Please find below our Market Update for the week ending 26th October 2018.
A brief insight into the latest market dynamics and details of any changes occurring within our model portfolios.
Blue Sky Comment
It’s not been pretty this week, with global equities taking a pounding. The focus is really on one thing; the Federal Reserve.
The question is, will they continue to raise interest rates aggressively? Trump is criticising the Fed for raising rates but, with low unemployment and wage rises, the principle of raising rates is a sound one to head off any future inflation worries. It was Trump, of course, who announced the massive tax cuts for businesses, which are potentially inflationary for the economy.
As always, with central bank policy, it’s is a delicate balance. The dollar has been strengthening due to interest rate rises, which is not good for the world’s number one economy who need to export their goods. Simply put, it makes US goods more expensive.
In the US, we have just entered the earnings season and the results and accompanying statements are being scrutinised microscopically for signs of an economic slow-down. Some companies are alluding to the trade tariffs as a cause for concern. So far, it has been a mixed picture, which hasn’t helped matters.
At the start of the week, equities got a small reprieve after China announced fresh measures to ease funding for private companies but market wise, this effect proved to be short-lived.
Blue Sky portfolios
Our Sapphire portfolios have responded the best as they have a significant proportion in UK commercial property funds. This sector has a low correlation to both equities and bonds. It does, however, link to the health of the UK economy and, with Brexit fears, we are guarded as to how much we hold. On saying this, in the short term, this holding is working well and has not fallen in value.
LGTV and 7IM hold a significant proportion of fixed interest stock to provide ballast to portfolios during periods of volatility. Gilts and fixed interest stock, however, haven’t been behaving in their traditional way due to Quantitative Easing. This week though, they have responded positively as yields have fallen. Having this asset class has tempered the aggressive falls in equity prices. By way of an example the LGTV balanced portfolio currently holds 19% in fixed interest and the 7IM AAP Balanced fund hold 29.5% in fixed interest.
Both LGTV and 7IM hold alternative assets with the former holding Absolute Return funds and the latter holding assets designed to lower risk and volatility. Again, as an example, the LGTV Balanced portfolio holds 18% in Absolute return funds and 7IM 15.4% in alternative assets.
We have warned of late regarding the danger of buying cheap index trackers and this recent turmoil reinforces the need for a well-diversified portfolio.
Chair of Blue Sky’s investment committee.
Blue Sky’s market comments in conjunction with our investment partners
The last few days have been extremely volatile, with the Dow Jones market driving this by being down heavily on Wednesday and then a very strong rebound on Thursday. Year to date, our portfolios are down between -1% (Defensive) and -4% (Adventurous). Over the same period, the FTSE All Share, Europe and Japan all down around -7%, and Emerging Markets down -12% (in sterling terms).
The alternative holdings (JPM Global Macro Opportunities, Troy Trojan and Artemis US Absolute Return) are in positive territory for the month to date, and the index-linked gilt position is also up. The detractors since the start of the month (and incidentally quarter) are European equity (Blackrock European Dynamic, Henderson European Smaller Companies) and smaller companies equity (Merian UK Smaller Companies, Henderson European Smaller Companies, Baillie Gifford Japanese Smaller Companies).
Equity and bond markets have suffered a tough October but, as always, it is important to look at the fundamentals, which don’t look to have changed during this time. Fundamentals across Japan, Asia, Europe and the US remain intact and LGT Vestra believe this is one of those times where investment managers should hold firm, potentially looking to take advantage of market falls rather than panic and reduce equity exposure at this juncture.
Whilst the size of these market moves are unusual and can be alarming, it is important to remember that as markets fall, they become less risky as their valuations reflect lower future growth prospects. The S&P 500 now trades on a forward Price/Earnings ratio of 16.3 or an earnings yield of 6.1%, which still compares favourably with US treasury yields around 3.3%. The FTSE 100 trades on future P/E ratio 12.3 or an earnings yield 8.1%. These are not expensive valuation levels looking back over the decades. Another important factor to bear in mind is that we are in earnings season, and therefore companies cannot change their share buyback programs. This means a major market participant is not there to ‘buy the dip’.
If the market takes a further leg down from here, the central LGT Vestra Investment Committee will reconvene.
The Alternatives continue to provide a diversified source of return for the 7IM portfolios. In combining an array of alternative assets, 7IM believe they can deliver characteristics similar to traditional fixed income securities. The characteristics are stable, low volatility and diversified returns, when compared to equities.
Commodities and Infrastructure have performed well considering the increased turbulence seen in equity markets recently. Unfortunately, the trend following strategies have suffered, as markets have seesawed over the summer. 7IM continue to look at opportunities in the alternatives space as doubts remain over Fixed Income returns in the future.
Sources: LGT Vestra and 7IM