Quarterly Investment Comment

Quarterly Investment Comment: Q4 2013

Review

In Q3, Sterling rose strongly against almost all foreign currencies, gaining an impressive 6.4% against the US Dollar and 2.6% against the Euro.  Sterling’s strength masked a bubbly performance by risk assets around the world, as reflected by the currency-adjusted returns shown above.  In Sterling terms, European stocks and the UK All Companies led the way.  Elsewhere, Sterling returns were less favourable: Asia-ex Japan stocks rose but US and Japanese stocks fell.  Overseas bonds generally fell, whether long-dated US treasuries, Emerging Market sovereigns or European sovereigns.

In summary, stocks rose and overseas bonds fell as investors anticipated a pick-up in growth and an end to easy money.  Whilst the recovery is underway, growth may be weaker than markets imply and the Fed may not be in a position to taper its support any time soon.

Will the deleveraging be “beautiful”?

While government largesse on both sides of the Atlantic has fuelled consumer demand recently (witness Britain’s Help-to-Buy scheme), it is plain to see that the recovery of the past five years has been anything but normal.  Five years on, real GDP growth in the UK is a mere 1.3% year-on-year, and only 1.6% in America.  Simply put, even modest growth has required unprecedented stimulus due to high debt overhangs.  Asset prices have been the main beneficiary, but wealth effects have been narrow.

The concept of a “beautiful deleveraging” was recently coined by investor Ray Dalio (Bridgewater) to describe the brilliant master plan envisaged by the Federal Reserve and the administration to ensure a gradual normalization of the American economy.  The idea was that the authorities would guide a gradual, drawn-out reduction in debt/GDP by suppressing nominal long-term interest rates well below the growth rate of nominal GDP.  Implicit in this plan was that inflation and private lending would pick up and boost nominal GDP but also that the Federal Reserve would contain long-term interest rates even as they pulled liquidity from the market.

The last quarter suggests the plan may be coming undone: Inflation continued to decelerate (latest CPI +1.5% yoy), private sector lending remains weak and long term interest rates recently almost doubled on mere fears of “tapering”, in spite of subsequent backtracking by Fed governors.  US nominal GDP growth is now 3.1%, only just above 10-year treasury yields at 2.65% (and below 30-year yields of 3.7%).  With near-term growth likely to undershoot due to the government shutdown, not helped by the impact of higher long-term interest rates on the housing market, the stage could be set for continued worsening of system leverage.  In summary, the Fed suddenly appears less than omnipotent and yet has no choice but to delay tapering perhaps indefinitely for lack of a plan B.

Where to now?

Surveying the backdrop here in early October, Sterling appears extended and so, in our view, it may be wise to consider shifting some exposure into international stocks and commercial property.  We retain our more neutral view on American stocks until the current over-valuation is cleared, but continue to view equities positively in Japan and other Asia Pacific countries.  Although economic recovery in Europe is slow, the valuations of many businesses are at historic lows.  The rehabilitation of Europe in investors’ minds has only just begun, and this provides an investment opportunity.

As always, it is important to have a balanced portfolio invested in all the major asset classes, in line with your objectives and attitude to investment risk.  Any changes in asset allocation should be gradual, because of the difficulty with precisely timing the markets.

Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.