Range-trading, relief rallies, and a rude awakening for bondholders
The main stockmarkets range-traded over the month, with direction largely determined by the latest leaked — or denied — rescue package for Greece. Emerging markets generally trended lower as fears of a US rate rise drew nearer, with the notable exception of China, where ongoing retail demand pushed the market to a seven-year high. Yet the real story was in bonds, where a sharp sell-off sent yields surging and reminded investors that fixed interest is not always the quiet end of a portfolio.
A Tory majority lifts the City while Wall Street cheers bad news
In the UK, a majority win for the Conservatives gave stockmarkets a boost, with relief buying concentrated in banks and utilities — sectors that had been weighed down by fears of a Labour-led coalition. The political clarity was welcomed, even if the broader economic picture remained mixed.
Across the Atlantic, the S&P 500 closed at a record high, perversely following comments that members of the Federal Reserve had doubts about the strength of the US recovery. This was supported by a revised GDP reading of minus 0.7% on an annualised basis for the first quarter. By the beginning of June, the International Monetary Fund was sufficiently concerned to advise the Federal Reserve to put off raising rates until next year.
Draghi tells investors to live with volatility — and they get a taste of it
In a break from convention, fixed interest was the most exciting asset class this month, though the main action came during the first week of June. A positive inflation reading for the eurozone of 0.3%, and Germany in particular at 0.7%, unsettled investors holding bunds on close to zero yields.
ECB President Mario Draghi then lit the touch-paper by commenting that investors should learn to live with bond volatility. The implication that European quantitative easing would be restricted to targeting inflation — rather than bailing out investors — saw the ten-year bund, which yielded just 0.06% last month, briefly hit 1.0% before settling back at around 0.85%. With little liquidity in the market, other sovereign bond markets saw similar sharp falls in price, causing yields to rise across the board.
Can't pay, won't pay — but not just yet
The Greek saga of "can't pay, won't pay" continued to overshadow European markets. It was agreed to allow Greece to defer its default by combining all its debts due to the IMF in June into a single payment on the last day of the month. The arrangement bought time but resolved nothing, and the rolling uncertainty continued to weigh on sentiment across the continent.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
Japan offers value while Europe remains hostage to Athens
Europe and Japan are pretty much zero-sum games at present. A weakening currency drives markets higher, and vice versa, but when translated back into sterling the moves show little overall change. However, whereas we consider Europe will remain vulnerable whilst the Greek farce persists, we feel that Japanese equities offer reasonable value. At a time of record stockmarket highs elsewhere, the main Japanese indices are still 50% below their 1989 highs.
Yields on fixed interest bonds will rise further in our view, but may settle down at between 2.5% and 3%. In the near term it would be reasonable to expect some buying after the recent sharp sell-off, but for us this would be a move suitable only for short-term traders. Our view remains that there is little reward for the risks to capital.
Emerging markets and Asia have suffered recently as investors expect an adverse reaction when the US starts to raise interest rates. We agree that there are risks, but still regard this area as representing better long-term value than most developed markets.
At a time of record stockmarket highs, the main Japanese indices are still 50% below their 1989 highs.
We remain underweight fixed interest funds across the portfolios, preferring a combination of equity income funds, absolute return funds and a relatively high weighting in commercial property. We are continuing to run a reduced level of risk as we think there will be better buying opportunities over the next few months.
Underweight bonds, overweight property and absolute return
With little reward on offer for the risks to capital in fixed interest, we continue to favour a combination of equity income funds, absolute return funds and commercial property over traditional bond allocations. The exception is on our income portfolios, where we mostly prefer the higher income from bond funds to lower-yielding absolute return funds.
Bond proxies: the case for defensive equity income
There has been some concern recently over so-called bond proxies — large defensive equities offering higher income yields than bonds. Some fear that a rise in bond yields will drag these yields higher too, resulting in a fall in prices. We think prices could dip with the general market, but that the yield on offer will attract new income-hungry investors. For example, BAE Systems offers a dividend yield of around 4.14%, comparing favourably to the 3.65% yield on its ten-year dollar bond, with the added prospect of growth in the dividend and share price.
Patience for better entry points
There have been few changes across the portfolios this year as we remain happy with our existing fund selection. That is not to say that we are complacent — we are regularly researching suitable alternative funds for different market scenarios. We are continuing to run a reduced level of risk as we believe better buying opportunities will present themselves over the coming months.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
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