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With the General Election behind us, the UK economy is looking rather healthy, inflation is close to zero, petrol prices have fallen and the housing market is robust. The Bank of England remains very supportive and interest rates stand at record lows. Furthermore, with healthy employment levels and wages starting to pick up, this is providing many of us with higher levels of disposable income. A pretty picture and much the same across ‘the pond’ as we step back and look at the US economy.
Whilst the UK and US economies are in something of a sweet spot in a global sense, the last six months have proven more challenging for investors than one might have expected.
Our investment research team have provided comments for the last six months:
For financial markets the May election euphoria seems a somewhat distant memory and the last six months have proven to be a fairly noteworthy period for investors, with many stock markets making multi-year highs earlier in the spring, however investor sentiment became increasingly tested as the summer progressed.
Greece initially grabbed our attention although this quickly became overshadowed, as politicians there capitulated in the face of Eurozone demands, quietly forgetting the swiftly organised referendum and grandstanding of the final weeks of June. Ultimately the main focus of the period has been emerging markets, notably China, coupled with the possibility of a change in American interest rate policy.
The Chinese stock market bubble burst in June, prompting some increasingly fraught and poorly executed policy responses from Chinese authorities, culminating in a currency devaluation in early August. Aside from immediately making Chinese exports more desirable, and those of its competitors less so, it proved the catalyst for a bout of global risk aversion. During what is a typically quiet August holiday period, stock market volatility was driven to levels not seen since the financial crisis of 2011.
With concerns over the health of the Chinese economy, the world’s second largest and the biggest consumer of commodities, inevitability commodity prices were impacted. A position further exacerbated by years of over investment and hence over supply.
To add to the challenging backdrop, investors spent much of the period speculating as to when the US Federal Reserve might raise US interest rates. This is a major change, and something that the world has not experienced since June 2006. The global nature of markets and business mean that this is something that has global implications. Whilst the US economy appeared to be strong enough to merit a rise in September, this was ultimately overridden by what was going on globally.
Global Equity Market Overview
At a headline level no major stock markets completely escaped the volatility, although emerging markets were particularly weak.
Here the twin challenges of weak currencies and falling commodity prices caused much angst, not least from the perspective of trying to fund ongoing domestic spending commitments. Interestingly during the period Saudi Arabia issued its first bond for eight years. It also became clear that overseas investments were being liquidated to help cover the deficit resulting from the low oil price. The fact that Saudi Arabia, a comparatively wealthy country, is having to undertake such measures means that Governments elsewhere must be really feeling the pinch, particularly so where they have borrowed in foreign currencies.
Recent years have typically seen some form of new monetary stimulus unveiled from one of the major central banks. Whilst the Bank of Japan and the European Central Bank continued to undertake QE over the period, no new measures were forthcoming in the developed world, and as such economic fundamentals really came to the fore.
With many major US companies generally failing to grow earnings, not helped by the strength of the Dollar, US equity markets have not progressed. However they did arguably experience some renewed interest as equity investors sought the relative safety of US companies relative to other global markets during the market turmoil. Consequently, from a relative perspective, the US was amongst the ‘least worst’ of global stock markets.
Similarly European markets fared reasonably well on a relative basis, although the latter revelation of the VW emissions scandal was a very unwelcome development for Germany in particular, and Europe in general. The importance of the auto industry and manufacturing for Europe’s largest economy cannot be understated, and this is not what a country that prides itself on quality needs.
Whilst headline equity market performance was disappointing, the sector performance within many global indices was actually polarised. Commodity businesses performed poorly whilst consumer focussed companies outperformed.
UK Equity Market Overview
When one considers the performance of UK stock markets, whilst the main index, the FTSE 100, was impacted by global volatility, the mid and smaller indices fared much better.
At the headline level the FTSE 100 has a very international composition incorporating a meaningful allocation of mining and oil companies, as well as revenue which is mainly earned overseas.
By comparison, the smaller UK indices are domestically orientated with very little commodity exposure. The result is that UK smaller companies actually managed to rise over the period, typically benefitting from a strong domestic economy, aided by falling commodity prices and rising real wages.
Encouragingly, global M&A is at its highest levels since 2007 and UK companies are finding themselves subject to takeover approaches. This reflects a combination of continued confidence amongst company management teams and the availability of very cheap debt.
The broad sell-off of commodities has impacted developing economies, particularly countries in the Middle East and Africa. These are struggling to marry historic Government spending plans with significantly lower commodity, backed revenue streams. As a result, we are currently witnessing a reallocation of capital from these nations existing currency reserves to accommodate for this funding shortfall, albeit longer term commitments may need to be revisited. As such, political extremism, and ultimately social unrest in these regions, remains a key concern.
Yet lower commodity prices, principally oil, are hugely beneficial for consumers and consumer focused economies, effectively acting as a tax cut. Whilst growth rates in developing economies have been falling due to lower commodity prices, alongside weakening growth from China, upward revisions to growth rates of developed economies has been typical over the past few months.
As a result, the US Federal Reserve is approaching its first rate rise in over nine years. This is inevitably causing market volatility, however this move should be viewed as a positive signal about the US economy and support a longer-term recovery, rather than the market’s current preoccupation around concerns over global growth. Globally, central banks remain supportive.
In spite of the macro-economic backdrop, global takeover activity is near all-time highs as management teams have sought to take advantage of attractive valuations to support growth prospects in this ‘low growth’ environment. This activity appears to be broadening from predominantly mega-cap deals last year, towards mid and smaller capitalised companies this year and is likely to remain a feature over the coming months.
Finally, following the period end, the FTSE 100 enjoyed its biggest weekly gain since the Euro-crisis in 2011, which we feel bodes well for the coming six months.
This publication is for informational purposes only and should not be relied upon. The opinions expressed here represent analysis by an Alpha Portfolio Management representative at the time of preparation and should not be interpreted as investment advice.
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