Whitechurch Asset Views - September 2017
August witnessed escalating tensions between the US and North Korea over the latter’s nuclear tests, culminating at the end of the month in a missile being fired over mainland Japan before landing in the Pacific. However, despite these events combined with the devastation caused by Hurricane Harvey, bond and equity markets generally rose. In addition, sanguine inflation numbers across the globe saw investors focus again on a low growth and low inflation outlook during the month. This proved particularly beneficial for Government bonds and perceived higher quality equity sectors.
However, there was some performance dispersion within equity markets. The UK was the pick of the Developed Markets, whilst the S&P 500 finished the month marginally up. Europe and Japan were largely flat, both finishing the month marginally down (in local currency terms). Asian and Emerging Market equities (particularly the latter over the month) continued with their strong performance year-to-date.
Risk aversion returned in August, albeit fleetingly. After months of very low volatility within equity markets, we did see the ‘fear’ index, the VIX, spike by nearly 40% (from a low of 11 to 16) during mid-month as investors became concerned about the stand-off between the US and North Korea. This was the first time that the VIX closed above 16 since the day of last year’s US election. However, by the end of the month it was once again around the 11 level.
For UK investors August proved to be a bit of Brexit-vote deja-vu. UK large / mega cap dollar earners led the markets higher whilst UK investors within overseas markets saw returns boosted as sterling weakened against all other major currencies over the month. This meant that whilst leading European and Japanese bourses were marginally down for the month, returns were boosted by around 3% for UK investors as the pound weakened. We do not make big currency calls and we are not starting now but it does feel like the full extent of a bad Brexit is being priced into sterling at the moment.
It’s not only sterling that is weakening, so is the global reserve currency – the US dollar. This has continued to benefit Asian and Emerging Markets. There are many positives for these markets at the moment. As well as the US dollar remaining relatively weak, the lack of inflation is putting a lid on any potential interest rate rises, Chinese growth remains robust and commodity prices have had a bounce back. Although, there appears to be a good level of momentum in the near-term, continued muscle flexing (or worse) by North Korea has the potential to reverse investment flows to these regions.
With the rare recent spike in equity volatility during the month, lower risk bonds returned to favour. In addition, global inflation numbers only reinforced for investors that the ‘goldilocks’ environment of steady growth accompanied by a lack of inflationary pressure reduces the pressure for rising interest rates. However, the strong performance of bond markets continues to raise concerns over valuations. We continue to see more opportunities in corporate than Government bond markets, but the yield differential between corporate and Government bonds is now lower than it has been since the Global Financial Crisis – so it remains to be selective and diversified.
As mentioned last month, we have moved back into UK commercial property. Now that it appears the FCA is not taking any punitive measures on open-ended funds, we feel far more comfortable in moving back into the asset class. The yields offered by the asset class appear attractive relative to bonds, whilst the UK economy has proven resilient and overseas buyers continue to support demand. As a result we have added a modest weighting to cautious and balanced mandates.
During August the posturing from the US and North Korea was a short-term reminder to investors that after months of complacency, volatility can return to risk assets and quickly. However, with cash continuing to provide a negative real return, a well-diversified portfolio can provide many opportunities to exceed miserly cash returns for those prepared to ignore short-term noise, focus on valuations and take a longer-term perspective.