Typical signs of overheating aren’t present. There are no great inflation concerns currently, and company earnings in the US and Europe remain supportive.”

US Q1 earnings in 2017 were up 15 per cent, and around 75 per cent of companies are ahead of analyst expectations. Cautious optimism is also Bull’s opinion on stock market opportunities. He thinks valuations are still reasonable, but investors need to be careful with individual stock and sector picks.

He points to Carillion as an illustration. The construction support services business has seen its share price plummet following a profit warning early this year. Other companies, such as Mitie and Capita, have reported a slowdown in the awarding of contracts following the UK’s vote last June to leave the EU.

Question of timing

If we’re close to the end but not at the peak of a bull run, should investors look to time the market? This idea gets short shrift from Zedra’s Farley. “Timing the market is impossible. The biggest influence is human behaviour and investors tend to look in the rear-view mirror – people buying at the top and selling towards the bottom, the kind of panic we saw in Q1 2009.”

The market could rise another 10 per cent before falling, he says, but trying to anticipate the peak exactly isn’t the most sensible strategy.

It’s also important to get the re-entry point right. Rather than jumping on a white-knuckle-ride with 100 per cent exposure to equities – possibly even in one high-flying sector – investors should look to diversify and lower their risk.

In times of uncertainty, it’s better to be as diversified as possible. “You don’t want any overriding theme in a portfolio now. It makes sense to have a mix of equities, bonds, property, and also a broad sector spread – for instance, pharma, financials and so on,” Farley explains.

So, what will be the key drivers in the months ahead and what economic indicators will the experts be watching? Lea says the question for investors during the second half will be the extent to which bond and equity markets can withstand the gradual withdrawal of monetary stimulus, given the US Federal Reserve’s plans to reduce its balance sheet and the potential reduction of quantitative easing by the European Central Bank.

He adds: “Growing dissent within the Bank of England’s Monetary Policy Committee could also herald a rise in UK interest rates, though we think this less likely given the Brexit-related uncertainties overhanging the UK economy. 

”China will also be on the radar. We continue to keep a close eye on developments in China, where we expect economic growth to slow during the second half,” Lea says. “Maintaining economic stability remains a central aim ofthe Chinese government, which we think has done a good job so far.”

WHAT’S HOT AND WHAT’S NOT

HOT

• US equity valuations – These are stretched a little, but there are likely to be stock-picking opportunities given a positive US economic outlook and low unemployment.

• European earnings – An earnings pick-up in Europe means this market could provide good returns over the next year.

• Emerging markets – These have been the star performer year-to-date, underpinned by the improving global growth outlook, weakening US dollar and a solid rise in local corporate profitability. There may be further upside there.

NOT

• Domestically focused UK companies – There’s caution around these given the significant uncertainties posed by the Brexit process. For UK exporters, the concerns are considerably less.

• Fixed income – A rising interest rate environment is potentially negative for fixed income and high-dividend-yielding stocks.

• Commodities – Commodities such as oil and gold have shown little sign of improvement in pricing.


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