It was a summer of ups and downs as a sharp fall in August was sandwiched between positive returns in July and September. Taken as a whole, the quarter provided a demonstration of how holding your nerve can be a better bet than selling out as all of the Personal Portfolio Funds ultimately delivered a positive return over the three months.
With economic growth slowing, central banks have enacted policies intended to stimulate economic activity. The US Federal Reserve cut interest rates twice – by 25 basis points in July and the same amount in September – while the European Central Bank also unveiled new stimulus measures to bolster the eurozone economy. The Bank of England kept interest rates on hold at 0.75%, and policymakers indicated that prolonged Brexit uncertainty would keep rates lower for longer.
These measures are intended to counteract the effect on companies of a slower economy by making it easier for them to raise cash as money becomes tight, meaning they can develop and expand. This means that they should continue to be able to grow their profit, which has supported share prices this quarter and contributed positively to the performance of our funds.
Falling interest rates are also good for government bonds. Positive returns in this sector supported our funds, particularly at the more defensive end of the spectrum where they have a higher bond allocation.
Despite political shocks in August, markets turned in a broadly positive performance in the third quarter, with the MSCI AC World Index of global shares returning 1.1% in local currency terms. This translated to 3.3% for sterling investors as a falling pound boosted the value of non-sterling assets. Over the year-to-date, market performance remains very strong, with global shares returning 17.2% in local currency terms.
Events that unnerved markets in August included political unrest in Hong Kong, an increasingly fractious debate about Brexit in the UK, and rising temperatures in the US and China trade dispute. But while political news flow can lead to increased volatility, the global economy has a more powerful impact on long-term investment performance than geopolitics.
Economic growth remains in good shape, with reasonably resilient growth, supported by central banks, continuing for the time being. Our funds are more defensively positioned than this time last year with more of the amount in shares invested in developed markets – principally the US – and a greater allocation to US Treasuries which we see as less risky than UK government bonds.
Further political noise came at the end of September. In the US, Democrats moved to start impeachment proceedings against President Trump, while in the UK there were remarkable scenes in Westminster as the Prime Minister tried to assert his Brexit agenda.
We think market reaction to potential impeachment proceedings are overdone – the process could cause some administrative delays in the US, but in our view it’s unlikely to result in the removal of the President from office. Brexit uncertainty continues to put the pound under pressure, but we have reduced the amount invested in sterling-based assets in recent months. However, given sterling’s attractive valuation, we are watching the situation closely for opportunities should the political climate improve.
Despite a sharp drawdown in August, funds benefitted from strong performance by shares in July and a solid recovery in September. This demonstrates the value in staying invested during volatility as the quarter ended with positive returns from all strategies.
We’ve added to US shares, bringing our allocation up to a more or less neutral weight. US shares typically display higher quality characteristics and tend to be better placed to perform over different economic conditions.
While we’ve reduced the amount invested in sterling-based assets recently in recognition of short-term volatility, we retain a modest preference on the basis of our contrarian principles.
All strategies rose in the second quarter as markets continued to recover from December’s sharp falls. Gains over the first half of the year have more than made up for 2018’s losses, and on a 12-month view to the end of June 2019 all strategies delivered above-inflation returns, protecting the real value of customers’ money.
The driving forces behind market performance remained the same in the second quarter of the year as the first – central bank policies and trade tensions against a background of slowing global growth. A low interest rate environment tends to be positive for the economy and financial markets because companies can borrow money relatively cheaply to develop and expand, and it costs them less to service existing debts. The US Federal Reserve has been clear that it will continue to support growth by keeping rates low and other central banks are likely to follow its lead. However, the trade dispute between the US and China continues to weigh on investor confidence and a resolution failed to materialise at the end of the quarter, despite initial hopes.
While the world economy continues to expand, the pace of growth is slowing as we reach the latter stages of the business cycle. The manager anticipated this slowdown and, while remaining cautiously positive, has tilted funds away from riskier markets and towards more defensive areas. This has left the funds less exposed to areas that are underperforming, such as Japan, and with more focus on regions that are likely to provide more stable returns, such as the US. The manager increased investments in European stocks in the second quarter as the outlook for the region improved.
The second quarter was broadly positive for markets. Trade tensions remain a matter of concern for investors, but markets recovered from a sell-off following an escalation in rhetoric in May, and most regions ended the quarter in positive territory.
While the pace of global growth continued to slow, central banks have maintained their commitment to supporting economic growth. Interest rates on both sides of the Atlantic are widely expected to remain low, with the possibility of a cut by the US Federal Reserve before the end of the year. The Bank of England has kept interest rates on hold at 0.75% and suggested a long-term average of just 1% – lower than previous estimates.
Trade negotiations between the US and China seemed to be progressing well in April until President Trump raised duties on $200 billion of Chinese exports in May. China fought back with higher tariffs on American goods and stock markets around the world wobbled. While the immediate impact on markets of these flare-ups is negative, investors have typically returned to risk assets as valuations become more attractive, as happened on this occasion. Trade tariffs remain a risk, but the world’s two largest economies look likely to settle their trade-related differences eventually.
UK equity returns remained subdued in June relative to global markets. Investors remained cautious owing to Brexit uncertainty along with the added distraction of the Conservative Party leadership election. Theresa May’s announcement that she would stand down as Prime Minister didn’t trigger much of a response from markets because it was widely expected. Despite faring reasonably well during the first quarter of the year, the UK economy showed signs of strain in the second quarter and the economy contracted by 0.4% in April.
Against the current economic and political backdrop, we are considering a number of factors such as valuations, business cycle sensitivity and technical measures to guide our investment decisions. These continue to suggest a balanced approach to investing in risk assets and government bonds.
Over the second quarter, the manager trimmed equity exposure in favour of cash. In the highly volatile markets seen over recent months, a higher cash allocation provides flexibility to take advantage of any opportunities that arise.
The manager increased investments in European stocks slightly over the period. The Eurozone economy grew in the first three months of the year, benefitting from supportive central bank policies – particularly the European Central Bank, which announced that it would postpone further rate rises – and economic stimulus measures in China, a key export market for Europe. While challenges remain, this has improved the outlook for the region.
All funds have benefitted from increasing exposure to longer duration gilts, except for Personal Portfolio Fund 5, which doesn’t hold bonds.
All strategies rose in the first quarter of the year as markets recovered robustly from December’s sharp falls. As prices fell at the end of the year, it became apparent that the sell-off was overdone and valuations became more attractive – leading investors back to the market.
The gains of this quarter have made back the losses of 2018, and on a 12-month view to the end of March 2019 all strategies have delivered above-inflation returns, protecting the real value of clients’ money.
A key factor behind the shift in market mood was the US Federal Reserve adopting a more patient approach to raising interest rates in January. The central bank signalled it would ease off monetary tightening for now, and this more accommodative stance was echoed by many of its peers across the globe. Less pressure on monetary policy is positive for markets as it reduces the cost of borrowing, making it easier for companies to develop and expand, and to service existing debts. Increasingly positive signs that a US-China trade deal could be reached also bolstered markets.
Global economic growth has continued to slow. The manager saw this slowdown coming and, while remaining cautiously positive, tilted funds away from riskier markets and towards more defensive areas. This move has benefitted performance as the funds have had less exposure to areas that are underperforming, particularly Europe and Japan.
All funds fell in the fourth quarter. Markets continued to be challenged by increased friction between the US and China, concerns about US interest rates, the direction of the US dollar, Brexit and the Italian budget crisis. But despite the global slowdown a range of measures show continued, above-trend growth. This suggests the broader economic environment is sound.
To reflect slowing economic conditions, the Investment Manager for NatWest Invest decided to increase the amount of cash they hold. This was done in December by reducing their investment in European equity, reflecting their softer view on the opportunities in Europe. Also, holding more cash helps them stay nimble and ready to take advantage of opportunities as they arise in 2019.
All major equity markets suffered losses over the quarter. There were particularly heavy losses in the US, with the S&P 500 returning -11.5% in sterling terms. The FTSE 100 also fell, although it offered a marginally better return than US or European equity. While these results are alarming for investors, we believe that positive economic data could see investors re-focus on fundamentals and return to risk assets.
All funds delivered positive returns in the third quarter of the year. Markets are supported by solid, albeit slowing, global growth which is being led by a strong US economy.
Over the quarter, UK equities have been flat. However, they have made a positive contribution to performance so far this year. The manager opportunistically increased their investment in a FTSE 100 fund in February following a sell-off, and it benefited from a subsequent rebound.
Continued strength in US equities means the funds have benefitted from the manager’s decision earlier in the year to move money to America from emerging markets and Europe. In local currency terms, US equities outperformed their European and emerging market counterparts respectively over the quarter.
The funds’ holdings in emerging markets have been a drag on performance this quarter. The manager’s decision to reduce holdings in emerging market equities earlier in 2018 has reduced the negative impact. However, they continue to favour emerging market debt as high yields provide some cover for poor price performance.
After a rough end to 2018, markets have staged an equally dramatic rebound. Changes in sentiment were driven by three factors that we believe still have the capacity to influence markets.
The major catalyst for the rally was the change in the US Federal Reserve’s (Fed’s) monetary policy outlook. While this more dovish approach is good news for markets, the Fed has been clear that it will continue to be driven by data, and interest rates could start rising again should the economic backdrop change.
Positive news on trade negotiations between China and the US also provided relief to investors. Further moves towards an agreement would be positive for investor sentiment not only in Asia, but also in Europe’s export countries, like Germany.
The perceived instability of the US government at the end of 2018 – exacerbated by the US government shutdown – made investors cautious. While concern over the political mood in Washington still has the potential to knock investor confidence, the risk has receded somewhat since the end of the investigation into the 2016 presidential election.
Markets have reacted calmly to Brexit uncertainty, with UK equities recovering substantially, although perhaps with less confidence than elsewhere, and sterling remaining steady within a relatively narrow range. A longer extension has been priced-in and there is potential for UK-focussed midcaps to benefit from the eventual resolution.
Overall, the environment for risk assets now looks fairly balanced. The economic slowdown that our in-house indicators identified last year is still ongoing, but growth remains positive for the time being.
Stock market volatility continued during the three months to the end of December, with a substantial fall at the start of the quarter. Investors were concerned about rising interest rates in the US as well as persistent trade tensions. Meanwhile fears over the impact of the strong dollar on emerging markets remained.
In the UK, consumer price inflation fell from 2.4% in October to 2.3% in November, led by lower energy prices. The Bank of England kept interest rates at 0.75% in December. However governor Mark Carney suggested there could be a faster pace of rate increases if the UK managed a smooth exit from the European Union (EU).
In Europe, the political landscape looked uncertain. Reacting to rising fuel prices, French gilets jaunes protesters called for President Emmanuel Macron to resign, while Angela Merkel announced she would stand down as German Chancellor in 2021. Meanwhile, Italy’s long-running budget dispute with the EU came to an end, with the populist government postponing some of its planned spending.
The US Federal Reserve (Fed) raised interest rates to a range of 2.25% to 2.5% in December – the fourth hike in 2018. However, due to concerns about global growth, Fed officials intimated that future increases could come at a slower pace. Elsewhere, the European Central Bank confirmed it is ending its bond-buying scheme, despite a slowdown in the region’s recovery. Although the scheme is worth €30 billion a month, making this a significant move, the bank kept interest rates on hold. In the manager’s view, the possibility of a rate rise in the near future is slim.
In the third quarter of 2018, strong US economic growth and markets, backed by soaring tech stocks, continued to underpin a healthy environment for investors. Brexit uncertainty, trade war tension and emerging market woes did nothing to derail global growth and global equities made a positive return overall.
The manager believes the global economic backdrop remains sound and will continue to support investment markets, despite some turbulence in October triggered by rising US borrowing costs. Higher borrowing costs have the potential to hurt company profits, which is a concern for investors. Markets are likely to remain choppy over the coming weeks as the correction plays out, but the manager’s long-term view remains positive.
Currently, world growth is a tale of two economies. On the one hand, the US has continued to grow robustly thanks to some strong sectors such as tech, and President Trump’s tax reforms putting extra money into the economy. Growth outside America continues but is slowing after last year’s very positive expansion. This saw US equities significantly outperform other markets in the last quarter, continuing the pattern of the year so far.
Emerging markets continued to struggle. Recent turbulence in Turkey and Argentina appear to be isolated events, but there is ongoing concern among investors about the risk of contagion to other emerging markets.
UK government bonds fell slightly over the quarter as investors generally continued to prefer shares in the current growth environment. Prospects for the UK economy continue to be overshadowed by Brexit uncertainty, but UK equities should be supported by the solid global backdrop.
Over this quarter the manager has trimmed equity exposure in favour of cash. In the highly mobile markets seen over the last six months, a higher cash allocation provides flexibility to take advantage of any opportunities that arise.
The manager reduced exposure to Japanese and European equity last year. Europe and Japan are key exporters so their markets have been hit by the trade tensions of previous months and a slowing Chinese economy – both of which dented demand for their goods. Resolution of trade tensions is likely to benefit these markets, however, and so the funds retain a neutral allocation.
All funds increased exposure to longer duration gilts – except for PPF5 which doesn’t hold bonds – and subsequently benefitted from recent gains. The manager also added some exposure to dollar-denominated emerging market government bonds based on attractive yields, while turning negative on UK corporate debt and adding the proceeds to cash.
These moves have left the funds with a slightly higher overall allocation to bonds than at the start of the year, although still marginally below benchmark and neutral on equities.
Global economic growth is slowing but still above trend, particularly in the US. Economic indicators are showing healthy labour markets, wage growth and robust corporate profits – all of which should support markets in the near future.
Following the strong economic growth seen in 2017, the outlook for Europe has softened over the year. As a result, the manager reduced the allocation to European shares and added to US equities earlier in the year.
The manager increased exposure to a FTSE 100 fund in February after sharp falls made the index look like good value. While the effects of Brexit on the UK economy remain uncertain, the manager sees these internationally focused, large-cap companies still benefitting from the supportive global economic environment.
In December the manager reduced their exposure to European equity and high yield bonds in favour of cash and emerging market hard currency debt. Holding more cash helps ensure they can take advantage of opportunities as they arise in 2019.
Within bonds, the manager favours corporate debt over government bonds generally, but sees diversification benefits in both. This is particularly true when equity markets are more uncertain.
The manager sees a global economy that’s in good shape, which should be positive for equities despite growth moderating outside the US. The funds remain positioned accordingly, with a modest preference for equities and other risk assets.
The outlook for Europe has softened over the year following the strong economic growth seen in 2017. As a result, the manager reduced the allocation to European shares and added to US equities earlier in the year, but maintains a positive position on Europe. At the same time, US equity prices have continued to rise and the US economy is experiencing continued, strong economic growth that the manager believes will continue to provide support.
The manager increased exposure to a FTSE 100 fund in February after sharp falls made the index look like good value. While the effects of Brexit on the UK economy remain uncertain, the manager sees these internationally focussed, large-cap companies benefitting from the supportive global economic environment.
Within bonds, the manager favours corporate debt over government bonds. Investment grade corporate credit offers a better yield than government bonds and a similar diversification benefit for only a marginal increase in risk.
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