Quarterly Review

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Quarter ending September 2019

Our Reviews look back at the markets over the last quarter as well as our thoughts on today's major issues.

Review of the markets over Q3 2019

Despite the US Federal Reserve (the Fed) lowering interest rates for the first time in 11 years in an attempt to keep the record-long economic expansion going, and the European Central Bank hinting its intention to further loosen monetary policy, global equity markets made only modest gains in July as the likelihood of any imminent trade deal between the US and China seemed increasingly elusive. In local currency terms, developed markets had the edge over their emerging market counterparts as the latter struggled with concerns over global growth and the ongoing trade tensions.

Meanwhile, Boris Johnson, the newly appointed UK Prime Minister, in announcing that the UK will leave the EU on 31 October ‘come what may’ caused sterling to fall to a five-year low as the currency markets became jittery on the prospect of a no-deal Brexit. However, UK-based investors benefited as a weak sterling enhanced the returns from any overseas market exposure, as well boosting the share prices of those UK-listed large cap companies whose revenues are predominantly sourced outside the UK.

August saw global equity markets retreat as the trade war between the US and China escalated, concerns deepened over the outlook for global economic growth, and a brief inversion of both the US and UK yield curves (where long-dated bonds pay lower interest than short-dated bonds) was interpreted by some market participants as a signal of a forthcoming recession.

Market expectations were initially dampened by comments from the US Federal Reserve chairman, Jay Powell, that July’s US interest rate reduction was not the beginning of a prolonged rate-cutting cycle. President Trump then announced that from 01 September the US would apply 10% tariffs to a further $300bn of Chinese goods, immediately triggering retaliatory steps by the Chinese. Oil prices also tumbled over fears that the US-China trade war would significantly reduce demand. Add in to the maelstrom the civil unrest in Hong Kong, the seemingly endless Brexit debacle, the fall of the ruling coalition in Italy and an upset in the primary elections in Argentina, there was little surprise that investors sought the ‘safe-haven’ assets of sovereign bonds, the Japanese and Swiss currencies and gold.

The first half of September saw global equity markets begin to recover on news that October would bring the resumption of trade negotiations between the US and China, while the European Central Bank announced additional monetary stimulus to support the region’s ailing economy. But sentiment soon soured as an attack on some Saudi Arabian oil installations sent oil prices rocketing upwards and doubts were voiced over the extent to which the US Fed would further reduce interest rates. Uncertainty also grew as US Democrat leaders moved to begin impeachment procedures against President Trump, mixed messages circulated relating to the US-China trade dispute, and the Brexit-related shenanigans continued; it is perhaps surprising that global equity markets managed to end the month in positive territory.

At a market level, September also saw a rotation by investors who sold out of defensive low volatility stocks and higher growth technology companies into value stocks which have underperformed the market in recent years. The fixed income markets also had a challenging month with many sectors recording their first negative monthly return in 2019.

Market Returns to 30 September 2019

Asset Class 3 Months 6 Months 1 Year 3 Years
FTSE All Share 1.3 % 4.6 % 2.7 % 21.7 %
S&P 500 4.9 % 11.8 % 9.7 % 50.9 %
FTSE World Europe ex UK 1.6 % 10.5 % 6.4 % 33.1 %
TOPIX 6.5 % 9.3 % -0.3 % 26.9 %
MSCI Asia ex Japan -1.4 % 0.3 % 2.2 % 26.7 %
MSCI Emerging Markets -1.1 % 1.9 % 3.7 % 25.5 %
UK Gilts 6.2 % 7.6 % 13.4 % 10.0 %
IBOXX Sterling Corp Bond 3.7 % 6.1 % 11.0 % 11.3 %
FTSE EPRA Nareit Global Real Estate 6.6 % 9.3 % 19.2 % 25.5 %
Brent Crude Oil (US$/bl) -2.9 % -1.5 % -19.2 % 28.6 %
GSCI Commodities Index -1.0 % -0.1 % -11.4 % 10.4 %
Gold (US$/ounce) 7.2 % 19.7 % 29.6 % 15.2 %

Source: FE Analytics - rebased in Pounds Sterling

The Outlook

At the time of writing, and despite some pullback in the markets in the first few days of October, 2019 has (so far) been a good year for investors with our Balanced Growth Portfolio having gained in excess of 13%. But pleasing as this figure is, it masks a reducing trend over the three quarters since the start of the year. Over 50% of this return was generated in Q1, followed by 30% in Q2 and 20% in Q3. The fact that the MSCI AC World Index shows a virtually identical pattern suggests that this diminishing return reflects market conditions and not poor investment choices on our part. For some investors, this decreasing return may not come as a surprise, especially in the light of the steady slowdown in the global economy which has become increasingly aggravated by the uncertainty caused by the US-China trade dispute. But many will wonder whether the markets will manage to generate a positive return in Q4, especially given the plethora of economic and geopolitical headwinds to contend with?

In last quarter’s Review, we commented that a global economic recession is not an absolute given, although recent survey data suggests that advanced economies certainly ended Q3 on a weak footing, pointing to softer exports, jobs growth and core inflation. So, even if a recession does not materialise it is likely that the global economy could easily bounce along the bottom for a while, caught in a vortex of relatively low growth and low inflation. In the short term, much depends upon whether the downturn in global manufacturing spills over into the services sector and labour markets begin to suffer. Some economic commentators believe that this is inevitable, and with little likelihood of a settlement in the trade war anytime soon and despite the intervention of central banks in loosening policy even further, we may not see anything akin to a recovery until well into next year. Yet despite the economic and geo-political factors buffeting the markets, the equity indices seem to keep rising.

Although the markets were initially disappointed in the US Fed’s somewhat hawkish statement bringing into doubt whether we would see additional rate cuts this year or next, it didn’t take very long for the equity market to shed its concerns. Two further events could have inflicted some serious damage to the equity markets: the sudden 15% spike in oil prices, which had the potential to increase the cost of living for millions of consumers on whom the global economy depends, also proved short-lived as the Saudis managed to largely restore supplies quite quickly; and memories of the financial crisis in 2008 were resurrected when the Fed had to step in to provide liquidity to US banks seeking very short-term (usually overnight) funding. In both cases, relative calm has been the order of the day.

Moreover, the slowing but largely stable picture in the US economy and the noises emanating from Europe that there may be some fiscal loosening alongside the existing monetary stimulus, investors in the markets may be entirely correct to remain steadfast.

For now, we are inclined to agree and so we have decided to retain our current equity exposure across our portfolios although we have made some tactical adjustments (- the broad changes are detailed below). However, we are conscious of the need to remain vigilant, as although the US economy is not as challenged as many other economies it certainly has not been immune from the slowdown in manufacturing, and the noise of the November 2020 US presidential election will only get louder as the weeks pass.

Holding one’s nerve through the stormy times this year has certainly been rewarded, but with further storms likely as 2019 fades into 2020 we do not expect to see the same level of return in the remaining few months of this year.

Recent changes to the Parallel portfolios

We rebalanced our Core portfolios in September and effected some changes to reflect our views on the short-term outlook. These are summarised below:

  • Asset allocation

    Cashdecrease in the Cautious, Balanced and Conservative Income portfolios
    Alternativesno material change to weighting but increased diversification across portfolios
    Propertyno change
    Fixed interestminimal change
    Equitiesminimal change
  • Equity regions

    UKminimal change
    USincrease in Cautious, Balanced, Adventurous, Global Opportunities and Balanced Income portfolios
    Europeno change
    Japanno change
    Asia Pacific & Emerging Marketsdecrease in Conservative, Cautious, Balanced, Adventurous, Global Opportunities and Balanced Income portfolios
    Globalincrease in Conservative portfolio, decrease in Balanced Income portfolio
    Specialistincrease in Cautious, Balanced, Adventurous and Balanced Income portfolios

In the Alternatives element of our Core portfolios we have reduced our exposure to the Investec Diversified Income Fund and introduced the BNY Mellon Real Return Fund to provide some additional diversification.

For several years we have held a number of equity funds in our Global Opportunities model portfolio which we describe as ‘Specialist’; these have an investment focus limited to areas such as: biotechnology, technology, agriculture, etc. We consider that the present pace of technological, environmental and economic change is such that there is merit in including a limited exposure to some specialist funds within our other Core portfolios, excluding those with a lower risk and return profile. We have introduced a holding in the Legg Mason RARE Global Listed Infrastructure Income Fund as we believe that governments will increasingly apply fiscal policies, including infrastructure spend, to support the monetary policies already adopted by central banks. Growing climate change pressure is also supportive of this sector and we consider that the Legg Mason Fund provides a relatively defensive means of gaining access to the opportunities we have identified. We have also introduced a holding in the Merian Gold and Silver Fund to gain exposure to gold, largely to provide some insurance against the possibility of conventional currencies becoming increasingly devalued.

The asset allocation changes detailed above are broadly mirrored across our Core, Passive and SRI portfolios.

Risk warning: Investors should be aware that past performance of investments is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them may fall as well as rise. The content of this bulletin is for general information and reflects the general market view of Parallel Investment Management Ltd. - it should not be interpreted as recommendations or advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of the content.

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