Third Quarter 2016
As At 30th September 2016
Most financial markets have recovered following the UK’s vote to leave the European Union (EU) in June, although political uncertainty remains a risk.
Data shows that in the short term, the UK economy has been resilient. Unemployment continues to fall, consumer spending is buoyant, and business activity has been strong, particularly in the services sector.
It is too early to determine the effects of Britain’s vote to leave the EU. PM Theresa May announced at the Conservative Party conference in October that Article 50 of the EU treaty, which will officially kick-off Brexit negotiations, will be invoked before the end of first quarter of 2017.
UK equities and commercial property recovered strongly from their post-Referendum sell-off during the quarter, but the pound has continued to fall sharply.
While the FTSE 100 reached new highs for the year and the S&P 500 set a new record over the review period, the performance of different sectors has diverged sharply. Exporters have done well as they sell cheaper goods abroad, and as earnings are translated into more pennies and pounds in the UK. However, UK and European banks continue to hit new lows, as they struggle with regulatory fines, reputational fall-out and low margins in this ultra-low interest rate environment.
Over the quarter, we have tried to take advantage of sell-offs in some domestically exposed stocks where we thought that the underlying business would remain robust, despite uncertainties following the vote, as valuations have fallen and they look good value.
The Yield Squeeze
Bond yields fell to new record lows (prices rose) early in the quarter as major central banks ramped up their monetary easing measures. The Bank of England (BoE) cut the base lending rate to a record low of 0.25% in August and resumed its bond-buying programme, while the Bank of Japan announced yield caps at its latest meeting and committed to buying assets until inflation exceeds its target of 2%.
Ten-year gilt yields tentatively reached a low near 0.5% soon after the BoE rate cut and have been inching up since. Ten-year US Treasury yields reached lows in early July and the German 10-year yield, which dropped into negative territory in late June, was marginally positive by the time of writing. Our portfolios remain underweight in government bonds, which we view as expensive.
Political uncertainty continues past the US vote, well into 2017, as French and German elections loom large in the minds of Merkel and Hollande (and the Brexit negotiators on both sides).
Investment grade (higher credit quality) corporate bonds have performed well this year, and we believe they still offer attractive risk-adjusted yields over government bonds. While the UK commercial property sector still faces some headwinds, evidence shows that concerns over a post-Brexit exodus are exaggerated and UK commercial property in general is reasonably valued, particularly for overseas investors attracted by the fall in sterling.
We continue to invest for the long term and select assets that we believe offer good value and remain diversified in order to reduce risk.
As ever, speak to your Portfolio Manager with any questions about your investments, and do refer to adambank.com for more insight.