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Third Quarter 2016

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  • UK equity markets have proven remarkably resilient in the third quarter, despite the uncertainty created by the vote to leave the European Union on 23 June. The devaluation of the pound has been supportive of large UK-listed companies, as over 70% of FTSE 100 company revenues come from overseas.

    Within this, internationally exposed banks such as HSBC and Standard Chartered have outperformed, and HSBC also announced that it intends to return excess capital to shareholders. Commodity stocks have enjoyed a strong quarter as economic data from China steadied. With interest rates still extremely low, UK equities that offer a robust and sustainable yield have also continued to perform well.

    The devaluation of the pound has been supportive of large UK-listed companies, as over 70% of FTSE 100 company revenues come from overseas

    The mid-cap FTSE 250 index, which is more representative of the domestic UK economy, has risen 10.7% over the course of the third quarter. This index had sold off sharply after  the vote, but a string of better than expected economic data points has alleviated concerns about the immediate prospects for the UK economy.

    Markets are also optimistic that new Chancellor Phillip Hammond will utilise fiscal policy to support the domestic economy. This speculation has boosted investor sentiment towards both property and infrastructure related stocks that would benefit from increased government spending. 

  • Equity markets rose by 3.9% during the third quarter, hitting a new all-time high in August. The market was led by a strong performance from the technology sector, boosted by strong Q2 results from heavyweights Apple, Alphabet (Google) and Microsoft.

    Meanwhile, the energy sector continued its rebound from its January lows, as confidence grew in a sustained recovery in oil prices. The Financials witnessed a recovery in share price performance during Q3 on growing hopes for a rate rise at the December meeting of the FOMC.

    Politics was a focus for investors during Q3 as candidates Donald Trump and Hillary Clinton battled for the Presidency

    What has been notable about recent US equity market strength has been the broad participation of stocks and sectors. All sectors are in positive territory over the past 12 months and around 70% of S&P 500 equities are above their 200-day moving averages. This suggests a ‘healthy’ advance, in contrast to previous environments when the market’s advance has relied on one or two sectors.

    Politics was a focus for investors during Q3 as candidates Donald Trump and Hillary Clinton battled for the Presidency. The healthcare sector was buffeted by concerns of potential regulatory action on drug prices, following a number of comments from Hillary Clinton during the campaign.

  • Despite the precipitous falls seen in the immediate aftermath of the UK’s decision to leave the European Union (EU), European markets appeared to take a more relaxed attitude to the event over the summer months. In local currency terms the FTSE AW Europe Ex UK rose 4.8%, the French CAC was up 5.2% and Germany’s DAX rose 8.6%.

    Against this uncertain backdrop, economic data suggests that the European economy continues to muddle through, buoyed by a combination of government spending, negative interest rates and ongoing asset purchases by the European Central Bank. Consumers and businesses have benefited from cheap borrowing. Unemployment is also on a downward trajectory, albeit from a high starting point.

    Political uncertainty is rife, the migrant crisis is unresolved and banks are struggling

    At the individual stock level, Syngenta was strong over the period as the US national security regulator approved ChemChina’s plans to acquire the Swiss agrichemicals company. This had previously been perceived as a significant obstacle for the deal. European healthcare names were weaker as the markets began to turn their attention to the upcoming US Presidential Election and possibility of increased pricing pressure in the event of a Democrat win.

    Europe faces multiple challenges over the coming months. Political uncertainty is rife, the migrant crisis is unresolved and banks are struggling, with Deutsche Bank becoming the latest casualty. Furthermore, electorates in France and Greece are openly dissatisfied with the EU, so while Theresa May frets on how to negotiate the best deal for the UK, European leaders are increasingly turning their attention inwards to their own domestic affairs. Italy will vote on constitutional reform later this year, and economies accounting for over 40% of the EU economy are due to go to the polls in 2017. We will be watching closely to see how this plays out.

  • Japan was helped by a further government stimulus package - and the realisation by politicians that low interest rates by themselves are no longer enough to keep the economic recovery on track.

    After some years of underperformance, emerging markets built on a good first half to deliver further strong growth.

    Emerging markets benefitted from the decision by the US Federal Reserve to keep interest rates on hold for another quarter, as well as continuing decent economic data from most major economies.

    There is also more optimism that China will be able to manage its long-term shift from being a managed economy to one driven by consumer demand. Chinese consumer spending on autos and other goods remains robust.

    The focus of global investors on higher-yielding assets helped markets with high dividends such as South Africa, Russia and Brazil, particularly as commodity and oil prices improved.

  • The result of the EU Referendum surprised investors. While sterling fell sharply and has remained weak, UK government bonds (gilts) provided a return of 2.3% over the third quarter. They continued to perform strongly during July and August with yields falling to historically low levels. The redemption yield on a 10-year gilt fell to below 0.6% before rising again to the current level of around 1%. Gilts benefitted from post-Referendum uncertainty and the actions of the authorities to counter it, but have suffered recently on fears of inflation from a weaker currency.
     

    Policy Response

    Concerns have focused on the timing, process and terms of leaving the EU, and the extent to which consumer and business confidence will be affected. To provide support to the economy, the Bank of England (BoE) took action in August. There was a cut in the base lending rate to 0.25% (from 0.5%), the first since 2009. Further reductions could be made if necessary by the Monetary Policy Committee by the year end, although Governor Mark Carney has stated that he does not expect negative interest rates in the UK.

    The BoE also extended its quantitative easing programme by a further £70bn. This involves purchasing gilts across all maturities and now includes investment grade corporate bonds. The aim is to keep yields and borrowing costs low to inject funds into the economy.
     

    Economic Outlook

    While economic statistics since the EU Referendum have, on balance, been better than feared, the outlook for growth has been trimmed this year and reduced next. The BoE cut its growth forecast for the UK economy to 0.8% in 2017 (from 2.3%) in its August Quarterly Inflation Report, while the International Monetary Fund (IMF) has set growth at 1.1%. Inflation forecasts have been raised as well with the BoE expecting the CPI to almost reach its target of 2% by this time next year.

    Despite all the action taken by central banks around the world to support global growth, the focus has moved from loose monetary policies to the role of fiscal policy. In the UK, Philip Hammond, the new Chancellor, has confirmed that the government no longer plans to balance the budget by 2020 and that he is prepared to undertake targeted infrastructure spending.

     

    Strategy

    With Article 50 expected to be triggered by the end of March 2017, a weaker sterling increasing inflationary expectations, and the prospects of a looser fiscal policy framework, we take a cautious approach to fixed interest in portfolios. With over $10tn of global sovereign bonds providing a negative yield, valuations look relatively unattractive. Our focus remains on achieving secure income with stability in capital from a diversified exposure to gilts and corporate bonds, avoiding longer-dated issues.

Note

The source data for each graph is supplied by Thomson Reuters Datastream, as at 30 Setptember 2016 total return, local currency unless otherwise stated.

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