Welcome to Market Musings – a lighthearted commentary issued from time to time, summarising recent economic data, the drivers of stock and bond markets along with other key global developments.
In the first edition of 2020, we reflect on the important economic events of the past twelve months and offer insight into what drove our own performance over that time. We also share some thoughts on what we think 2020 has in store.
We hope you enjoy this edition, please do share your feedback and suggestions for future topics with your Investment Manager or Banker.
Equities were the largest contributors to performance in 2019, turning in double-digit returns across the board. Notable performers included an allocation to domestic Chinese equities, which we bought during the nadir of October 2018 whilst completing our Silk Road research project. This decision was made on the premise that domestic speculators were underweight, the government was reversing its ‘over-tightening’, and that fears surrounding US-China tensions were overblown. Since then we have witnessed a significant outperformance. We have also seen noticeable gains from our fund managers holding concentrated portfolios of high conviction stocks. Noteworthy contributors include US equity manager Vulcan Value (based out of Alabama) and European equity manager Zadig Memnon who profited from investments in companies with continued earnings growth such as Swedish Match.
UK property, typically a sleepy sector, received much attention from our Investment Committee (and from the media) due to concern over M&G’s ‘over-exposure’ to retail property. We took steps to exit their fund during the summer of 2019 and switch into a position with lower exposure to retail and higher exposure to office blocks. The type of commercial properties populating the new fund are ‘smaller-ticket’ assets and in theory easier to liquidate. The M&G fund subsequently suspended withdrawals, gating their investors – thankfully, a bullet we were able to dodge.
In our Fixed Income allocation, we have tactically adjusted between ‘defensive’ and ‘aggressive’ positioning during the year. We started holding a higher level of UK gilts and US treasuries; these served us well in the latter stages of 2018. In January 2019, with the trade winds changing between the US and China, we added to our emerging market debt position which subsequently delivered strong outperformance. We later took profits on this position towards the end of the year.
One of the commitments we made at the beginning of 2019 was to increase our communication with you. As such, during 2019, we launched two campaigns, Half Time and Home Stretch. During these roadshows we stressed our views, firstly, that trade tensions would cool because both President Trump and President Xi needed a ‘deal’ and secondly that Trump would pressurise the Fed to cut rates in order to support stocks and the housing market (via mortgage refinancing). Although our forecast of Trump pressuring the Fed developed as expected, our view that the Fed would not cave did not manifest. However, this actually helped our performance, as equities delivered outsized returns as rates were cut. We also suggested ignoring the noise around the weakness in Germany, firstly, because manufacturing is now a smaller percentage of GDP than it has been historically and secondly, the ECB would continue to offer a supportive backdrop to markets. Finally, we stuck to our guns on Japanese equities pointing to Abe’s resolve to drive/promote growth and were vindicated when a $121bn stimulus package was announced at the end of 2019.
Brexit was front and centre with the Pound serving as an excellent barometer for the ebbs and flows of sentiment towards the divorce plan. We benefited in the first half of the year from the Pound falling and then in the latter half of the year we further benefitted by trimming our US equities and rotating into unloved UK equities (thus increasing our GBP exposure). Moving into October, the Pound and UK equities rallied as a potential pathway to a Brexit deal emerged. To remove some of the foreign exchange risk, we continued to hedge our overseas foreign exchange exposure by initially rotating from the FTSE 100 to the FTSE 250 (higher domestic revenues). We then continued to hedge through switching the share-class of one of our European equity funds out of EUR into GBP. These decisions helped when the Pound rallied going into the General Election.
Looking into 2020, we expect a continued improvement of Sino-American relations, which should benefit export-heavy economies like Japan and Germany. Global central banks should remain on hold which offers stability and certainty to investors, but also muted performance (bonds tend to deliver strong returns when rates are going down, but only deliver their coupon when rates stay put [holding credit rating constant]). In other words, when interest rates, credit ratings and market conditions stay unchanged (or normal), the assumption is that investors would only receive their coupon – which in a low yielding environment would not amount to very much.
What will we be watching extremely carefully in the coming months? Corporate earnings will be top of mind. Stocks can continue their upwards ascent, but eventually earnings need to deliver and if they don’t we could witness a correction (a decline in the market). Of course, the US elections will be a big one. We expect President Trump to do everything in his power to make himself ‘look like a hero’ in the run up to November. Perhaps most interestingly, all eyes will be on Christine Lagarde. Will she lead the ECB out of negative rates and will she be successful at convincing Germany to turn on the fiscal taps? We will attempt to address that big question in our forthcoming QE thematic research paper to be released in March 2020 (see below).
Finally, will we see continued style rotation into unloved value stocks? Will big technology companies such as Facebook start to feel the pinch of increased regulation? The first question/scenario would be easier to ‘capture’ in portfolios by moving from one asset to another, but the second would be much harder as begging for/hoping that technology stocks go down can be a very risky endeavour indeed.
QE thematic research paper: We will be investigating the biggest question facing investors today namely Quantitative Easing: Are we Sleepwalking into the Next Financial Crisis? Over the past decade, the four main central banks have ballooned their balance sheets to $15trn via an insatiable demand for bond buying, but credit excesses are beginning to appear. Is there a bubble? Will it pop? And how might the markets react? Finally, what are Arbuthnot Latham’s forecasts for the future? This is the focus of our efforts. As an investment team, we want to be best prepared for the different eventualities and position accordingly.
Co-Chief Investment Officer
Arbuthnot Latham & Co., Limited
Co-Chief Investment Officer
Arbuthnot Latham & Co., Limited