MONTHLY MARKET COMMENTARY

APRIL 2018

UNITED

KINGDOM

Our theme is famous composers – after the sweet music that risk assets have been playing for some time, with President Trump claiming to be conductor-in-chief, February/March 2018 have been rather more akin to the music one might deliver in private, say in the shower. A deterioration in the tune is no surprise, and the instruments that have been used to deliver the symphony now look as if they need a good overhaul. Political deterioration is another matter (and we stress, as ever, that this publication is apolitical). Despite the apparent positives from Europe last month on the Brexit negotiations, PM May has no easy task, and the ongoing discord within her own party is only matched at present by the issues faced by the party in opposition. Recent equity index falls are not down to UK political issues, but it is fair to say that GDP is probably weaker, and will likely remain so, until there is clarity on the issues of Europe and trade in particular. We are pretty sure the Prime Minister has a Chopin Liszt … In an environment that anyone starting work since 2007 has not experienced in their working lives, namely rising interest rates, a reminder; previously it might have been the norm to see stronger GDP and rising inflation. In fact, inflation is part of the problem, but rampant it is not. Will the Monetary Policy Committee (MPC) remain composed, or will they leap to the sound of the inflation drum and raise rates sooner/by more than many would have thought likely even three months ago? As can be seen in the Market Data at the rear of our Commentary, our underweight position in UK equities has been helpful, especially as (more than is the case for many competitors) we have chosen smaller companies as our ‘bias’ where we do own locally. Current levels are clearly a better entry point for many markets than was the case even in January (when the main UK index hit an all-time high), though we remain happy to have discipline flexibility within our asset allocations, and the processes that led to those decisions are robust.

Our portfolios have not been immune to recent volatility, though they have experienced reduced drawdowns and we have seen signs that those who slavishly flew into tracking indices are suddenly regretful. We believe clients need to take some risk to deliver real returns – cash won’t do for most assets. However, having those assets managed can result in as many different outcomes as there are composers/songwriters. We are getting a tune out of portfolios despite the conditions.

MONTHLY MARKET COMMENTARY

APRIL 2018

UNITED

KINGDOM (cont’d)

Term or word(s) to watch: trade wars … which according to President Trump are always ‘good and easy to win’. His belief, it seems, is that to repatriate orders for the likes of steel, aluminium and tech to US producers guarantees that funds come ‘home’. China is an obvious target. However, he (a) doesn’t know his history and (b) is missing a rather large point. Firstly, though the stock market crash of 1929 had already happened, there are many that put the depth and intensity of the Great Depression of the 1930s squarely at the door of tariffs, imposed by the Smoot-Hawley Tariff Act. President Hoover’s idea was to raise the cost of imports, protecting (as it was then) the farmers of America and thereby the nation’s economy. This is a similar approach to that espoused by President Trump. Today, his belief that tariffs will both safeguard US jobs and bring US dollars home is somewhat misplaced. The impact of price rises on steel and aluminium alone will almost certainly hit auto and oil industries, destroying jobs in the process. There is also the very real prospect of inflation, something that thus far the Federal Reserve (Fed) has more or less kept a lid on. Beware protectionism … and look out for more references to trade wars in the coming weeks/months.

NORTH

AMERICA

If sentiment hadn’t fundamentally changed at the time of the last Commentary, it certainly feels as if it has now. US stocks have entered correction territory with concerns over the technology sector and rising trade tensions between the US and China acting as the primary catalysts. Though distinct, both emanate from political risk and the (apparent) randomness of President Trump’s tweets. The President apparently ‘has it in’ for Amazon, whose business practices are being blamed for job losses (not actually that controversial) and whose record on tax hasn’t delighted the administration. The stand-off with China is proving most unhelpful, and though we get the occasional reassurance that things will not spiral out of control, the various retaliatory measures are increasing at quite a pace and a diversified range of businesses are now being negatively affected, with their share prices following suit. Remember, stocks entered the year at much stretched levels so any change in sentiment – whatever the cause – was always going to be material. We could of course see a bounce back in equity prices – the fiscal stimulus from the Trump tax cuts has not yet manifested itself – but this would merely compound fears of another correction further down the line.

MONTHLY MARKET COMMENTARY

APRIL 2018

NORTH

AMERICA (cont’d)

The US’s most famous composer is probably George Gershwin whose compositions have influenced generations in the classical and jazz spheres. Though plagued by gastrointestinal problems including constipation and cramps, which local equity markets might currently recognise, he produced a body of work that has established itself in the US (indeed global) musical lexicon. We had no way of telling what the proximate cause of the sell-off would be, but we knew we were close to one and have been wary for some time. In truth, the causes this time have been of greater concern than one might have expected – no change in economic outlook seems discernible but sentiment has still markedly changed. The US-China altercation is to be taken very seriously indeed, and a market that was narrowly driven by the largest tech names is clearly undermined by what is occurring in that space.

The ‘better value’ argument after a material sell-off may have a certain logical appeal, but the US looks a long way off representing compelling value to us. We expect to maintain low exposure in direct US funds with niche sector ideas remaining preferable.

EUROPE

We have remained underweight to European equities for quite some time, removing the last specific geographical allocation before the Italian Constitutional Referendum in November 2016. This month we examine why we have taken this non-consensus position, with many institutions being overweight to the region. European equities have massively underperformed against US equities since the global financial crisis, and many point to this catch-up potential as an attractive characteristic. It also can be noted that European equities are trading in line with their long-term average, whereas US equities are at a premium. We, however, see this as justified. European companies have seen a recovery and improving profitability; however, this pales into insignificance to the fiscal measures being seen in the US, through tax cuts and deregulation of certain industries. The ‘Zum Roten Igel’ (Red Hedgehog Tavern) in Vienna was a frequent haunt of many celebrated composers including Schubert, Mendelssohn, Schumann and Brahms. Brahms in particular was a regular and stubbornly refused to have his midday meal anywhere else. The staff even kept a barrel of Hungarian Tokay in the cellar just for him. The makeup of the indices also needs to be considered, with the US having far more technology stocks than most, giving their indices a ‘growth’ bias whereas Europe has far more ‘value’ type companies, with industrials and financials particularly noticeable.

MONTHLY MARKET COMMENTARY

APRIL 2018

EUROPE (cont’d)

It is true that Europe has been witnessing growth, but we see most of this already priced in. Companies will also begin to see their cost of borrowing rise as the European Central Bank begins to taper its extraordinary monetary policy, with the current environment at odds with the still largely negative rates on the continent. We also remain cognisant of the structural issues still to be solved in Europe, such as the low labour mobility rate. Politics adds another negative, with any renewed political instability in either Italy, Spain (Catalonia) or any other of the 25 EU states potentially damaging to sentiment.

We remain underweight to European equities and have no specific geographical allocation to the region, although we have some exposure through thematic areas. We continue to see other areas as more attractive.

JAPAN

Our enthusiasm for Japan has recently been tempered by concerns over a risk-off period in markets strengthening the yen and hitting Japanese equities disproportionately. This must remain a very real concern, and a world of elevated trade tensions will not help an economy with so many large exporters. When a stock market has done so well due to inflows from global investors, it is also wise to monitor more technical factors that could influence equity prices. One thing to watch on this front is the possible change in the MSCI weightings involving Japan (bear with us, we recognise this already sounds incredibly boring!). Many Japanese companies have strategic stakes in them taken up by large insurance companies – these are not really traded or ‘free float’ components of the equity shareholder base, so some believe this would be better reflected in the make-up of the MSCI World index. Currently, the MSCI treats any stake of more than 5% held by Japanese insurance companies in domestic stocks as non-free float, but from June this could be lowered to 2%. This will mean a reduction in the Japan equity weighting in the free float adjusted global index. An announcement is due in mid-May, but this could have a meaningful impact on how global investors respond with regards to Japan. Japanese composer Mamoru Samuragochi falsely claimed to be totally deaf. The alleged disability led to comparisons with Beethoven until his claim was exposed. In 2014 it was also revealed that most of the work previously attributable to him had in fact been composed by Takahi Niigaki! There is a reason Samuragochi is not a household name …

MONTHLY MARKET COMMENTARY

APRIL 2018

JAPAN (cont’d)

Changes in any index are interesting (honestly); here, it is an instance where the topic of corporate governance is a negative in the Japanese story rather than the positive it has been thus far. Of course, ultimately it could lead to a further improvement in the structure of the marketplace, though it could create some short-term headwinds. There is still a corporate change story intact here and this has been a substantial part of the overall Japan investment case for some time; another reason to be a little more cautious and our recent trimming of positions looks sensible.

ASIA

Asian markets remain some of the most exciting available to investors, but their unique credentials make them vulnerable to any weakening of conviction in the global economic growth story. As a result, the recent trade tensions between the US and China in particular have caused problems for the region that was starting to recover from the geopolitical tensions over North Korea. As a developing region, trade is exceptionally important to Asia, and any disruption to the free flow of goods and services is potentially a major negative. The travails of the technology space have also been unhelpful both in terms of general sentiment and the impact on a sector that is well represented in the region. As with most things in North Korea, music should be ‘compliant’ and jazz was outlawed under several leaders, though was encouraged under Kim Jong-il, the father of current Supreme Leader Kim Jong-Un. North Korean pop music does exist – who can forget the classic ‘I Also Raise Chickens’ or the infectious ‘Potato Pride’? As to the composers, who knows? Or cares. South of the ‘border’, the global hit ‘Gangnam Style’ was penned by Psy – not exactly Beethoven himself. Looking for positives though, perhaps there are some characteristics of Asian equities that will provide some durability in these stressed times? Aside from the long-term prospects that are undeniable, if the US-China spat does degenerate into a full-blown trade war, some of the countries (particularly in Southeast Asia) may benefit. These countries may be able to continue to operate with both economic superpowers and would be in a position to form alternative supply chains. If global growth does stutter, investors will probably place a greater ‘growth premium’ on those areas offering visible and predictable economic expansion, which could favour the Asian region.

Dismissing the impact of a trade war would clearly be unwise, but there are reasons to think that the Asian region can withstand short-term difficulties better than many others. It remains one of our preferred equity strategies.

MONTHLY MARKET COMMENTARY

APRIL 2018

EMERGING MARKETS

After a difficult quarter for stocks, emerging market (EM) investors will be pleased to have registered some outperformance of their developed peers. This is something of a reversal of what ordinarily happens in periods of turmoil in markets, as EM usually get impacted much harder when the ‘flight to safety’ instinct kicks in. Some of this protection comes from the relative valuation arguments that are well rehearsed; there are reasons to remain alert. Bond yields have arrested their recent rise in the US, but the trajectory still feels established and the current geopolitical outlook is far from helpful. On the first point, if the Trump administration’s fiscal stimulus really kicks in, the rise in US yields will inevitably affect the relative attractions of most EM. The amount of debt accumulated by companies and governments in EM is also a real concern, and EM debt has delivered negative returns since the start of the year. Some funds have seen inflows slow materially, and investors are becoming more discriminating in where they seek returns. We still like pockets of EM on a long-term basis, but investors must always recognise that there is a point where the winds of change mean positions should be finessed. Growing too attached to something like EM debt is unwise and although we are comfortable with current exposure, we recognise that the dangers of searching for yield are real.

GUEST

SECTION

It is true – we just could not resist. Readers have probably had enough of eggs; we have chosen eggs as (part) of our guest section this month – not chocolate in composition (who else had too much over Easter?), so we are instead writing about Fabergé eggs. These (always fabulous) bejewelled eggs were commissioned by the Russian royal family and designed by the House of Fabergé. Some 50 eggs were made, and it is believed that 43 survive. As a result, they hardly ever come up for sale, but, in large part due to their rarity, their value to collectors is quite extraordinary. The last to be auctioned was the Vacheron-Constantin Imperial egg that sold for over £20m in 2014. The eggs typically contained jewels and were given as gifts between members of the Russian royal family. Their extreme rarity means that their distribution is predictably narrow – the Queen (ours) has three, one of which is the Mosaic Egg that was purchased by King George V in 1933 for the incredibly low sum of £250. Russia houses the majority within the Kremlin Armoury Museum, though private collectors account for a significant number.

MONTHLY MARKET COMMENTARY

APRIL 2018

GUEST

SECTION (cont’d)

The lack of liquidity means we cannot consider Fabergé eggs for investor portfolios, but even these extremely niche areas of collectibles can give indications of a change of sentiment in wider financial markets. The cooling of the fine art and classic car markets can often herald the tide of liquidity going out for more mainstream financial market instruments. We think one of these more challenging periods is currently upon us. If you do have a Fabergé egg, hang on to it … unless you really need the money.

FIXED

INCOME

We appear to be moving into a new environment for fixed income with higher rates as well as a modest widening of credit spreads amid increased volatility and a broad equity sell-off. Broad US fixed income yields, now in excess of 3%, are at their highest level in almost eight years. Spurred by positive economic data, the Fed delivered on a highly anticipated rate increase on 21 March and signalled its intention to maintain the forecast for three further rate rises this year. This was fully expected and priced in and therefore had a limited impact on bond markets. Whilst the new rate of 1.75% is low by historic standards, it does mark the central bank’s fourth increase in the past 12 months, illustrating a certain level of confidence in the economy. The Fed Chairman, Jerome Powell, has stated his desire to take ‘the middle ground’ on rates, with a view to raising them enough to curtail an eventual spike in inflation without derailing economic expansion. Rate rises in the US are not usually welcome news for EM countries. Refinancing costs rise as investors expect the yield provided by perceived higher risk EM debt to increase in order to maintain their spread with less risky US treasuries. In addition, a continued increase in their borrowing rate can result in outflows being exacerbated were a financial crisis to occur, leaving EM particularly vulnerable in periods of financial turmoil. Kurt Cobain is arguably one of the most influential and famous composers of the modern era. His anthemic compositions such as ‘Smells Like Teen Spirit’ inspired a legion of artists that followed. However, his financial legacy is a little more fraught. Following his untimely death in 1994, his widow Courtney Love found herself in debt following the alleged theft of near $530 million from the vast fortune that she inherited from the late Cobain’s estate. In contrast, UK rates have remained at historically low levels with the Bank of England (BoE) having revised the rate back to 0.5% in November 2017, the first increase in ten years.

MONTHLY MARKET COMMENTARY

APRIL 2018

FIXED

INCOME (cont’d)

In March, a 21-month post Brexit transition arrangement between the UK and the EU was agreed, somewhat reducing political uncertainty. In addition, a pleasing labour market report showed UK unemployment falling back to a cycle-low of 4.3%. This environment, along with some hawkish comments from BoE Chairman, Mark Carney, has increased expectations for a rate rise in May. Across the board, central banks seem to be leaning towards monetary policy ‘normalisation’, albeit at somewhat varied paces. Broadly, we have a cautious view on the fixed income sector, given that rates have the potential to rise at a decent pace from current levels. At some point over the medium term, developed market debt instruments may begin to look more interesting, if they can rise enough before central; banks need to use their favoured tool to restore easier money in a recessionary environment. We have relatively low exposure to fixed income within our portfolios through a diverse spread of investments, including high yield and EM debt. Last year we trimmed our position in investment grade bonds and have been avoiding all government debt due to general sensitivity to interest rate rises. We have also sought to keep duration low given our belief that we are in a transitory period.

COMMODITIES

Electric cars have long been seen as a disruptive force to the dominance of oil. However, this month saw Tesla miss yet another production target, with figures coming in way below analyst expectations. This isn’t anything new. Last year saw the spectacular failure to hit Model 3 targets where production was 80% lower than revised guidance. Clearly the market is losing patience with the firm, which despite the falls trades on an eye watering valuation. In fact, many big institutions are making significant bets against Tesla and figures suggest 25% of freely available shares are sold short. The question is, has sentiment turned against electric cars? Or is this simply a company specific issue? After a very strong 2017 where prices rocketed, lithium seems to be coming back to earth in 2018. After the announcements made by a number of governments last year, with bold targets outlawing the use of petrol and diesel vehicles in relatively short periods of time, investors have come to realise that more widespread adoption of this new technology is likely to be a gradual process.

MONTHLY MARKET COMMENTARY

APRIL 2018

COMMODITIES

(cont’d)

Whilst lithium prices have fallen recently, traditional commodities such as gold and oil have risen. The talk of trade wars and increasing geo-political tensions has helped to boost prices for both. Oil managed to test the $70 mark, before falling back to around $68 per barrel. Further questions over Venezuela’s output forecasts, given the political situation and the implications of geo-political tension, led some investors to question future supply levels. However, some claim the price has a natural ceiling, whereby the increased price allows more projects to come on-stream, increasing supply and causing prices to fall. Gold prices typically struggle in a rising interest rate environment. However, threats of rises seem to have been outweighed by the talk of trade wars and moderate but sustained levels of inflation. The precious metal has performed well in recent market volatility, proving its worth in our portfolios both in terms of diversification and insurance. Our positioning remains unchanged.

PROPERTY

People tend to think of property in two distinct camps, namely residential and commercial. We do not have any residential property exposure within managed portfolios, but we acknowledge that some of the yields on offer are interesting and it is a sub-sector that we monitor. Commercial property, on the other hand, is an area that we have been keen on for some time. We are increasingly looking at interesting themes within the sector that can help to drive returns and provide diversification benefits. One such area of interest is care homes, where we see continued growth in demand due to the ageing population. Over the next 20 years, the number of over-85s is expected to double, mainly due to advances in medicine. At present, average care home occupancy is at around 91%, which is a ten-year high. Supply is also favourable for investors, as we have seen a net reduction in beds as part of a continuing trend. Around 80% of care homes were built before 2000, highlighting the lack of development in the sector. Properties typically have long lease lengths, often around 30 years, and investment trusts in this space can offer yields of around 5%. Though the leases are lengthy, they often have RPI linkage or fixed annual uplifts, helping to protect investors against inflation. At the other end of the lease-length spectrum is student property, where tenants occupy properties for under a year at a time. Whilst this does give more uncertainty over future demand and occupancy levels, owners of the properties can be more responsive to changes in average rents and inflation rates.

MONTHLY MARKET COMMENTARY

APRIL 2018

PROPERTY (cont’d)

Political sentiment and fears over Brexit have led to falls in foreign student levels; however, the outlook for the next academic year looks improved. Parents sending prospective students to the UK will be aware of the political uncertainty, but if we were to have a hard Brexit, a weaker sterling (assuming this were the case) could be a tailwind for foreign student numbers. As with care homes, we can access a diversified portfolio of student properties via closed-ended funds. We often talk about themes in our portfolios and our choice to focus on certain areas of the market we particularly like, for example healthcare. We generally play these themes using equity funds, but there are some interesting and exciting areas of the property market outside of the conventional high street, industrial and office commercial property funds.

CURRENCY

Having previously written about the death of cash (in hard form coins/notes – it remains our view), the hot topic in the UK last month was whether little used 1p and 2p coins might be consigned to history sooner rather than later. Alongside the Spring Statement (truly underwhelming as it was), the Treasury has said it will review their use, as it makes ‘little economic sense to produce coins (and notes – they are also reviewing the £50 note) that are used infrequently’. It is said that it costs more to produce 1p and 2p coins than they are worth, which is a good economic reason to halt their production/use.

If you feel strongly either way, you can have your say – the Treasury has asked for responses to their consultation document ‘Cash and digital payments in the new economy’, and we are happy to share their email address: cashanddigitalpayments@HMTreasury.gsi.gov.uk

UK INTEREST

RATES

When 7–2 becomes 4–5, that’s when we need to sit up and take notice. The MPC of the BoE remains, at first sight, relaxed with the interest rate at 0.5%. Inflation, sticky at or above 3%, is seen as temporary at those levels, with an expectation that a fall towards 2% (the target set for the MPC by the Treasury) will happen pretty soon. A strengthening of sterling has helped somewhat, particularly from early 2017, yet there are other inflationary pressures that we are less sure will play ball.

Accordingly, as highlighted elsewhere, we do expect a rate rise this year, and possibly one of a full 0.5%, rather than one or two of 0.25% each. Whilst these numbers are clearly historically insignificant, the need to ‘normalise’ interest rates is clearly high in the minds of the MPC – can they get the base rate above 2% before a recessionary environment demands using lower rates to stimulate the economy?

MONTHLY MARKET COMMENTARY

APRIL 2018

NUMBERS OF THE MONTH

Our monthly look at numbers that may or may not have grabbed the headlines.

235% $23bn c. 37,200 The rise in the cost of a first

class stamp since 1989.

The estimated market cap of

Spotify ahead of its NYSE

listing.

The number of tweets from

President Trump’s Twitter

account (around 36,400 more

than Theresa May).

MARKET DATA

Index 29.03.18 1 month 1 year 3 years

Bovespa (Brazil) 85,365.56 0.01% 31.36% 66.89%

Hang Seng 30,093.38 −2.44% 24.81% 20.85%

Dow Jones Industrials 24,103.11 −3.70% 16.65% 35.59%

RTS (Russia) 1,246.98 −2.99% 11.96% 41.63%

Nikkei 225 21,159.08 −4.12% 11.90% 10.16%

S&P 500 2,640.87 −2.69% 11.77% 27.71%

BSE (India) 32,968.68 −3.56% 11.30% 17.92%

M-DAX (Germany) 25,591.52 −2.60% 7.06% 23.72%

MSCI United Kingdom Small Cap 413.39 −0.97% 6.48% 21.19%

IPD UK All Property* 0.98% 6.21% 11.70%

Numis UK Smaller Companies 5,612.96 −1.54% 4.36% 24.23%

CAC 40 (France) 5,167.30 −2.88% 0.87% 2.66%

Shanghai A (China) 3,309.98 −3.04% −1.92% −15.74%

IBOXX UK Sterling Gilts All Mat. 123.98 1.45% −2.28% 0.94%

MSCI United Kingdom All Cap 1,330.25 −2.26% −2.61% 5.56%

MSCI United Kingdom 2,042.63 −2.50% −4.23% 2.73%

*Figures delayed by one month

MONTHLY MARKET COMMENTARY

APRIL 2018

The Monthly Market Commentary (MMC) is written and researched by Simon Gibson, Richard Smith,

Scott Bradshaw, Jonathon Marchant and Lauren Wilson for clients and professional connections of Mattioli

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Sources: www.bbc.co.uk, www.bloomberg.com, Financial Express, www.safevaultstore.com, www.ogdcl.com,

en.wikipedia.org, www.ratekhoj.com, www.killerfashionirl.wordpress.com. All other sources quoted if used directly;

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