2nd Quarter 2017

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves. I can’t recall ever once having seen the name of a market timer on the Forbes annual list of the richest people in the world. If it were truly possible to predict corrections, you’d think somebody would have made billions by doing it.”

These observations were made by Peter Lynch, the legendary investment manager who was responsible for the best performing mutual fund in the world (Fidelity Magellan) between May 1977 and May 1990, achieving an annualized return of more than 29%! Lynch created the investment process commonly referred to as “Buy What You Know”, a mantra we wholeheartedly endorse at Ash-Ridge.

The fact that investors can become all too easily confused by market noise was also confirmed in a recent piece of research in the US, that showed that while the market as measured by the S&P 500 had returned 9.3% per annum over the last thirty years, the average investor had only achieved an annualised 1.9% while invested in stocks! The figures sadly prove that a typical investor acting alone is more likely to act on emotion rather than discipline when looking to fulfil their objectives.

Last Quarter Review

The first quarter of 2017 saw major equity markets continue to post gains on the back of an increasing expectation that the economic policies of the new Trump administration can maybe “make America great again” after all, while concerns about the potential negative effects of the “America First” policies for the rest of the world took a back seat, at least for now. The new confidence that the economy was set to continue growing, and possibly at an accelerating rate appeared to be confirmed by the actions of the Federal Reserve (Fed) who raised interest rates for a third time in two years to the giddy level of 1%, the highest in a decade!

Meanwhile the robustness of the UK economy post Brexit continued to surprise many, including officials at the Bank of England, whom had warned of a downturn in fortunes if Britain elected to leave the European Union (EU). Towards the end of the quarter, Prime Minister Theresa May triggered “Article 50”, setting in motion the negotiations that should result in the United Kingdom finally exiting the EU at midnight on the 29th March 2019.

The first quarter also saw emerging market giants China and India finally join the post Trump election euphoria that has been present in other major equity markets since the 8th November election, with seemingly the only party poopers being Japanese stocks, as the Nikkei 225 fell just over 1% over the three months. European equity markets, despite all the political uncertainty surrounding the outcome of key forthcoming national elections within the Union, as well as President Trump’s rather frosty approach thus far to the EU, were some of the best performers, and soared on the back of renewed economic confidence.

Concerns surrounding a surging US dollar, driven in part by the anticipated growing American economic recovery and rising interest rates from the Fed, as well as the development of a potential shortage of offshore Eurodollars (as discussed in last quarter’s MV) which is likely to be exacerbated by the Trump administration’s proposals to try and eradicate the trade deficit, appear to have abated for now. The dollar’s trade weighted index (DXY) was broadly unchanged over the quarter, while fears of Trumponomics resulting in excessive inflation also appear exaggerated for now, as the price of oil fell around 5% over the quarter and the yield on the US long bond (30 years) and benchmark ten year Treasury remained broadly unchanged (3.02% and 2.40% respectively).

Key Economic & Market Data 2016 Q4 GDP 12 month GDP Base Interest Rate - End Mar 2017 Equity Index - Last Quarter Equity Index - Last 12 Months Sovereign Bond Index - Last 12 Months
% % % % % %
USA 2.10 2.00 1.00 +5.53 +14.71 -1.20
UK 0.70 1.90 0.25 +2.79 +18.92 +7.22
Euro Area 0.40 1.70 0.00 +6.64 +15.79 -1.58
China 1.70 6.80 4.35 +3.83 +2.37 -0.28
Japan 0.30 1.60 -0.10 -1.07 +12.83 -1.59
Germany 0.40 1.20 0.00 +7.25 +23.55 -0.68
NB. GDP Data shown is to the 31st December 2016; Interest Rate, Equity & Bond Index Data is to the 31st March 2017; Equity Indices used: US – S&P 500, UK – FTSE 100, Eurozone – Euro Stoxx 50, China – Shanghai Shenzen CSI 300, Japan – Nikkei 225, Germany – Xetra Dax; Sovereign Bond Indices courtesy of Bloomberg

Current Considerations

Following the failure of the Trump administration to get Congress to approve its healthcare reforms, some market commentators understandably are beginning to question the strength of the post election rally on Wall Street, and what might be the impact on markets if the widely anticipated tax reforms and infrastructure spend also fail to get Congressional approval. The April 1st edition of The Economist in its Buttonwood article titled “Repent at leisure” went so far as to even suggest, “Honeymoons don’t last forever. Having been a reluctant bride to President Donald Trump when courted in the run-up to November’s election, American stockmarkets quickly melted into a mood of euphoria. Shares rose by 12% between election day and March 1st. But in recent days, sentiment has dimmed. There is talk of the ‘Trump-disappointment trade’.”

However at times like this when US domestic ($68.49 trillion) and global (in excess of $225 trillion) debt headwinds appear insurmountable obstacles, it may be as well to remember the well-worn investment adage “a bull market climbs a wall of worry”! We are also mindful that while the current business cycle expansion at ninety-four months is the third longest on record, it will need to run for nearly three further years before it exceeds the longest in history, which lasted 128 months and ran through the nineties to the dot-com peak.

Additionally to further muddy our macro analysis, there is arguably more noise in the US and other major global economies and markets now than at any time since the commencement of this equity bull market in March 2009. Worryingly, the Fed is raising interest rates at a time when the US recovery, while admittedly long in the tooth, remains extremely fragile as evidenced by nominal GDP growing by just 2.9% in 2016, the slowest rate since the current expansion began, leaving the economy vulnerable to any sort of outside shock.

Of course equity markets are renowned as efficient discounting economic predictors, and maybe Mr. Market is telling us that against all the odds, it really is “morning again in America”, to quote the catchy 1984 re-election advert run by the Ronald Reagan team at the height of the Reaganomics boom. Notwithstanding the last week of the first quarter when Wall Street equity markets had their first set-back since the election, investors are giving Trumponomics the thumbs up, suggesting the bull market that commenced eight years ago may have some time to run yet!

For this to happen, we shall ideally require both US government debt markets and the dollar to remain relatively stable. The consensus market view has been suggesting for some time that the thirty-five year secular bull market in US Treasuries is over, but we are not so sure as, for this to be so, the global deflationary forces that have prevailed since the collapse of Lehman Brothers will probably need to be overwhelmed by inflationary pressures showing through in wage demands and price increases throughout the economy.

While there have been some tentative signs of this happening, such as the increase in energy prices last year, these have been too sporadic and inconsistent to convince us that a sea change is yet in place. Of course should it transpire that we are wrong and inflation is becoming a problem, we would not necessarily be concerned about equity exposure as other than possibly physical gold, the best asset class historically to be holding during inflationary times has been proven to be the shares of companies.

One of the main arguments for a continuation of the global equity bull market has been that a paradigm shift in income investment occurred following the collapse of Lehman Brothers in 2008. As a result of central banks throughout the developed world following the Fed and introducing zero interest rate policies (ZIRP) and some even experimenting with negative interest rate policies (NIRP), the interest (or yield) payable on traditional cash and money market deposits collapsed.

At the same time the yield on US Treasury’s, and other developed market government debt continued to fall, with the result that the majority of risk averse investors, whom traditionally had invested most, or all of their hard earned savings in these low risk asset classes, had to look to equities to get income comparable to what they had previously enjoyed. Despite the Fed now raising interest rates, it will likely be many years before the income available from cash and low risk fixed income asset classes comes anywhere near what it was pre-Lehman, meaning equities will probably remain the asset class of choice for retiring baby boomers and others whom need regular income.

Yet amazingly despite these factors having been in play for the best part of a decade, data from the Fed show that some $11.7 trillion is sitting in US bank deposits, up from just $7.23 trillion at the start of 2009, shortly after the Fed cut rates to near zero. Of course some of these cash deposits will never enter the equity market, but there has to be a strong likelihood that even as the Fed tightens monetary policy through raising the deposit rate, a large percentage of this money will find its way into Wall Street stocks, especially if the Trump rally gathers momentum, and more and more investors become concerned about missing out.

There are also several other positive factors at play that suggest that the global equity bull market has some way to run, and this includes the improving data from China, the world’s second largest economy, where a hard landing now seems much less likely, as evidenced by industrial profits being almost a third higher in the first quarter than at the same time last year. Meanwhile, in Europe, investors also have reason to be excited as the German IFO survey of business confidence recently hit its highest score since 2011.

Forward Outlook

As we explained in last quarter’s market view, we believe the key question for 2017 is the likely direction of the dollar, and as sterling investors, how the pound will fare now that Article 50 has been triggered and the market wrestles with the positive and negative implications of the UK leaving the European Union in two years’ time. Last year we were handsomely rewarded for having allocations in global portfolios, that benefitted both from a heavy exposure to Wall Street stocks, and from the currency appreciation of dollar and other foreign currency denominated stocks, as the pound fell heavily following the Brexit referendum decision.

It is likely that most if not all of sterling’s depreciation has now occurred, and therefore we are unlikely to see much more potential currency gains from being invested in foreign markets this year, and indeed it could well be the reverse if markets were to decide the pound has been oversold. We believe therefore it makes sense to take profits in some of these holdings, which also reflect relatively expensive Wall Street stock valuations, and seek to invest a higher proportion of portfolios into a combination of UK higher yielding equity, and smaller company growth funds.

We believe also that Europe, having disappointed investors for many years, will continue to improve economically notwithstanding the political headwinds surrounding the forthcoming national elections. Accordingly we shall be looking to selectively increase exposure within portfolios to funds invested in diversified large cap European stocks underpinned by dividends.

While we remain sceptical that the thirty-five year secular bull market in US Treasury’s, and other developed economy government debt markets is over, we are concerned about the liquidity issues that potentially exist in many corporate bond funds, especially those with a bias towards sub-investment grade debt. We were given a timely reminder of the dangers of this sector on March the 31st when Reuters informed the world that “Third Avenue Management and its founder Martin Whitman have reached a $14.25 million settlement of a lawsuit by investors who accused the well-known value investment firm of mismanaging a junk bond mutual fund that collapsed in December 2015.”

We believe also that Europe, having disappointed investors for many years, will continue to improve economically notwithstanding the political headwinds surrounding the forthcoming national elections. Accordingly we shall be looking to selectively increase exposure within portfolios to funds invested in diversified large cap European stocks underpinned by dividends.

Based in Manhattan, Third Avenue closed the “Focused Credit” fund on the 9th of December 2015, and halted redemptions after investors flooded it with withdrawal requests, which it said it could not meet by selling assets at what it called "rational" prices. Focused Credit had posted a nearly 30 percent loss in 2015 prior to the closure, and had lost nearly three-quarters of the $2.97 billion of assets it held in late 2014.

As always, risk is at the forefront of our recommendations and, whilst it often necessary to undertake adjustments in portfolio allocation in order to maintain individual preferences, we are confident that our current fund selections remain well placed to realise potential and will continue to be effective in meeting our client’s objectives.