Investment Comment August 2014

Why should investors be interested in Quantitative Easing?  The US Federal Reserve Bank has been tapering QE for almost a year, and plans to stop asset purchases after October.  The Fed has amassed over $2.5 trillion and the Bank of England £325bn.  This is around 25% of GDP for both countries.  However, the Bank of Japan and European Central Bank look set to extend accommodative policy.  The Bank of Japan has amassed over 50% of GDP, targeting ¥270 trillion by year end.  The ECB announced a €400bn lending programme for Eurozone banks in June and also cut interest rates.  The UK and USA are ahead of the pack in turning off asset purchases, and are also ahead of the pack in indicating interest rate rises as economic growth returns to more normal levels.

UK unemployment dropped to 6.5% last month in the UK, and inflation rose from 1.5% to 1.9%.  However, Mark Carney noted that wage inflation is low, and 2 million people are still out of work.  His choice is raising interest rates “earlier, but slower” (before the end of 2014), or “later, but faster” (probably by spring 2015).  He has also indicated that the ‘new normal’ is 2.5% to 3%.  House prices clambered 12% in the UK (and 25% in London) over the past year.  To cool this, the Bank of England gained powers to cap lending at both multiples-of-income and loan-to-value, in addition to April’s FCA Mortgage Market Review introducing tougher affordability checks.  The number of mortgages approved has declined for four months before picking up in June.  So while house prices will fall unless wages keep up, we remain keen on commercial property, which is still 30% under 2007 levels.

Geopolitical risk has increased as a result of wars in Ukraine, Iraq and elsewhere.  In response, after a seven year low, the VIX Volatility Index rose 32% in a day during July.  Yet equity markets remain more attractively valued than bond markets, despite record issuance of high yield bonds and emerging market debt , or Argentina’s technical default on bond payments.  In the US and Europe, company earnings continue to grow steadily.  S&P 500 companies have on average 12% of their balance sheets in cash (which is twice the level of cash reserves held before the financial crisis).  European shares wobbled after difficulties at Portugal’s Espirito Santo, and Austria’s Erste Bank made higher risk provisions ahead of the ECB Asset Quality Review.  We think Europe is cheap but banks are risky.

UK share prices remain resilient despite the dilution of foreign earnings from the strong pound, albeit there has been a rotation away from growth stocks to value stocks.  Recent highs on the Top UK 100 Companies are sustained by earnings growth compounding annually at around 6%.  Notable corporate actions include Abbvie’s offer of a generous premium to take over Shire for £32bn.  Lloyds Bank was fined £218m because of “reprehensible” behaviour in rigging interest rates.  Happily, to prove that there can be payoffs from sporting events, Brazil’s Ibovespa Index climbed 14% in the past 3 months correlating to the World Cup.  Closer to home, Halfords announced that the Tour de France increased overall revenue by 8% and cycle sales by 21%.

Overall, we believe that there continue to be good opportunities in the equity markets as the business cycle continues to develop.  We expect the current corporate earnings cycle to be longer than normal.

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.