November 2017 Commentary
How markets have performed (to end October 2017)
Equities performed strongly across the board in absolute terms. Japan was a clear front-runner relative to other markets. A snap election resulted in a continued strong mandate for PM Abe, and markets reacted positively to the news. The S&P 500, in USD terms, has now delivered a positive return for the last 12 months in succession – which according to a Deutsche Bank report equals a record set in 1949-50 and 1935-36. European assets held firm despite the continued uncertainty and unrest in Spain. Fixed income markets displayed a little more volatility, but for no significant movement in performance during the month. In commodity markets, agricultural commodities were a little weaker, but energy and oil rose strongly, with crude hitting a new high for the year on fears of a supply cut. Gold fell during the month as investor worries eased and demand for the safe haven asset reduced.
What are we thinking
We see the current market environment as having a finely balanced range of economic and corporate outcomes offset by a higher than usual set of risks and uncertainties. In aggregate we believe the positive forces outweigh the risks in the near term and our investment strategy keeps us overweight risk assets.
The case for the positive is well defined: synchronized global growth, strong corporate earnings results and continued accommodative policy from central banks globally. We worry about: the lack of visibility in the global economic cycle, inflation (as we have mentioned previously), geopolitics, the difficulty central banks will encounter in removing their accommodative policy measures and what we believe are signs of complacency and pro-risk behaviour by market participants. These include: volatility at multi year lows, some stocks (“FAANG”) are considered infallible, ETFs are receiving huge inflows, junk companies and countries are issuing long bonds, and the extraordinary rally in bitcoin.
All assets are highly valued, and expected returns for all asset classes are low by historical standards. Our investment strategy follows three themes:
- Be prepared to accept lower returns than in the past
- Take lower risk than usual
- Try to change market risk to manager risk. We favour illiquid assets in which manager risk dominates
In summary, we retain our positive outlook for risk assets. We are selective in our allocations to corporate credit, wary of interest rate duration exposure and see value in the capital preservation and defensive qualities of cash and gold within a multi-asset portfolio.
Insights from some of our managers
One of our European equity value managers put forward a compelling case for shipping stocks, specifically oil and refined oil product tankers. He observes that the scrappage of these tankers is running well ahead of new capacity building, and that many of the most highly levered operators have gone to the wall in the face of a difficult operating environment. Taking a medium term view, the manager believes the fleet capacity supply/demand balance will shift in favour of the surviving tanker operators; day rates are 25% of historic average at the moment. The current market prices imply that this difficult environment will persist. However, we tend to agree with our manager that the demand for oil transportation is not disappearing in the near term and an interesting opportunity exists for patient value investors willing to take an early stance that the cycle for these stocks is turning.
The latest Investors Intelligence survey of US investor sentiment recorded the highest ratio of Bulls to Bears since 1987. Such sentiment data has no direct links to subsequent market performance – but is another indicator of the pro-risk behavior we believe is prevalent in investment markets, and one of the key risks in the current environment.