Investment Comment January 2018

UK equity markets reached record highs at the end of 2017 as the traditional ‘Santa Rally’ took hold during December. Despite a lack of major corporate news, the MSCI UK index climbed 4.94% through the month to end the year up +12.99%. Among the best performing sectors over the 12 months were housebuilders, which recovered from the post-referendum sell-off, and miners, which benefitted from rising metal (particularly copper) prices.

The strongest geographic performance over 2017 came from China and Emerging Markets. Technology stocks fared particularly well, with China’s ‘BATs’ (Baidu, Alibaba and Tencent) increasing on average by 80% and the US ‘FANGs’ (Facebook, Amazon, Netflix and Google) by 49%. The soaring valuations have been accompanied by strong earnings growth which reflects a more rational view than the sentiment-driven dot-com bubble of the late 1990s. Overall, global equities continued their upward trend since the financial crisis, adding over $8trillion in value over the year.

In the UK, progress on Brexit negotiations with the European Union was a driver of sentiment in December, as a formal agreement to move on to the next phase of negotiations was finally reached. Sterling initially strengthened on the news, but later slipped back on concerns that the next phase of talks will be more difficult than the first. Such uncertainty also prompted the IMF to downgrade their UK growth forecast for 2017 from 1.7% to 1.6%, on the grounds that British firms are delaying their investment plans.

Economic data released over the month was mixed. Unemployment remained at a four-decade low of 4.3%, however inflation as measured by the Consumer Prices Index (CPI) ticked up unexpectedly to a nearly six-year high of 3.1%, caused by higher air fares and fuel costs. Real wages continue to fall as wage growth (2.3% annualised to October 2017) is still lagging inflation. Regarding the housing market, mortgage approvals for November were at their lowest since August 2016 and down 5% from a year prior. It remains to be seen if the stamp duty abolition for first-time buyers, as announced in November’s Budget, will help to reverse this trend.

In Europe, the Italian Senate gave its final approval to the 2018 Budget. The Italian Parliament was subsequently dissolved by President Sergio Mattarella on 28 December in preparation for their national elections in March 2018, which are currently expected to produce a hung parliament.

Across the pond, President Donald Trump’s ‘Tax Cuts and Jobs Act’ was passed by Congress and signed into law. Key measures included a reduction in the corporate tax rate from 35% to 21% and a lowering of the personal income tax rates across all seven tax brackets. Despite the expected long-run benefits, several large multinationals such as BP, Shell, Barclays and Goldman Sachs will take a one-off hit as they can no longer use past losses to reduce their future taxes.

In addition, the US Federal Reserve (‘the Fed’) raised interest rates by 0.25% for the third time in 2017, with a new target range of 1.25 to 1.5%. The increase was widely anticipated on the back of strong economic data, as US unemployment fell to a 17-year low of 4.1%. The Fed now foresees rates reaching 2% in 2018, 2.5% in 2019 and then 3% (the ‘long-run’ rate) by 2020. Other things being equal, rate hikes should benefit banks by increasing their ‘net interest margin’ (the difference between the interest rate received from borrowers and given to savers). Despite this tapering, the GBP/USD exchange rate remained flat over the month at 1.35, and overall the Dollar (as measured by the Dollar Index) depreciated by 9.9% over the course of the year, due to uncertainty regarding the President’s proposed policies and a strong recovery in Europe.

Oil prices surged in December, as political unrest in Iran sparked fresh concerns over geopolitical instability. This, along with strong demand for crude imports in China and a surprise fall in US production, saw the price of a barrel of Brent crude oil rise from below $45 in June to end the year above $65 at a 2 ½ year high. Consequently, global oil stocks have rallied during the second half of 2017.

In company-specific news, Unilever announced they have agreed to sell their spreads business for £6bn to private equity house KKR. The division was put up for sale as part of a plan to overhaul the company after the rejected £115bn takeover approach from Kraft Heinz in February. International packaging business DS Smith released a positive trading update, with revenues increasing by 19% over the first half of the year, although profits dipped slightly due to higher paper prices.

In conclusion, global equity markets have rallied over 2017, driven by strong synchronised growth and robust corporate profitability. With markets at record highs, we believe that holding a well-diversified, fully invested portfolio is the most effective way to alleviate any potential market volatility. History shows that ‘time in the market’, rather than ‘timing the market’, is crucial to benefit from total return and the power of compounding.

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.