Central banks diverge, but markets find their feet
October witnessed a marked divergence in monetary policy. The European Central Bank hinted at further easing while the US Federal Reserve moved closer to its first rate rise in nearly a decade. Equity markets rallied strongly, with Japan leading the charge, and although economic data remained mixed, the month offered a welcome recovery from the turbulence of the summer. In fixed interest, European bond yields fell further into negative territory even as yields in the United States and United Kingdom rose on the growing expectation of tighter policy.
Draghi stands ready while the Fed opens the door
President of the European Central Bank, Mario Draghi, announced that the ECB had discussed cutting interest rates and was "ready to act if needed" should the economic recovery disappoint. The contrast with the United States could hardly have been sharper; the Federal Reserve meeting left the door open for a rise in interest rates in December. Although economic data was mixed, a further fall in US unemployment to 5% strengthened expectations that the Fed would finally move.
The flip-flopping "forward guidance" offered by the major central banks is almost beyond parody. Although the volatility presents opportunities, it has become pointless taking comments on the timing of interest rate rises seriously. Luckily this suits our style of developing robust portfolios that aim for performance over the longer term but with lower than average volatility.
A broad rally, but the summer's scars remain
Equity markets rallied to varying degrees over the course of the month. Japan led the way, rising by nearly 8% in sterling terms; Russia, Asia and some emerging markets gained around 5%, and developed markets were not far behind. The US S&P 500, backed by a strong dollar, regained all of August's losses.
Europe and the United Kingdom fared less well, remaining roughly 4% lower than at the start of August. October's rally was not a surprise after the recent collapse in equity markets, and historical trends suggest that this could continue into the year-end. However, with the European Central Bank meeting in early December and the US Federal Reserve deciding on any rate move in mid-December, we could be in for a rocky month.
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
A tale of two bond markets
There was a greater disparity in global fixed interest than in equities. European bonds welcomed Draghi's comments with a fall in yields to the extent that there is now a record €2.3 trillion of Eurozone debt with a negative yield — investors are paying to lend money. By contrast, bonds in the United States understandably reacted to the intermittent but growing risk of a rate rise, the benchmark 10-year bond now yielding above 2.25%.
Despite Governor Carney's most recent hint that UK interest rates might not change in 2016, gilt yields sided with the US, returning above 2% on 10-year bonds. Although high-yield bonds have recovered the worst of their losses, we remain cautious of the sector where leverage has been increasing and default rates are starting to rise. The demand for income has meant that too many bonds have been issued on the sellers' terms, with few or no covenants, to retail investors who do not always understand what they are buying.
Beijing plans for a new economy while Portugal stirs trouble
China announced its thirteenth 5-Year Plan, which focused on rebalancing from "old" industrial businesses to a "new" consumer-led economy. It also announced a further cut in interest rates as growth and inflation continued to slow. The US and UK central banks are still expected to raise rates one day, the Chinese economy is still slowing, and both of these factors continue to weigh on emerging markets and commodities. None of this is new and therefore should already be priced into markets.
A slow-burner to watch for next year: an anti-austerity alliance has defeated the newly formed Portuguese government's opening programme. This was effectively a vote of no confidence and could lead to the President either asking the alliance to form a new government or calling for a fresh election. After the German-led Eurozone spent much of this year confronting Greece, it may have a new and more significant fight on its hands in 2016.
We don't believe that the level of outstanding global debt will allow much scope for rate rises without precipitating a very nasty crash.
December looms large for both sides of the Atlantic
Overall, the picture has not changed much. Historical trends suggest that the year-end rally could continue, but with the European Central Bank meeting in early December and the US Federal Reserve deciding on any rate move in mid-December, volatility is likely. We do not believe that the level of outstanding global debt will allow much scope for rate rises without precipitating a very nasty crash. This is something that central bankers are well aware of and take into consideration at their meetings.
We continue to run overweight positions in property and absolute return funds, mostly in place of fixed interest. We used the recent correction to add selectively and further tilted portfolios towards UK equity income.
Reducing fixed interest exposure
We further reduced our exposure in fixed interest; in some cases by switching into funds with a lower sensitivity to interest rates, but on our higher-risk portfolios we sold fixed interest funds outright.
Adding to UK smaller companies
Having used the recent market correction to add to our weighting in UK smaller companies, we further increased these funds during the annual rebalance.
Increasing UK equity income
We increased our weightings in UK equity income funds across the portfolios. This is a sector rich in talent with a proven ability to add value over the longer term, and with several top funds offering more income than fixed interest funds.
Overweight property and absolute return
We continue to run overweight positions in property and absolute return funds, mostly in place of fixed interest funds. These provide diversification and a degree of insulation from the volatility in bond markets.
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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