Q1 Market Commentary

By Scott A. Middleton, Chartered Financial Planner
James & George Collie Financial Management

Despite a perceived background of worldwide uncertainty and volatility the Q1 of 2017 has witnessed further upward growth for many investors. The FTSE 100 Index increased in value by 2.86%, the FTSE World Index by 2.89% and there was a significant upturn in European Equities, which increased in value by 7.31% measured by the FT Europe (ex UK) index.

Sterling strengthened by nearly 3% during the quarter, which reduced the performance of equities that traded in overseas, dollar based, assets in Sterling terms, but boosted the performance of more UK focused firms in the ‘mid caps’ sector which rose by 9.34% measured by the FTSE 250 (ex IT) index.

During March the upward momentum in major markets appeared to reduce significantly as President Trump withdrew his healthcare bill after it failed to gain sufficient support to pass in Congress. The ‘snap’ UK election also caught many people by surprise when it was announced on 18th April and this led to a fall in the FTSE 100 whilst the progress of the far right party of Marine Le Pen in France, also caused market volatility. After a long period of strong upward returns many investors are now asking the key question ‘Is it time to bank profits and avoid the risk of a market pullback?’

It is undeniable that P/E ratios are a little on the high side. This ratio measures the share price of a company divided by the earnings per share or, to put it another way, the number of years it would take for the company to pay for itself based on current earnings. There has been some press coverage that this measure has only been above current levels on two previous occasions and both times a significant market crash followed, suggesting that investors should expect a similar outcome.

Although this press speculation is broadly accurate, there are two further pieces of immediately relevant information investors should consider. The first is that on both previous occasions valuations went up considerably further than current levels before the crash occurred suggesting that even if history does repeat itself, it is still too early to take profits. The second is that PE ratios need to be considered alongside the alternative investment option of bond yields in order to make a meaningful comparison.

Interest rates have fallen and fallen over the recent investment cycle, which began in the late 1980s. This period has been heralded as a super cycle for fixed interest markets. Yields have fallen from double digit returns to historically low levels and therefore whilst PE ratios may look high historically the yield available from lower risk asset classes is lower still and therefore equities continue to look good value on a relative basis.

Current valuations aside, the main driver of equity returns will rest on the ability of companies to increase earnings into the longer term. The last six months has witnessed an increase is equity asset valuations and this effect has sometimes been described as ‘Trumpflation’. Donald Trump, as one of his election policies, wanted to reduce taxes and increase government infrastructure spending, targeting economic growth of between 3% and 4%.

There is a widespread need to replace infrastructure within the US as many bridges, roads, railways and dams are in a poor state of repair and need imminent replacement. The combination of the potential improvement to infrastructure and the economic boost of spending the $1trn mentioned during Trumps campaign, won support from many voters and equity traders.

Stock markets have responded positively since Donald Trump won the election, but suffered a set-back in mid-March as his plans to repeal Obamacare, another key election pledge, ran into difficulties and were withdrawn. Investors began to wonder if his spending program could be relied upon, which caused equities to fall back whilst bonds recovered from a period of weakness. Whilst this set back does raise some concerns, we continue to expect the spending plans to go ahead given that the Obamacare repeal bill was closely contested and the spending plans have wider support.

Theresa May’s announcement of a ‘snap’ election on 18th April caught many by surprise, not least because she had categorically ruled out this action on, at least, 5 previous occasions. With hindsight, this decision was perhaps flawed, and the effect on the political power base and Brexit negotiations currently remains uncertain. The future potential moves of Sterling are too difficult to predict at this stage and will be influenced significantly by political developments, which are unpredictable in nature.

We continue to consider the potential future influence of the estimated $13trn which has been printed and injected into bond markets since the credit crisis by central banks. Had $13trn been spent directly within the global economy, the direct economic effect would have been incredible with a huge rise in economic activity, growth and inflation but only on a temporary basis. The mechanism of injecting this money into the bond markets has been the equivalent of a muscle based injection with a slow release over time. The impact on the real economy has been small but there is evidence that cash is moving from bond markets and impacting the real economy.

Economic data over the last twelve months has been positive with economic growth and inflation showing a more stable upward path. Confidence indications have also trended higher as companies, in particular, are more confident about the future and therefore are more likely to trigger capital spending programmes, which are stimulatory in nature.

Although it is not a good idea to rely on the past too greatly, we do recognise that some patterns in financial markets can be seen to repeat frequently. At the moment some analysists are particularly excited by the FTSE 100 as this index has been in a maximum trading range of circa 7000 since January 2000, but has recently broken above this figure seventeen years later. They point out that seventeen years is a long period for a new high not to be reached and historically, when a breakout occurs, the next cycle is often a significant upward rise and this occurred between 1992 and 2000 when the FTSE 100 increased by over 160%. Whilst this point has little relevance in isolation it does provide some context with regard to market timing in relation to the other positive economic observations.

In summary, this is an interesting time for investors with few historical reference points, especially in recent history. Yields and interest rates have not been as low as current levels in modern times (the information age which began in the 1960s and significantly impacted the global economy from the 1980s). The economic back drop has shown a generally upward trend and valuations are reasonable on current factors continuing earnings growth being likely to improve this picture. The key downside risks are largely political at present and although recent European elections have had favourable outcomes, the risks of populism are on-going in addition to global political uncertainty, especially given the unpredictable nature of President Trump.

Strategy

There are many uncertainties at present, both domestically and internationally, however we believe that there is risk on both sides. A case for significant increases in equity market values can be justified as well as outlining risks, which could lead to equity market falls. In either scenario it is difficult to see fixed interest investments being able to off-set the risk through the normal diversification process, as yields are generally too low to offer much upside to any negative news.

On balance, we see more opportunities for further growth in equity markets than downside risk and therefore portfolios are positioned with increased equity weightings. Lower risk portfolios are diversified through short dated fixed interest holdings, which are relatively less sensitive to interest rate increases, and are expected to reduce the overall volatility of the portfolio. In addition we have also included inflation linked holdings, which will benefit if inflation continues to accelerate as we expect.

The outcome of the General Election could have a major impact on your financial plans and investments.
Why not canvass our professional adviser’s opinion on the best way forward?
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Contact us on 01224 581581 or scott.middleton@colliefinancial.co.uk to arrange an appointment.

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