Our Investment Commentary for Q3 2014 (1 July – 30 September)

The UK market, however, had a difficult quarter as the FTSE 100 fell by more than 2.5% excluding dividends. The US market remained virtually unchanged, but sterling investors saw a healthy increase of 6% due to a resurgent dollar. Despite a deterioration at the end of the quarter, there were signs earlier on in the period that sentiment is returning to some emerging markets, however Russian equities fell by over 5% due the volatile situation in the Ukraine. Finally, Europe’s ongoing battle to stimulate growth continues and European markets struggled, reflecting the tough challenge faced by the ECB of implementing an appropriate monetary policy.

UK

The FTSE 100 has performed relatively poorly this quarter despite the fact that the UK economy seems to be in a fairly good position following positive unemployment and growth figures. The question remains over when and how Mark Carney decides to increase interest rates going into next year. This has been delayed largely due to a decline in real wages and rising costs of living, reducing the spending power of consumers. Undoubtedly this has impacted the market and contributed to the loss of investor confidence this quarter. Lack of wage growth is a key concern in the UK and looks unlikely to change any time soon, so a prolonged squeeze on spending power looks probable. Furthermore, the strong pound has continued to dampen inflation and squeeze firms’ profits this quarter, restricting equity growth. Finally, uncertainty leading up to, and following the Scottish referendum has clearly adversely affected the market.

We expect there to be greater value in more defensive stocks in a rising interest rate environment as fixed income investors may look to switch in to these equities for an attractive yield and capital preservation.

Eurozone

The economic situation in Europe appears to be deteriorating. Gaps in economic performance between countries are widening and there are worries for the European Central Bank over lower than expected inflation and growth. As many Eurozone states have been edging closer to a deflationary trap, Mario Draghi has become more prepared to use a full range of monetary tools in order to inject some growth back in to the economy. However, there is no specific Eurozone stimulus programme, which has led to jittery markets and a flagging economic recovery. In addition, September saw the first contraction in German manufacturing in fifteen months, delivering another blow to the hopes of a Eurozone recovery.

Budgetary reforms and movements towards a fiscal union are also essential as many Eurozone countries are running an unsustainable debt-GDP ratio whereby low inflation is causing the real value of debt to be more pronounced.

US

Both inflation-adjusted consumer spending and employment figures improved during Q3 and this undoubtedly helped support the US market. In contrast to a contraction of growth in Q1- largely due to bad weather- American GDP growth for the spring has been revised up to a staggering 4.6%. As with the UK, the Federal Reserve has been able to maintain a relaxed monetary policy for longer due to low inflation and lack of real wage growth. There is no doubt that the timing of monetary policy expansion in 2015 will have important implications for the equity and bond markets going forward.

Asia

The Chinese market had a very strong start to the quarter, but finished less than 2% higher after a collapse in September. There are signs that the economy is slowing as the profits of industrial firms fell in August for the first time in two years. In addition there have been four consecutive months of decline in house prices which has erased almost all of the gains made over the last year. The property market accounts for around 15% of the economy so this is a trend which could harm consumer confidence going forward.

The Indian economy, on the other hand, looks well placed to continue growing as its fundamentals continue to improve. This has been reflected by the market which increased by over 5% this quarter.

A contraction of the Japanese economy of 1.8% in Q2 had led to questions over the effectiveness of economic policy, however, the Japanese market also grew by around 5% in Q3. Real wages had suffered, which in turn reduced consumer spending but Shinzo Abe continues to adopt further reforms such as improving the flexibility of the labour market. In addition, a survey illustrated that the country’s largest manufacturers’ confidence rebounded in the third quarter, so perhaps there is reason to be more optimistic about Japan looking ahead to October.

Emerging Markets

Emerging markets performed very well in July and August, but struggled in September, so showed minimal growth overall this quarter. Certain economies have been knocked by more than others in the past few months. Ongoing political issues in Russia have had a negative impact on the market, which has fallen by 5%. Clearly there is value to be had amongst some emerging economies with a few countries in particular trading on very low price ratios, such as Turkey and Russia. However, emerging markets are surrounded by risk and uncertainty and significant exposure to this space requires a large appetite for risk.

Markets

The table below shows the performance of key global markets in local currency and UK sterling terms, including dividends re-invested between 1^st July and 30^th September and the full year (30^th September 2013 – 30^th September 2014).

As the table shows, sterling strength has eroded returns from the Japanese and the Eurozone markets, whilst the dollar has rebounded in the last quarter flattering returns on US markets for a sterling investor.

Outlook for Q4 October to December 2014

We remain positive on equities in the medium term, although we expect further volatility in the short run. Markets are grappling with the Fed’s imminent end to the monthly bond buying programme and questions over the first US interest rate rise in years. Also the lack of clarity surrounding the unconventional tools Mario Draghi plans to use in order to ease Europe’s monetary policy is likely to be unsettling for markets going into the final quarter.

In the UK, the housing boom seems to have cooled slightly, but the concern of wage stagnation looks set to continue. This is likely to restrict consumption and investment, holding back market growth going in to Q4. However, there are reasons for investors to be optimistic as the UK has returned to pre-crisis levels and is posting positive economic data.

The US also continues to boast good economic data and this has been reflected in the equity market which reached an all-time high this quarter. Going forward, given that the US market now appears to us to be quite expensive, we expect some profit-taking as the bond buying programme ends and we wait to see how and when the Fed raises interest rates.

We remain watchful of Asian markets over the short term, particularly in China, given the recent signs of economic slowdown and social unrest in Hong Kong.

Given the uncertainty surrounding Mario Draghi’s methods aiming to stimulate the Eurozone, we are cautious over European markets due to the economic challenges facing individual countries as well as the union as a whole.

Overall, despite geopolitical issues throughout Q3, economic fundamentals continue to indicate a global recovery, so we remain hopeful of positive returns in Q4 and going in to 2015.

Our Approach

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.

[Matthew Clark, Seabrook Clark Ltd, 3 October 2014]

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.