Monthly Markets Update - FEB 2017

HOW WE ARE POSITIONED FOR THE REMAINDER OF 1Q17

We anticipate markets will remain mixed and volatile for the remainder of 1Q.

·         Investors will keep buying USD denominated assets, especially equities on the back of strong economic data and expansionary fiscal policy announcements.

·         Bond prices to remain under pressure as the Fed is set to increase interest rates as early as this month. 

·         Commodity markets to remain mixed with oil in a range and gold looking toppy.

·         Overall we remain constructive on stocks; However, we wouldn’t chase the rally and we would buy into a correction. US equities have led the rally, with Europe and Japan underperforming. Nonetheless, we remain vigilant on the risks and see political risk rising from Trump policies, and elections in Europe as the wild cards.

·         Market complacency is at its extreme and we don’t think this can be sustained: therefore, we advise to buy protection ahead of the elections. Global data surprises have supported risk sentiment – although they are starting to lose some momentum which is a backdrop for risk.

 

·         Inflation continues to surprise to the high-side… 

·         …which is good backdrop for asset appreciation…

 

·         …and suggests equity market volatility is on an upward trend…

·         As manifested by stronger inflationary expectations....

--

·         It is now a consensus view that the market is predicting a done deal rate hike at the next Fed meeting on 15th March, and possibly 3 more hikes by the year end. The speeches from the Fed as well as the actual pace and

extent of USA interest rate rises will be key for market volatility and pricing of risks. It is interesting to note that historically global equities go up on average 6% higher 12 months after a Fed lift off, so our view is that

moderate Fed hikes this year will be market friendly, provided the US Dollar won’t rise in value dramatically as a result of the rates differentials.

·         While we do see a number of political risks in Europe, with the implementation of Brexit, and elections in the Netherlands, France and Germany, we are inclined to think that a selloff in European or UK assets will be a buying opportunity, 

similarly as it happened last year after the Brexit Referendum. The existence of cheap valuations, generally underweight European assets and a cheap currency, make European equities an attractive proposition.

·         One factor mitigating the risks is that the polls the 2nd round in the French elections see Le Pen losing to either candidates.

·         We are constructive on China, South East Asia, Australia and New Zealand.

·         We are mindful of the danger of Trump’s policies if his Administration pursues an anti-trade stance, it would be negative for China and EM Asian countries with large trade exposures to the States for example Malaysia, Singapore, South Korea and Taiwan. 

MARKETS OVERVIEW 

Equities – Cautiously Bullish

·         Investors have cheered Trump’s election on the 8th November. Expectations of increased fiscal spending, reduced taxes and removal of regulatory burdens for business all have spurred the S&P to record highs. 

However, with valuation multiples looking stretched, we are selectively overweight equities over a 12-month horizon they still offer the best return prospects vs. other asset classes, especially bonds.

·         The US stock market is expected to be the key beneficiary of any continued flows out of Bond markets and into USD denominated assets. If a tax packagedoes not come until later this year and infrastructure spending 

is deferred until 2018, investors will want to see more progress on economic plans rather than additional promises. Any disappointment with scale or timing would leave markets vulnerable. Therefore, we caution not 

to chase the equity market rally. It will be a stock pickers market and remain focused on preferred sector exposures including: consumer, cyclicals, durables and financials.

·         Meanwhile, markets are starting to focus on rising European political risk.

·         French sovereign bonds yields over Germany have been widening over the past 3 months the only time French sovereign bond yields spread spiked was during the European debt crisis of 2011-12 when there were 

fears of an EU breakup. A so called Frexit is not our base case, but investors need to be aware of this tail risk. If Frexit happened, France would leave not just the EU but also the single currency and introduce a devalued 

French Franc. In the UK, political instability is going to stay since the EU and UK have contrasting objectives in the exit negotiations.

·         Our Investment committee therefore actively continues to monitor a core portfolio of 20-25 securities within our broader watch list. Our preferred equity exposures are for high quality blue chip dividend yield stocks in 

USA as well as currency hedged European and HK equity exposure. 

 

Bonds – Bearish

·         With a rising interest rate environment, and a multi-year bull market and inflows, most Bond markets are vulnerable. After the big rise, last year, US bond yields have stalled in a range, as the market has been watching the 

Fed and news over the tax policy. A large fiscal boost could push growth higher and widen the budget deficit with grave implications for bond’s yield prices.Most sovereign bonds are looking especially overbought, with 

some core countries still offering negative yields. Low grade corporate bonds also look expensive from a risk to reward perspective.

·         If investors need to be positioned in fixed income, we prefer either inflation protected bonds (e.g. TIPS) or high quality corporate bonds with short duration trading at or near face value.

·         Our previous view was to use Bonds as an alternative for cash balances which are earning next to nothing. However, in this environment the risks of capital loss on bonds outweigh the potential rewards for trying to get a 

better than zero percent coupon.

 

Commodities – Expected Rebound Markets

·         Oil prices remain toppy with continued high inventory levels and signs that non-OPEC production will keep rising in response to the rebound in prices over the past year.

·         Oil demand continues to grow at a steady pace around 2%. On the other hand, supply is quickly increasing. The US rig count has almost doubled from the lows of May 2016, so we think a range 45/55 seems reasonable.

·         Gold has been rallying in the past months amid European political risks and worries about US fiscal policy. At the current level, we are neutral on Gold, while we think the price should be supported into the 

French elections. This said, we see Gold as an insurance policy against geopolitical risks than as an uptight investment given Gold’s has zero yield.

Currencies – Consensus Bullish on USD

·         The US dollar will continue to move sideways against G7 currencies, until we see more clarity on Trump’s policies. While interest rate raises will benefit the USD, the Administration policies could put a ceiling on the

value of the greenback. The main driver for US dollar strength will come from the US interest rate rise, as well as from increased expectations of inflation (which is often more important driver than inflation).

·         We still believe that countries that rely on export growth will try to devalue their currencies in order to compete globally, i.e. “currency wars”.

·         Currencies most at risk are many of the Emerging countries that have trade deficits and borrowings in USD.

 

Alternatives – Bullish

·         We are generally positive on Property markets, with a preference for commercial over residential. Our favoured countries for exposure include Australia, UK, South East USA, and Vietnam. Please ask for

more information on some of the projects we are currently working on.

·         We also are positive on Private Equity, as we see better growth opportunities at lower valuations compared to most local equity markets.

BULLISH SECTORS

·         Technology and Healthcare led the rally in February while Energy and Telecom lagged. 

·         Technology rose 9.5% YTD and 30% on a 12-month basis, versus MSCI World 5.3% and 20.7% respectively, benefitting from improving earnings growth prospects and growing risk appetite. On one hand,

execution of US tax reform should boost technology profitability. On the other hand, exposure to Asia could be negative, and valuations have risen significantly. 

·         The Healthcare sector continues to benefit from improving pipeline productivity with an increasing number of new drugs approved by FDA.

·         We also like the Telecom sector given the domestic nature of its business. Its names are less vulnerable to Trump trade wars and valuations are attractive, potentially allowing these sectors to benefit from

less regulations.

 

·         Global banks shares have risen considerably. We still like the Financials.

·         improving business and consumer confidence should continue support credit demand.

·         Stronger economic growth will reduce non-performing loans

·         Capital ratios have improved, and steeper yield curve should be positive.

·         The global Financial Sector has historically performed well in a rising interest rate cycle, and remains one of our key sector overweight.

·         

·          Banks’ valuations remain attractive on the basis of relative underperformance, relative PE and relative Price-to-Book ratios 

 

 

HOW WE MANAGE RISK - PORTFOLIO PROTECTION, HEDGING & TAKING PROFITS

As opposed to just going to cash, we prefer alternative strategies such as hedging via options and option writing strategies to smooth out portfolio volatility.

We also actively monitor profits using trailing stop losses with the view of protecting and locking in gains.

 

PORTFOLIO MANAGEMENT SERVICES

Please let us know if you would like to hear more about our Discretionary Portfolios and how we consistently generate an additional 0.5% to 1.5% per month using our Options Overlay.

CONTACT

We would be more than happy to have an informal chat about these and the other services we offer as well as the current opportunities we are looking at.