MONTHLY MARKET COMMENTARY MAY...

MONTHLY MARKET COMMENTARY

MAY 2016

UNITED

KINGDOM

Our theme this month is newspapers. The newest UK print newspaper was launched just nine weeks ago … and is to close on 6th May! the New Day (the lower case t is correct, apparently they thought it might make the difference) was published by Trinity Mirror who targeted a circulation of c. 200,000, but found they could scrape only c. 40,000. It was the first national UK paper since the smaller version of the Independent, “i” which started selling in October 2010. The oldest UK national newspaper is The Times, established in 1785, whilst the oldest continuously published English newspaper is said to be Berrow’s Worcester Journal, probably in print since 1709. Our Market Data table shows a better month for the FTSE100, bucking the trend of the year to date and as at the end of April, delivering a positive (c. 1.5%) return for 2016, following two calendar years of declines. This was in part down to improved sentiment from investors since mid-February, and partly due to the effects of an increasing oil price and better data on some of the behemoths that occupy the upper echelons of the UK equity market by market capitalisation. Our view is unchanged – we prefer to look lower down the cap-scale, believing it is easier for the more mobile, fleet of foot businesses to deliver real growth for investors, whilst still (perhaps more securely as regards cover) delivering decent dividends. The Financial Times (established 1888) regularly leads with oil, China, Yellen and/or Trump/Clinton, showing the significance that the US has on all our investing lives. As you can read later, we remain less than enamoured with US equities. Having said that, should investors in UK equities worry about the potential contagion of a bout of US economic flu, or are markets better prepared nowadays, dosed up on apples, vitamin C and lemsip (better GDP, broader trading partners and our own central bank, if you will)? There will be one more edition of our Commentary before the EU Referendum, six more before the next US President is voted into office and maybe none until Greece again hits the headlines (with the word “debt” firmly attached) – meanwhile, we continue to invest across multi-assets, globally, and with a modicum of caution, at least for now.

Despite another more positive month, we remain cautious in our outlook for 2016 across all risk strategies. Newspapers (sadly) tend to lead with bad news, yet it is not all bad, by any means. The UK equity market remains of interest to us; we are ready to be agile if we need to be, most likely if sentiment turns back to early-2016, or if some of the (currently OK) fundamentals turn negative.


MAY 2016

UNITED

KINGDOM (cont’d)

Term or word to watch: Sell in May ... Long-standing readers will know that we regularly review whether this old adage was the right course of action when we get past St Leger day (September). At the time of writing, a few trading days into May, it already has legs – major markets have fallen since the end of April (some only modestly, others more significantly) and there certainly are reasons to be on the cautious side (EU Referendum, Trump vs Clinton (vs Bloomberg?), Greek debt, political fragility, global growth and central bank hubris to mention a few). Having laid those miserable foundations, it is fair to say that the reasons for the adage are long gone – the idea that trade stops for Henley, for example, or that Derby day means less activity in markets is nowadays fanciful, not least on the mobility of media but also of trading. Additionally, four plus months is now a long time in markets and we may be as likely to see such a strong July and August that we should be piling in to these (relative) lows. Suffice to say, we do not invest based on this or any other adage, and nor do we feel you should. Just read the next Sunday money supplement article with interest, and smile that you already knew a bit more about it than you realised …

NORTH

AMERICA

As Trump closes in on the Republican nomination it becomes ever more difficult to get a handle on the state of the American nation, its society and indeed its economy. The GDP figure for the first quarter of this year was 0.5% annualised, representing a sharp fall on the figure for the final quarter of 2015 (1.4%). This figure is undeniably weak and probably reflects the deterioration in confidence during the early months of the year, which fed through to the real economy. The tenor of this datum stands in sharp contrast to other data from the US labour market, which has been strong, and it must be remembered that we have seen soft GDP data before which has been followed by revisions and strong rebounds. The collapse in mining investment in the first quarter was dramatic and will have impacted – though this will not be a factor next quarter. It is true that there has also been some discernible weakness in the housing market, with US housing starts falling more than expected in March and permits hitting a one-year low. Of course this uninspiring backdrop means that the Federal Reserve is unlikely to push ahead with an aggressive rate hiking programme and it would be surprising if we see more than two rate rises this year. This has allowed the market to enjoy a period of respite, with a weakening in the dollar removing several of the strains affecting the global economy over the first couple of months of this year.


MAY 2016

NORTH

AMERICA (cont’d)

Source: Google Images

The middle-market “USA Today” is the widest circulated print newspaper in the United States. It is published by the Gannett Company and was founded relatively recently in September 1982. It seems to us that our fears over an anaemic US economy are materialising and yet the market barely seems to care. Retail sales are weak, production is down in several key areas, and there is the feeling that things are “running out of steam”. Valuations remain full but profits are under pressure (S&P earnings falling) as wage growth has crept up. The market is being sustained by low rates arguably more than anywhere else if one considers the impact of share buybacks (£600bn annually) and this creates an additional vulnerability. On top of this, credit markets are looking stretched with corporate debt running at $5.5 trillion with 60% at BBB rating or worse. We are comfortable maintaining an underweight exposure here. This has not been rewarded in recent months but valuations make the risk-return profile unattractive in the extreme. The last time US markets went a year without a new high was 1987 – we have a feeling the next time that stat is used the year will be 2016.

EUROPE

With the official first quarter GDP data figures now released across Europe, there have been some positive surprises. Starting with the eurozone as a whole, the quarterly growth figure of 0.6% represents the fastest growth rate in a year. It also represents a speedier growth rate than the rest of the EU, which grew at 0.5%, with UK GDP growth of 0.4% creating a drag as the EU Referendum perhaps weighs on confidence. The news will be particularly welcomed by ECB policy makers who have increased stimulus measures, which seem to be having a positive effect. There were positive surprises too from both France and Spain, respectively the eurozone’s second and fourth biggest economies. Spain, widely expected by analysts to show a slowing of GDP growth, matched the growth rate for the last quarter of 2015 with a 0.8% expansion. Despite this, Spain still faces many challenges, particularly its nagging high unemployment rate and the continuing impasse over forming a working government following the inconclusive December election. Indeed, this has now seen King Felipe VI dissolve Parliament and set up a fresh round of elections on 26 June. The earliest newspapers date to 17th century Europe, when handwritten newssheets were replaced with printed periodicals. “Relation aller Fürnemmen und gedenckwürdigen Historien” (translated as Account of all distinguished and commemorable news) is widely recognised as the world’s first newspaper dating from 1605. It does seem a more august title than “i” …


MAY 2016

EUROPE (cont’d)


France’s GDP showed growth of 0.5% in the first quarter, improving on 0.3% from the last quarter of 2015. France’s official statistical bureau Insee reported a strong recovery in household spending as a key driver. Figures also saw the biggest monthly fall in unemployment in 15 years, with 60,000 fewer people out of work. This will be viewed positively by the government of Socialist President François Hollande, currently trying to push through long awaited reforms in the labour market. It also comes as a timely boost with recent polling data suggesting Hollande is the least popular President in France’s recent history; as it stands he would be eliminated in the first round of voting for next year’s Presidential election.

GDP figures released in Europe have generally seen positive surprises at the headline level. Looking beyond the headlines, there are still challenges facing European nations, which we feel justifies our current neutral weighting to the region.

JAPAN

Last month we wrote about the tepid data coming out of Japan. This time we focus on the yen. The currency has strengthened very significantly against the dollar since the start of the year and this has been a negative for market sentiment. The monetary authorities surprisingly decided against further easing at their most recent policy meeting and the initial flirtation with negative rates has done little to boost the economy. A weak yen benefiting exporters is far from the only component of the bull case for Japanese equities but to overlook its importance would be negligent. If the yen sustained its strength for a long period of time this would be a major negative and the threat to the carry trade (whereby people borrow in yen at cheap rates to invest elsewhere) is undermined – threatening equities more generally. This weakening dollar story has supported risk assets in general since mid-February, so we may be seeing a dynamic at play which means Japanese equities become increasingly less correlated with their US peers. The Japanese authorities may of course be reserving their ammunition for a future time when more urgent action is required, as markets are now starting to question the deployment of such strategies. Negative rates on banks’ excess reserves are now working through the system and this may have impacted sentiment. Those hoping for the Bank of Japan to increase its purchase of ETFs and REITs have been disappointed but there is still the fundamental question of whether a central bank should be doing this and if this would simply be storing up problems for the future. Central banks need some “shock value” capability and, as we have written before, should a major crisis occur, then having used all one’s bullets is far from ideal.


MAY 2016

JAPAN (cont’d)

The first modern Japanese newspaper was the Nagasaki Shipping List and Advertiser, which was published bi-weekly by an Englishman, A W Hansard, first in 1861, though they started in the 17th century as printed handbills. Perhaps the restraint shown by the Bank of Japan will prove a long term positive, but even optimists on the investment case for the country have to admit to a feeling of growing unease. The decision to hedge the Japanese currency has been a huge determinant of returns from the country, with the stronger yen hammering the performance of hedged investments. This said, the currency movement looks unreadable and this has to make investors nervous. Reassurance for now comes in the form of reminding oneself that the country has no option but to push on with this reform project and that the central bank has the most to lose (versus their peers) by not engaging in extraordinary policy.

The investment case does feel weakened; however, we maintain overweight positions in portfolios for now whilst looking for improved news flow.

ASIA

As we have commented in previous editions, it is difficult to judge just how reliable the official GDP figures are out of China. There are suggestions that the figures may be influenced at both national political level (as China tries to smooth the transition away from manufacturing to services) and at a regional level (as provinces are thought to inflate data to be the number one). It perhaps comes as no surprise then that the annualised growth rate in the first quarter of 2016 (of 6.7%) sits in the very middle of the targeted range of 6.5% to 7.0%; the data for 2015 as a whole at 6.9% was also very close to the official target of “about 7%”. The 6.7% represented a slowing from the previous quarter’s 6.8%, although still at a level most developed markets would sell their own grandmothers for (Ed: to be clear, we are not suggesting that, with the ageing population, the developed world should sell their grandmothers to boost GDP). The slowing represents the ongoing transition from a manufacturing based economy to a more services led, domestic consumption economy. Given the dubious nature of the GDP data, analysts often look for alternative data sources to assess the economy and in these there are signs that sentiment has shifted to a more positive footing for Asia’s biggest economy. The Purchasing Managers Index (PMI), monetary growth and industrial production indicators have all shown improvements.


MAY 2016

ASIA

(cont’d)

There are also positive signs that the economic repositioning is working. Looking at the manufacturing side, data such as electricity consumption, rail freight haulage and bank loan growth have all been fairly steady and seen some growth. Meanwhile, on the domestic consumption side, figures such as aeroplane ticket sales, retail sales figures and parcel delivery numbers all suggest a strongly growing domestic economy.

We remain relatively positive on Chinese equities and believe that the area offers significant long term upside, particularly from those exposed to names likely to benefit from domestic consumption.

EMERGING MARKETS

We wrote last month about the improvement in the fortunes of emerging markets as the weakening dollar provided some respite from the storm clouds hanging over many. Higher rates in the US have serious implications for capital outflows from emerging markets but one cannot point the finger at the Fed too aggressively. We live in a connected global world and emerging markets have to adapt to this. Part of this means shoring up public balance sheets to ease the sensitivity to capital movements. In short they have to make difficult decisions to deal with their own societies and economies almost irrespective of global trends. One of the issues which confirms this dose of reality is demographics. We hear frequently of the growth opportunities provided by favourable population dynamics in emerging markets but in truth this is another area where heterogeneity maintains. Some countries such as the Philippines, Nigeria and Malaysia do indeed have favourable profiles but others face serious challenges and have demographics which are worse than the oft-cited problem countries of Japan and Germany. This is the problem in economic development parlance of countries “getting old before they get rich”. China is often talked about in this regard – she is expected to have a median age of 40 in 2024 but even based on current growth rates she will not “get rich” (often defined as having a median income of US$15,000 per capita) until 2030. This is frequently overlooked but is of tremendous long-term significance. Using this criteria, other countries facing “challenges” would include Brazil and Russia.

Investing based on demographics usually requires a timeframe so long that it is simply unsuited to the practical job of running portfolios. However, trends such as these are reasons to be healthily sceptical about certain claims for emerging markets and to remind oneself (again) of the diversity within the space.


MAY 2016

GUEST:

EXCHANGE TRADED FUNDS


Exchange Traded Funds (ETFs) form the basis of this month’s guest section. ETFs are investment funds which are traded on the stock exchange and often track an index, commodity or basket of assets. This type of fund has increased in popularity over recent years, due to low fees and high levels of liquidity. As the popularity of ETFs continues to grow, asset managers have started to seek more innovative ways of constructing portfolios. Traditionally, asset managers have used fundamental and technical analysis in order to aid stock selection. However, the use of social media has allowed them to gain an insight into the opinions of other investors and the wider consumer. One firm has taken this a step further with the introduction of its Social Media Insights ETF; a fund that buys stock based solely on social media. The ETF assesses the 100 most talked about stocks on social media and blogs, removing negative posts. The positive opinions are then weighted according to the contributor. Those who have made correct predictions in the past or have the ability to influence the opinions of others are awarded higher scores than the average user. The top 25 stocks are then selected and weighted according to their sentiment score. The portfolio is then rebalanced once a month, making it far less active than many other ETFs on the market. Whilst this ETF covers positive sentiment voiced on social media, there is clearly an opportunity for a similar product to short stock with high levels of negative sentiment. However, there are risks associated with this method of stock selection. The ETF could buy stocks that have been talked about positively as a result of price rises or strong results, thereby being late on/missing potential gains. It is possible that asset managers may become increasingly reliant on our opinions when selecting stocks. Indeed, another ETF allows members of the public to download an app and vote for one stock each month. The portfolio is then constructed based upon the most popular stocks and weighted according to sentiment levels. Whilst it is too early to pass comment on the performance of either of these ETFs, their alternative stock selection method certainly provides a fascinating talking point, as would a Selling Your Grandmother ETF.

Whilst we do not envisage holding these ETFs, we do use some ETFs and similar structures across client portfolios, typically to a) invest in otherwise inefficient areas of the market, b) gain access to otherwise inaccessible investment options and/or c) take advantage of a pricing weakness.


MAY 2016

FIXED INCOME

Hybrid Bond – part Connery, part Moore, part Brosnan, part Dalton (yes, get over it) and large chunk Craig. Of course, we are playing here, though we suspect that most would recognise the names above before being able to comment on the nature of a hybrid bond for investment purposes. Hybrid bonds can be an attractive method of raising capital, and are generally set up to incentivise the issuer to call (pay back) the bond early. Combining characteristics of both equities and bonds, hybrids vary. For investors, the potential attraction is an income somewhat higher (due to risks which include the call referred to and also coupon deferral) than conventional bonds (from high quality issuers). In the current environment, and accepting that one only gets what one pays for (no free lunch) hybrids can deliver a decent income boost. As for sovereign debt, a growing amount is trading at negative yields, and this is putting pressure on traditionally cautious/income sensitive investors to look higher up the risk scale. Fitch, the global ratings agency, recently reported that more than $10 trillion of sovereign securities now yields less than zero. One has to anticipate some pretty scary happenings to want to buy into a return of funds less than was invested, in a so-called “risk-free” asset. Not helped (in 2016) by the policies of the Bank of Japan and the ECB, these securities would, in 2011, have yielded c. $122 billion – today, they offer a negative c. $24 billion.

Fixed income markets are made up of many instruments with a range of risks – as stated last month, the traditionally “safest” of these look amongst the biggest risks to us, so we hold no government debt at all, across portfolios, preferring corporate debt where appropriate.

COMMODITIES & SPECIALIST

This month our focus turns to gold. The S&P GSCI Gold spot price returned a near 22% increase from the start of the year to the end of April in US dollar terms, with temporary factors influencing sentiment towards the precious metal. Weaker global equity markets and the reduced likelihood of further US rate rises both drove this strong performance. The equities of companies involved in gold mining also performed very strongly with prices exhibiting higher beta to the gold spot prices. Indeed, over the same period, the FTSE Gold Mines index returned close to 94%. “The Californian” was the first newspaper in California and was first published in August 1846. The newspaper was forced to close in May 1848 with all the staff having left as word of mouth of the California gold rush spread and the staff downed their pens for shovels. Indeed such was the word of mouth, the paper did not report on the discovery of gold!


MAY 2016

COMMODITIES & SPECIALIST

(cont’d)

Whilst these factors are most likely temporary, there are also positive longer term drivers for the gold mining industry. The decline in the number of new gold discoveries, paired with capital expenditure in existing assets being significantly scaled back to focus on cost savings should also prove constructive for the price over the medium term, as supply tightens. At the same time demand for gold looks set to increase with both Asian retail demand (particularly from India and China) continuing to grow and the inflationary pressures which extraordinary monetary policy such as quantitative easing should ultimately create. Over the shorter term too, a stronger US dollar has created margin relief for many gold mining companies, with the dollar sale price of the metal appreciating against the production costs to get the metal out of the ground. It is fair to say that the lack of an income from gold (often quoted by gold-bears as the reason not to invest) is perhaps less of an issue in our increasingly negative interest rate world … Gold appears in most of our portfolios, through either exposure to the spot price, or through exposure to equities of gold mining companies in higher risk portfolios. We remain positive on the long-term diversification benefits the metal offers and the potential value on offer for producers given long-term drivers.

PROPERTY

The downfall of BHS has been widely publicised, with around 11,000 jobs at risk. With 164 stores, covering around 5.5 million square feet, the retailer’s demise could leave significant gaps on high streets across the country. When Sir Philip Green announced his intentions to sell the business in 2015, potential suitors were enticed by the impressive property portfolio on offer. Eventual buyers Retail Acquisitions purchased the business for £1, with the agreement that £215m debt would be written off. However, the burden of an estimated £571m pension deficit eventually led the company to file for administration. The question is, why was BHS unable to raise funds from its property assets? One reason could be the size of the stores within the BHS property portfolio. Research by global real estate experts Cushman & Wakefield found that only 8% of BHS stores would be ‘easy to let’. They go on to suggest that Retail Acquisitions overestimated the value of the stores and the ease with which large high street properties can be sold. However, the issues surrounding property valuations extend beyond the high street. Last year, a number of supermarkets were forced to make a series of high profile write-downs on the value of their properties.


MAY 2016

PROPERTY (cont’d)

Indeed, Tesco reported a reduction of £4.7bn in the value of its property in 2015 as consumers shunned large out of town stores in favour of discount retailers. Whilst companies are able to assign values to property assets, the reality of selling large retail space can be difficult, as Retail Acquisitions discovered. The inability of BHS to sell property assets should not cast doubt over the opportunities offered by commercial property. One suggestion is that BHS may have been subject to the effects of “Brexit” concerns. In fact, investments in UK commercial property have fallen by 42% year-on-year, much of which can be attributed to uncertainty over the EU Referendum. In 1924 Elis F. Stenman of Rockport, Massachusetts constructed a wooden framed house with walls, floor and ceilings made from newspaper. Mr Stenman went on to furnish his house with items made from newspaper, creating a piano and grandfather clock. The technique of compacting, gluing and varnishing newspaper has certainly stood the test of time and the house is now open to the public. Presumably the house is … red?

Some investors are holding off on major decisions until after the Referendum. However, we believe that property remains an attractive asset class over the long term and continue to have exposure across most portfolios. Though we may have had the cream, we believe there is more to be gained from the bottle.

CURRENCY

The sun is out, the sky is blue, there’s not a cloud to spoil the view, but it’s raining … raining in currency markets. Since the start of May, the yen, euro and sterling have all traded in a range of close to 2%; we have written about the effects of a (recently weakening) US dollar on many emerging market currencies. Again, as covered elsewhere this month, gold appears to be the answer for some, the question being, “what is the safest thing to own” and the answer no longer (necessarily) being “the US dollar”.

UK INTEREST

RATES

Another month, another vote to keep rates at their record low. One month we will able to astonish readers by writing about a small rate rise (or maybe even a cut?); when that month may be is pretty tricky to call. The Monetary Policy Committee warned that uncertainty relating to the EU Referendum has begun to weigh on certain areas of activity and this could hit growth for the first half of 2016. Essentially it looks like concern over a (potentially) deteriorating economic outlook means a rise in rates is highly unlikely in the short term.


MAY 2016

UK INTEREST

RATES (cont’d)

Having said that, the only factor which appears to be challenging this view is sterling - if the currency continues to be impacted either in the run up to or following the Referendum, it is conceivable that the resultant inflationary pressures will cause policymakers to make a defensive move higher in rates. Even the US Federal Reserve has talked about “Brexit” risk in what looks like an early excuse not to raise rates in June and it feels as if tightening is to be delayed for the foreseeable future in the UK. Record low interest rates – a sign of the times.

NUMBERS OF THE MONTH

Our monthly look at numbers which may or may not have grabbed the headlines.

53.3% 6.7% 90

Share of the vote Donald

Trump took in Indiana,

effectively giving him the

Republican nomination.

Chinese GDP annual

growth rate in the first

quarter.

The age of HM Queen.

Congratulations Your Majesty.


MAY 2016

MARKET DATA

Index 29.04.16 1 month 1 Year 3 Years

IPD UK All Property* 0.42% 13.35% 50.61%

RTS (Russia) 951.11 8.55% 8.03% -34.86%

Bovespa (Brazil) 53,910.51 7.70% 5.40% -4.33%

Dow Jones Industrials 17,773.64 0.50% -0.01% 21.92%

S&P 500 2,065.30 0.27% -0.13% 31.62%

FTSE Small Cap 4,589.05 1.02% -0.21% 20.59%

FTSE British Gilt All Stocks 175.06 -1.29% -1.28% 2.26%

FTSE 250 16,801.55 -0.74% -1.69% 20.67%

M-DAX (Germany) 20,100.71 -1.46% -2.82% 50.88%

FTSE All Share 3,421.70 0.78% -6.60% 1.21%

FTSE 100 6,241.89 1.08% -7.84% -2.65%

BSE (India) 25,606.62 1.04% -8.41% 35.95%

CAC 40 (France) 4,428.96 1.00% -12.01% 18.69%

Nikkei 225 16,666.05 -0.55% -13.23% 34.43%

Hang Seng 21,067.05 1.45% -15.40% -5.53%

Shanghai A (China) 3,074.87 -2.19% -21.72% 31.35%

*Figures delayed by one month

The Monthly Market Commentary (MMC) is written and researched by Simon Gibson, Richard Smith and

Scott Bradshaw for clients and professional connections of Mattioli Woods plc, and is for information

purposes only. It is not intended to be an invitation to buy, or to act upon the comments made, and all

investment decisions should be taken with advice, given appropriate knowledge of the investor’s

circumstances. Mattioli Woods plc is authorised and regulated by the Financial Conduct Authority.

The MMC will always be sent to you by the seventh working day of each month, usually sooner, is normally

delivered via email, and is free of charge as the MMC is generally made available to clients who have assets

under our management in excess of £200,000, and to all clients under our Portfolio Management Service

(PMS). Normally, the MMC costs £397 + VAT per annum. Professional advisers and their clients should

contact us if they are interested in receiving a monthly copy.

Sources: www.bbc.co.uk, www.bloomberg.com, Morningstar. All other sources quoted if used directly; except fund

managers who will be left anonymous; otherwise, this is the work of Mattioli Woods plc.

http://www.bbc.co.uk/

http://www.bloomberg.com/

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