In addition to the problems facing Greece and the Eurozone, Global growth forecasts are under mounting pressure from the effect of a strong dollar, economic slowdown in China and the struggles facing some of the emerging markets.
UK equities were buoyed in May following a stable outcome to the General Election, however, Eurozone concerns dragged the market into negative territory this quarter. Perhaps surprisingly, small cap stocks have strongly outperformed large and mega cap stocks in the FTSE, rising by over 7% this quarter. Despite rocky global market sentiment, the domestic economic picture remains positive as unemployment continues to fall, wage growth is the highest it’s been for 4 years and economic growth in Q1 exceeded expectations. At Seabrook Clark we favour companies with predictable revenue streams and high returns on capital that will continue to generate value for shareholders regardless of the short term fluctuations in market sentiment.
Dollar strength is an ongoing theme which is impacting domestic production as well as the global economy. US exports have become more expensive and imports cheaper, impacting the competitiveness of US companies overseas and widening the trade gap, cutting an estimated 1.9% from growth in the first quarter. The economy contracted 0.2% in Q1 due to bad weather, spending cuts and the strong dollar, although this was less than forecasts.
Greece has been at the epicentre of the world’s financial attention which saw it default on its 1.5bn euro payment to the IMF at the end of the quarter. Eurozone ministers are now discussing a Greek request for a new bailout and a referendum is being held in Greece this Sunday (5 July) which could determine their future in the Eurozone. What is for certain is that both sides want a deal, but one which is to their best advantage, so inevitably negotiations will go right down to the wire. The Greeks are likely to have to compromise more as they are likely to face more severe consequences should they exit the euro.
In our view, this volatility is no bad thing for the long term investor and in fact opens up attractive buying opportunities for certain stocks which have seen their share price fall quite sharply, but no change to their underlying fundamentals.
Whilst Eurozone issues have rippled across world markets, Asia is more threatened by a weakening Chinese economy. Most economists agree that China’s economic growth will continue to slow down as industrial growth tails off. Policy makers will look to smoothen the decline by trying to implement effective economic policies in an attempt to spark growth from other areas such as consumer spending and services. So far monetary expansion has been targeting the deceleration of investment as property developers limit construction due to falling property sales.
Chinese stocks experienced significant volatility in Q2 highlighted by a drawdown on the MSCI China Index of nearly 17%. The Shanghai stock market was driven up by unsophisticated private investors to a level where price to earnings ratios averaged 70, nearly four times the worldwide average. This bubble was inflating whilst the economy was cooling. The Shanghai composite index crashed from its high of 5,166 to 3,700 between June and July, erasing $3 trillion off its market capitalisation.
In terms of local currency, the Japanese market has performed most strongly, rising 6.31% over the quarter. However, this gain was eroded into negative territory for sterling investors due to a stronger pound against the yen. The weak yen over the last year, however, has provided a strong tailwind for corporate earnings and quantitative easing has also helped economic recovery. Wage growth is at an early stage of improvement which, if sustained, will provide a boost to consumer spending. We favour Japanese stocks which have solid fundamentals and strong corporate governance in order to target long term growth.
Many emerging markets have dollar denominated debt, which is becoming inflated, increasing debt/GDP ratios and adversely impacting economic prospects. Growth is expected to slow to 4.2% in 2015 compared to 4.6% a year earlier, reflected by low commodity prices and tighter external financial conditions, particularly for oil exporting nations. However, the IMF expects economic growth in emerging markets to pick up to 4.7% in 2016.
Global growth is now at its weakest since the 2008 recession. Even though slowing growth would normally benefit bond prices, it appears the overvaluation had gone too far. In addition, with monetary tightening around the corner, bonds have been becoming an unpopular asset class.
However, fixed income is an important part of a diversified investment portfolio which helps to control volatility. We continue to favour bond managers who can be flexible in their approach and will be better equipped to cope with the change in monetary policy.
|Performance 2015 Q2 (% change) GBP
Performance 2014 Q2 – 2015 Q2 (% change) GBP
|Performance 2015 Q2 (% change) Local currency
|Performance 2014 Q2 – 2015 Q2 (% change) Local currency
|FTSE Europe Ex-UK
Our Strategic Asset Allocation
|Alternatives (e.g. Property/ Infrastructure) %
Bonds/Cash: 50, Equities: 39, Alternatives: 11
Bonds/Cash: 25, Equities: 65, Alternatives: 10
Bonds/Cash: 30, Equities: 56, Alternatives: 14
Bonds/Cash: 25, Equities: 65, Alternatives: 10
Bonds/Cash: 5, Equities: 87, Alternatives: 8
Bonds/Cash: 0, Equities: 92.5, Alternatives: 7.5
- Underweight bonds/cash due to the risk of interest rate rises on the credit market and better opportunities in other asset classes.
- Overweight equities in developed markets given the strength of many Western economies. We are currently cautious over Asian/emerging markets given the risks posed by a strong dollar and slowdown in GDP growth in China.
- Neutral alternatives, although overweight commercial property which offers attractive diversification from equities with consistent yields.
The global economy clearly continues to face significant headwinds which will impact global markets. However, we would expect many economies to benefit from sustained low commodity prices, particularly in the developed world, which will help to counterbalance growth.
The US is nearing an interest rate hike as the economy improves. There is likely to be a negative reaction from markets initially, but Yellen will attempt to mitigate this by managing expectations effectively. The UK will follow the US, but perhaps not until the start of 2016.
Ongoing QE will help support European growth and provide a tailwind for equities. We look to maintain our overweight position in Europe going into the second half of the year, focusing on quality companies with reliable earnings growth. Greece will no doubt provide uncertainty going forward, but it is the contagion which is the major concern, not its impact on short term Eurozone growth. After all Greece accounts for less than 2% of Eurozone GDP whilst other economies are recovering.
We remain cautious over China and emerging markets as we expect further volatility in the short term.
Our approach is to help our clients benefit from attractive equity returns and target sustainable dividends from a diversified portfolio, on the basis of our diligent research and analysis to highlight interesting investment opportunities and mitigate risk as far as possible.
[Jonny Rusbridge, Seabrook Clark Ltd, 2 July 2015]
Please note, our Investment Commentary is our view of markets and does not constitute investment advice. Past performance is not necessarily an indication of future returns; the value of investments and any income from them is not guaranteed and can fall as well as rise. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch.