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Review

First Quarter 2016

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  • UK equity markets experienced a volatile start to the year amid widespread global growth fears and the announcement  of the Brexit referendumof a referendum on EU membership at home. The FTSE 100 Index was broadly flat over the quarter, but was relatively resilient compared to mid- cap stocks, which were down 2.4% after having delivered superior relative performance in 2015.

    The past quarter was a significant one for the UK oil and gas sector, as the price of oil climbed back around $40 per barrel. The most noteworthy development was the completion of Royal Dutch Shell’s takeover of BG, which added BG’s attractive deep water and integrated gas positions to its existing portfolio. Shell also announced its financial year results in February, which saw profits decline by 80%. However, shares were up strongly as investors welcomed the substantial process the company has made in streamlining its business.

    After a tough 2015, UK-listed miners fared better as iron ore prices rebounded on the back of Chinese mills restocking ahead of the summer construction season. In February, BHP Billiton and Rio Tinto were up 7.6% and 11.1% respectively, and we remain confident that these holdings have the balance sheet strength to ride out the current downturn. Rio Tinto also announced a change in CEO, with its head of copper and coal, Jean-Sebastien Jacques, set to take over from Sam Walsh in July.

    In financials, UK banks had a poor start to the year as concerns over the spread of negative interest rates weighed on stock prices. RBS announced annual results which revealed an eighth straight year of losses, while Barclays’ shares suffered after downgrading its return on equity guidance for 2016.

    Meanwhile, Rolls-Royce was up byrose 22% in February after CEO Warren East reiterated earnings forecasts for 2016 following an earlier string of profit warnings. Although the dividend was cut for the first time in 24 years, it seems that investors are beginning to have confidence in the new management’s ability to turn around the company’s fortunes.

  • Having initially plumbed a near two-year low on fears of recession, US equities recovered to deliver returns of 1.3% over the quarter, amid better economic data and firmer oil prices.

    In another reversal from 2015, the dollar weakened against a raft of other major currencies, particularly after the Fed tempered expectations for future interest-rate increases at its March meeting. This helped boost a recovery in commodity prices and miners. Despite a recovery in cyclical areas towards the end of the quarter, it was the defensive sectors of telecoms and utilities that delivered the strongest returns over the three months.

    The fourth-quarter earnings season led to some big swings in share prices, even among the largest companies. Notable decliners included Apple, Boeing and Amazon, which all fell by more than 5% on disappointing earnings, while the biggest gainers included Facebook, which rose 15% after its earnings report.

    The quarter featured significant merger and acquisition activity: industrial United Technologies rebuffed a $92bn takeover offer from rival Honeywell, while Johnson Controls and Tyco International announced a $29bn merger. Elsewhere, hotel group Starwood was subject to a bidding war between Marriott and a consortium led by China’s Anbang Insurance.

  • Having outperformed in 2015, European markets were hit hard by the general volatility in global equities at the start of this year. The FTSE AW Europe Ex UK fell 6.1% over the quarter.

    Central bank policy was a key focus for European investors. With markets having been disappointed by the measures unveiled by the European Central Bank (ECB) in December, President Mario Draghi set out to reassure investors of his commitment to shoring up growth and inflation in the eurozone.  True to his word, the ECB surprised markets in March with a bigger-than-expected package that included a further cut to an already negative deposit rate.

    At a stock level, the banking sector dominated headlines. Fears over the impact negative interest rates would have on banks’ profitability led to a sharp sell off in February, before they stabilised. Oil and related stocks, meanwhile, were initially hurt by the steep drop in the oil price, though they bounced in March as oil prices stabilised.

    In company news, Swiss agricultural business Syngenta rose nearly 7% in February, following a $43bn bid from ChemChina. In March, we sold Danish pharmaceutical  group Novo Nordisk, which had performed well for us over the long term. In our view, its premium valuation had become difficult to justify considering increased pricing pressure in the US, new threats to their haemophilia franchise and evidence of sales cannibalisation in core markets.

    The political landscape in Europe remains a concern. There is uncertainty in the UK over a possible Brexit, Spain has yet to form a government following elections in 2015, the migrant crisis has escalated and terrorism remains a very real threat. Against this backdrop, we are prepared for further volatility as we enter the second quarter.

  • The FTSE AW Asia Pacific Ex Japan Index rose 4.6% over the quarter. In a reversal of 2015, ASEAN markets were the strongest regional performers, led by the South East Asian countries of Thailand, the Philippines, Indonesia and Malaysia. By contrast, China A-shares were laggards, with a bungled, and then abandoned, attempt at introducing market ‘circuit-breakers’ only serving to exacerbate confusion among retail investors and damage the credibility of China’s onshore regulators. The move also impacted offshore China markets, with Hong Kong-traded China H-shares and the Hong Kong Hang Seng Index similarly posting losses for the quarter.

    Japan, one of the market leaders last year, has struggled in 2016, with the Nikkei Index down 12% over the quarter – though the market has recovered about half of its losses from its mid-February low. There remains a strong inverse correlation between the Japanese yen and market performance, and yen strengthening over the period was a notable headwind. The yen appears to have remained in demand as a safe haven despite the potential for the Bank of Japan’s unexpected adoption of a negative interest rate policy in January to undermine the currency.

  • Top-tier government bonds powered to fresh highs over the first quarter, gaining strength from the general risk aversion that marked the start to the year as well as central-bank support and lacklustre inflation.

    UK gilts returned 4.9% over the three months, with the yield (which moves inversely to price) on the ten-year bond slipping from 1.96% at the start of 2016 to 1.3% in mid-February. While easing fears over global growth and a recovery in risk appetite led to a partial reversal, the Bank of England marked down domestic growth and inflation forecasts, capping the move back up in yields.

    Supportive action by the major central banks was a big theme for bond markets. The Bank of Japan’s surprise decision in January to adopt negative interest rates to fight deflation was followed by a move by Sweden’s Riskbank to cut its repo rate further into negative territory. Meanwhile, the People’s Bank of China continued to ease monetary policy to boost flagging domestic growth. And in Europe, the central bank unleashed a bigger-than-expected package of measures that included further rate cuts, an expansion in its asset purchase programme and incentives for banks to lend more.

    Even in the US, where investors had been expecting a divergence in policy to undermine the bond market – as the Fed continued on its path of hiking interest rates – support came from the surprisingly dovish stance of the central bank’s March meeting. Chair Janet Yellen talked of “proceeding cautiously in removing policy accommodation”, and projections of rate rises for 2016 were halved from four to two.

    Initial fears for global growth weighed on corporate bonds, with yields for the riskier sectors spiking (prices dropping) in January and early February. A heavy proportion of energy companies in the high-yield universe meant that the collapse in oil prices early in the year sparked a surge in the additional yields offered by such bonds over their government counterparts, on fears of rising defaults among energy firms. Debt offered by banks was also under fire from worries about the profitability of the financial sector in a world of negative interest rates. However, there was a rally in the second half of the quarter as investors took a more constructive view of the outlook for the global economy.

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