Investment View May/June 2014
May has been a steadier month with most markets improving over the period but both the FTSE 100 and S&P 500 fell away from their mid month peaks. The S&P reached an all time high during the month and the FTSE reached a 14 year high. It looks very much as the month comes to a close that both markets will once again reach or break these peaks. Small Cap stocks have had a fairly torrid few weeks, whilst emerging markets continue to stutter threatening to improve and deliver their potential.
Undoubtedly, the consensus amongst fund managers running direct commercial property funds is one of optimism after many years of gloom following the financial crisis. There are strong views that this sector should be capable of delivering double digit returns over the next three years, which would be very welcome to all investors. We have already started to see performance significantly improving through a mixture of yield and increased demand in the sector.
At a recent event, the chief economist of a major fund house suggested that we might see interest rates increase sooner than most would expect. It was suggested that the first rate rise of a quarter of a percent could happen as early as August and then further rises of a quarter percent through each quarter of 2015. The basis of the argument was simple. The economy is recovering strongly and a rise is now sensible. It is hard to support this view as an election in the UK is due next year and whilst it is a clear demonstration that the economy is now much stronger, it is doubtful that the electorate would see it other than a negative impact on their standard of living. Although it is worth mentioning that UK data showed business optimism at a 41-year high, and that growth in UK average earnings has finally risen above the rate of CPI inflation. So just maybe it could happen as he predicts. We will soon see if that view turns out to be correct.
UK equities continue to perform very satisfactorily with only small cap stocks running out of steam at the moment. Long term small caps have historically performed stronger than large caps but not without some anxious moments. Patience should be rewarded.
In continental Europe, country divergence was less marked than has been the case in the past few months. The gradual economic recovery in the region remains on track as consumer and business confidence indicators continue to move higher. Speculation has strengthened that the European Central Bank will act to address near deflationary conditions and support the regional recovery through some further form of monetary accommodation. European stocks still offer good value and we endeavour to take advantage of that.
Although first quarter economic growth was much weaker in the US than expected, the detail showed that this weakness was concentrated in areas affected by the adverse weather conditions experienced earlier in the year. Data for the employment market and retail sales was more positive, with the outlook for the US economy sufficiently strong for the US Federal Reserve to continue tapering its bond-purchasing programme at its April meeting. The first quarter earnings season results were better-than expected. Approximately three quarters of the companies that had reported earnings, had exceeded expectations. Much of the improvement in earnings was broadly attributed to improving profit margins rather than to increased revenues. This is encouraging as it lends strength to the re-rating that took place through 2013 and helps support valuations in markets, and also may spark some merger and acquisition activity, which is positive for markets.
Emerging equity markets slightly underperformed their developed markets peers. At a regional level, Latin America was the best performing equity market, while the threat of stiffer sanctions on selected Russian individuals and companies had a negative impact on stock prices in Russia. Undoubtedly issues remain in China, particularly in its banking system. Emerging Market valuations have become more attractive but in reality the discount is only in line with its average over 18 years. Growth is required to support values, and unlocking growth is the conundrum and challenge particularly if credit tightens. Schroders have produced an excellent article that looks into the issues surrounding emerging markets, which is worth reading.
Bonds achieved broadly positive returns in April and May as the market continued to be supported by evidence of growth in the major developed economies and relatively benign inflation data. Higher levels of yield and some spread tightening meant that lower credit quality bonds (High Yield) saw some outperformance. Inflation is relatively low across the developed economies. The headline rate in the US picked up in March from the 1.1% level of February, but only to 1.5%. Eurozone inflation was 0.7% in April, up from 0.5% in March. Against this backdrop, core government bond yields fell. While bond yields have fallen in recent months, they remain higher than a year ago, just before the Fed indicated the possibility of winding down its bond-purchasing programme. Fixed interest markets remain tricky to navigate and most portfolios have or will have a strategic bond to provide flexibility and allow opportunities to be taken where they can be found. We also continue to support high yield bonds and returns continue to be very acceptable.
Overall, global equity markets were marginally positive in sterling terms over the period, remaining resilient in the face of weaker than expected economic growth figures for the US and UK; renewed concerns over a Chinese hard landing and ongoing tensions in Ukraine, which may be easing following the election. UK and European equity markets were among the strongest performers, with the former helped by an improving trend of economic news.
2014 has been a rollercoaster year so far but it does look as though US and UK equities in particular are reaching for new highs and it is highly possible that 7,000 will be reached by the FTSE. Many believe this will be a major barrier to break, and once achieved the UK market will accelerate. As with the timing of interest rate rises I am not convinced as some fundamentals need to be delivered- growth and profits. That would be the foundation to progress.