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This month:
Markets ride high despite geopolitical turmoil
UK political uncertainty becomes worrisome.
The macroeconomic backdrop for equity markets shifts.
Risk management comes to the fore.
Emerging markets build their allure .
Featuring this month’s experts:
We are now eight years into a historic bull market, with many seeing conditions remaining broadly supportive for equities.
Yet, as leading wealth managers from our panel explain, political uncertainties still loom large, bringing risk management to the fore and arguably creating opportunities for active managers to prove their mettle. Also explained is why emerging markets look particularly attractive today.
The economic consequences of political uncertainty
Insights from:
Dean Turner, an economist at UBS Wealth Management, says:
It has been one of the most exciting party conference seasons for many years, leaving us with much to ponder in the months ahead. Though it would seem the Prime Minister has done enough to retain her job for now, nothing is set in stone. As one former Conservative leader pointed out, politics is driven by ‘events…’; the PM has had her fair share of those already, but that doesn’t mean another one isn’t just around the corner.
I have long been of the view that in the short term, the noise generated by our politicians has very little impact on the day-to-day activities taking place in the economy, and in turn the markets. Life carries on as most firms and consumers are too busy getting on with things. However, today the UK is probably an exception to this rule.
At a time when the rest of the G7 economies are delivering faster growth and sentiment surveys point to this continuing for a while yet, the UK’s sluggish performance stands out.
Many, myself included, are keen to point out that the economy has held up much better than initially expected in the wake of the shock referendum result. But to conclude that there has been no impact at all would be wrong. At a time when the rest of the G7 economies are delivering faster growth and sentiment surveys point to this continuing for a while yet, the UK’s sluggish performance stands out. Some of the blame for this, one way or another, can be laid at the door of Brexit. Thus, political uncertainty is having very real consequences.
One thing the party conference season has brought into focus is that even beyond Brexit, political uncertainty isn’t going to fade. If the current government doesn’t make a success of Brexit and the economy is worse off for it, the Labour Party are standing ready in the wings. A Labour government looking to deliver their own version of the so-called ‘British dream’ could end up being another example of where political uncertainty has very real consequences for the economy.
Dean Turner
An economist at UBS Wealth Management
Amid increasing geopolitical risks, why are the markets hitting new highs?
Insights from:
Christian Armbruester, Chief Executive of Blu Family Office, says:
With the greatest financial crisis the world has ever known still in vivid memory, not even Brexit or the US elections have been able to dampen what is now a historic bull market in its eighth year, and again making new highs. The news flow is turning ever more bizarre and the risks are seemingly becoming more and more acute. The VIX (Volatility Index for the S&P 500 Index) however, is near all-time lows: seemingly signalling that there is very little to worry about.
Have we all gone insane? I still remember when sterling stood strong, like a rock in the sea, at 2.08 versus the dollar at the beginning of the crisis, when many indices had already made big moves. Until it didn’t, and I watched it fall all the way to 1.50 in an almost instantaneous move. Of course, in today’s terms, that seems a lofty level, and maybe, just maybe, since we are now even further below this level, we should all be a little concerned? Anybody?
Managing your risk, particularly in times when things seem strange and quiet, is all the more important. Maybe it’s also potentially an opportune time to buy cheap insurance, when everyone else seems to have forgotten that things can also go down.
Onwards and upwards as they say, and the market is always right, but it begs to ask the question that when it falls, and fall it will (at least temporarily, as things don’t go up in straight lines forever), ‘Are we comfortable with the potential destruction to our investment portfolio?’ And if the answer is: ‘that worries me’, then we had better do something about it.
Managing your risk, particularly in times when things seem strange and quiet, is all the more important. Maybe it’s also potentially an opportune time to buy cheap insurance, when everyone else seems to have forgotten that things can also go down.
Christian Armbruester
Chief Executive of Blu Family Office
A favourable backdrop for stocks overall
Insights from:
Daniel Casali, Partner at Smith & Williamson, says:
The S&P 500 operating profit margin is at a record high, as major companies have been adept at keeping labour costs down. If labour fails to negotiate higher wages from corporates, profit margins are likely to remain elevated. There are structural reasons to believe that labour is unlikely to regain pricing power anytime soon. Advances in telecommunications technology enable companies to parcel out service-sector jobs to areas with high unemployment, where wage rates are typically low.
Given that companies are becoming more profitable and we have a synchronised global growth environment, this probably explains why equities have been able to shrug-off a new cycle of monetary tightening by major central banks.
Starting with the US, the Federal Open Market Committee last month announced its intention to stop reinvesting all of the money it receives when Treasuries and mortgage-backed securities mature, but with caps added to reduce the risk of a sudden withdrawal of liquidity from the financial system.
In Europe, the European Central Bank is set to taper asset purchases, while the Bank of England has brought forward expectations of a rate hike. Considering that inflation is running below central bank mandates, monetary tightening is expected to be gradual.
Given that companies are becoming more profitable and we have a synchronised global growth environment, this probably explains why equities have been able to shrug-off a new cycle of monetary tightening by major central banks.
Global stocks have proved robust, in the face of political uncertainty. Although Angela Merkel secured a fourth term as German chancellor in the September federal election, it was not a great result for her party. Given the seat distribution in parliament, Merkel’s only realistic option to govern is to link up with both the business-friendly Free Democratic Party and the Greens to form a coalition. The inclusion of the FDP in the coalition, which is strongly opposed to EU integration, runs the risk of creating uncertainty over EU support for economies in the periphery of Europe.
The German election also has potential implications for Brexit. While David Davis and Michel Barnier are negotiating deal options, they are getting no firm guidance from Berlin on which direction to pursue and are unlikely to receive any until a German government is established. It remains to be seen how European leaders will respond to UK PM May’s recent speech on Brexit in Florence. Considering that the UK is in the uniquely difficult position of having the widest current account deficit and lowest real yields out of the world’s major economies, it will be difficult for sterling to rally far, even if market expectations for higher UK interest rates in November have intensified.
Daniel Casali
Partner at Smith & Williamson
Active management fights back!
Insights from:
Matthew Beesley, Head of Equities at GAM, says:
The market environment has certainly been challenging for active managers in recent years, with the advent of quantitative easing across much of the developed world aggressively distorting equity markets. Earnings growth has been low as the world has recovered from the bust of 2008, while asset price inflation has been high. With interest rates low globally, correlations between assets and also within asset classes have been high, which has led to a challenging period for active management.
But it has been a very different picture so far in 2017. The end of quantitative easing is nigh and interest rates are rising, at least in the US, signifying the start of a period of normalisation in global monetary conditions. With this significant shift in policy, active management has returned to the fore. And we think there is more to come.
When market downturns occur, this is when dispersion increases the most and active managers add the most value. We are now eight years into this current equity bull run and expect there will be a time soon when active managers really prove their worth to the discerning client.
The macroeconomic backdrop for equity markets is changing. As we have already noted, interest rates have begun to climb in the US, albeit slowly. A rate rise in the UK is not impossible in the next year, while economic data and ECB rhetoric firmly suggest that quantitative easing in the eurozone will be curtailed through 2018. We expect stock correlations to continue to fall and dispersions of returns to rise, creating a fertile environment for an active stock-picker with a clear and consistent investment process.
Matthew Beesle
Head of Equities at GAM
The attractions of emerging markets
Insights from:
Rory McPherson, Head of Investment Strategy at Psigma Investment Management, says:
Eight and a half years of rising markets combined with the $15 trillion splurge by global central banks hasn’t left many assets looking cheap. We believe that emerging market (EM) equities, whilst not kicking around in the bargain basement, are by no means expensive. To us, along with Asian equities more generally, they rank amongst the best regional opportunities for value on a global basis.
Although EM stocks are having an excellent 2017 (up nearly 20% year-to-date), they still lag behind their developed counterparts over recent time periods. Over the last three years, EMs lag global stocks by nearly 60% and are under-owned by global managers. Recent data from EPRF Global suggests that the average global manager has an allocation of some 8% towards EM stocks versus an all-country benchmark weighting of circa 12%.
We believe that emerging market (EM) equities, whilst not kicking around in the bargain basement, are by no means expensive. To us, along with Asian equities more generally, they rank amongst the best regional opportunities for value on a global basis.
EM stocks are currently attractive, not least because of their valuations. At a forward P/E multiple of circa 12.6x, they are trading at a marked discount to their developed market counterparts, which trade on a more full 16x multiple of next years’ earnings. In addition to this, EMs are enjoying extremely strong earnings growth (expected to run at 20% this year) combined with the virtuous kicker of rising profit margins. This earnings growth is especially pronounced within the Asia region, which is our preferred area. Value alone is not enough for us, but combine this with improving business cycles – along with the fact emerging markets are under-owned – and this story gets our contrarian juices flowing.
Rory McPherson
Head of Investment Strategy at Psigma Investment Management
Important information
The investment strategy explanations contained in this piece are for informational purposes only, represent the views of individual institutions, and are not intended in any way as financial or investment advice. Any comment on specific securities should not be interpreted as investment research or advice, solicitation or recommendations to buy or sell a particular security.
We always advise consultation with a professional before making any investment decisions.
Always remember that investing involves risk and the value of investments may fall as well as rise. Past performance should not be seen as a guarantee of future returns.
