Investment View February/March 2015
February has been a fairly settled month for most markets despite the concerns over Greece and the possible Grexit, the simmering conflict in Ukraine and Russia’s unnerving mood. Indeed the FTSE 100 has just closed at a record high beating the levels reached during the dotcom boom. Economic data has been positive, particularly in the US where an earlier increase in interest rates is looking more likely, whilst a rise in UK rates looks as though it may not happen until 2016.
The first couple of months of the year is a busy time for Fund Houses presenting their views on their funds and views on markets. Having listened to many presentations I believe there is broad consensus on each of the asset classes that we utilise in building portfolios. This month’s Investment View distils these many views to provide a picture with which we concur.
The greatest consensus of all the asset classes is direct property. The Investment Association saw its Property sector enjoy its higher ever net retail sales of £3.8bn in January. The UK commercial property market has seen a strong performance in 2014 driven primarily by buoyant investment activity. Most fund houses have upgraded projections for 2015 in light of the momentum being seen across the market. Recovery is not limited to London but is also across the regions and to more secondary stock. With the economy showing sustained growth and new supply still at low levels, rental growth is becoming more widespread and this may become a more important factor behind performance over time. Property remains attractively priced and further helped by market forecasts favouring a period of interest rate stability. The supply of property has been lagging as a consequence of the financial crisis and will not be caught up soon.
There was no fixed income manager that predicted the fall in yields in 2014 and all admitted to being wrong footed. After each fall they believed rates had to move up from there but they didn’t. Against a backdrop of an improving economic outlook driven by falling unemployment and rising wages, the recent bond market rally does not seem justified. Due to the oil price fall there is going to be deflationary pressures in the short-term. Lower energy prices will help drive consumption and economic growth higher. Markets are concentrating too much on where headline inflation is today rather than where it will be over the medium term. It is likely we are nearing the end of the current falling yield cycle. Bond yields are clearly mispriced if you view the outlook for the economy to be quite promising. We do. Despite immediate concerns over the level of bond yields we expect that we will get a re-normalisation of bond yields as interest rates start to rise in 2015, with the US leading the way.
Europe is very cheap compared to other asset classes, especially considering the recovery that could occur in companies’ profits. 2015 may be the first year in five that profits in Europe will grow faster than in the US. This is not only because the euro has weakened by about 15%, but also because of the fall in the oil price which, broadly speaking ought to boost consumption by around €750-€1000 per household. Both of these factors should provide a big boost to the economy and to corporate profits. Combine them with depressed earnings and reasonable valuation levels then there could be some attractive returns from the region.
Some companies look very expensive, but there is a very deep opportunity pool available. It is also very possible that there could be a significant asset allocation shift to provide further support. Most global investors are underweight Europe and overweight the US. If 2015 is the first time in five years that European profit growth outstrips the US, then there is potentially a huge amount of money that is going to need to move from one asset class to another.
Looking at the UK equity market, the consensus view seems to be that this business cycle was always likely to be extended, particularly given the unconventional stance of monetary policy, and the recent falls in the oil price will help to extend it further. Most agree that we are in the later expansionary stage of the cycle and portfolios are being more defensively positioned. There is little doubt that the election will be a challenging time for markets and one manager suggested that the impact could take many months to wash through. As the chart shows, that whilst FTSE 100 only delivered modest growth in 2014, the dispersion of performance was substantial and supports our preference for active management to deliver better performance. There is an opportunity to make decent potential returns in UK assets that have either been deemed not high enough quality or too cyclical. It was interesting to hear that many UK fund managers are once again looking at UK banks, believing them to be past the worst and potentially offering significant value. There is also interest in the supermarket companies that have been thoroughly battered in 2014. The following is the view of one of Schroder’s UK managers.
“2009 presented a generationally attractive opportunity to buy shares on low valuations. Six years later and with the UK market up nearly 100%, investors face a very different set of investment choices. Despite the market’s rise, pockets of value remain and today’s opportunities need to be seen in the context of long-term valuations, not near-term price moves. Areas like banks and supermarkets present compelling value for long-term investors and we are in a small minority buying in these areas.” (From my conversations I think other managers are looking too)
The greatest divergence of views is on the US market. All agree that it’s not new news that the US has had a fantastic recovery and some think returns from the US market will be slightly stodgy from here. In our view that stodginess is relative and would agree that progress will be nigh impossible at the same pace but economic data and investor sentiment are supportive. Valuations are now quite expensive and profits margins are likely to compress because of the impact of a stronger dollar on overseas earnings and higher wages.
Emerging markets are likely to revert to their conventional two-speed growth model. Much of the emerging markets will struggle as commodity prices stutter and global liquidity tightens, revealing once more the fragility of these economies. Asia will be the antithesis, benefiting disproportionately from its solid export manufacturing base, while demographics, innovation and reforms are creating some of the most powerful growth catalysts in the world today. For us, this view is best reflected in Baillie Gifford’s Pacific Fund which has significant exposure to the innovative technology companies in Taiwan and South Korea, internet leaders and reforming companies in China, and a range of Indian businesses from IT exporters to consumer titans. This fund has been introduced into many portfolios as we view its objectives and performance appealing to our portfolios.