Investment Comment October 2015

Mark Carney, governor of the Bank of England, said that the rapidly growing number of buy-to-let landlords could threaten the UK’s economic stability by leaving too many exposed to the booms and busts of the housing market, and exacerbating upwards and downwards trends.  Changes to the amount landlords can claim in tax relief on mortgage payments and expenses, which were introduced in the Summer Budget, allied to potential interest rate rises, may help to encourage calmer conditions.  Whilst returns from UK commercial property are unlikely to be as high as the large double digit returns seen in 2014, we still see opportunities for attractive rental yields and more moderate price growth.

The Chancellor of the Exchequer, George Osborne, led a trade mission to China, aimed at increasing Chinese investment in the UK. There are signs that the Chinese market is opening further to UK exporters, which should be positive for the UK economy.  Whilst the Top UK 100 Companies has fallen primarily due to its large oil and gas, mining and bank constituents, the Top UK 250 Companies Mid Cap index has been much more resilient, with non-banking financials and UK-focused consumer goods performing particularly well.

Mergers and acquisitions activity continued to be healthy in the UK. Innovation Group was the subject of a £500m takeover offer by US private equity firm Carlyle Group. Synergy Health was targeted by Steris with a takeover offer worth $1.9bn. After a court in the US rejected attempts to halt the takeover on competition grounds, the deal is now proceeding.

The Euro area’s negative inflation rate in September was mainly due to cheap oil, and was not sufficient to provoke ECB President Mario Draghi to increase its €1.1 trillion Quantitative Easing programme.  Nevertheless, the indications are that further stimulus will be necessary, with S&P predicting QE will be extended until mid-2018 and reach €2.5 trillion.  On balance, lower energy costs should help the wider European economy and leave consumers with more cash to spend on other goods.  Political minds also appear more focused on establishing a more stable financial structure within the Eurozone.  We therefore see select opportunities in European equities, despite the headlines of higher unemployment, deflation and structural inefficiency.

In the US, GDP growth for the second quarter was revised higher to 3.9%. The FOMC, the rate-setting committee of the Federal Reserve, left interest rates unchanged at its September meeting. Whilst this was initially seen by markets as an indication that the FOMC lacks confidence in global economic conditions, this concern was allayed when Janet Yellen, chairman of the Federal Reserve, said the committee still intends to raise rates before the end of this year.   With low unemployment rates, allied to the GDP data and expectations of interest rate rises, we remain positive about the outlook for US equities.

In Japan, deflation returned with an inflation reading of -0.1%. This caused several analysts to comment that they expect the Bank of Japan to begin a new wave of QE. However, the Bank itself pointed to core inflation, excluding food and energy, which was at 0.8%, to argue that the effects causing a deflationary reading are transitory and should be looked through. The Governor of the Bank of Japan, Haruhiko Kuroda, continues to state that Japan will reach the 2% inflation target by the middle of the fiscal year 2016.  Japanese equities have avoided the worst of the Asian crisis, thanks in part to the BoJ’s commitment to stimulus, and a relative “safe haven” effect.  Despite falls in Q3, Japan remains the strongest performing equity region in 2015.

In Emerging Markets, it was a story of mixed fortunes. Many countries are benefitting from lower oil prices, but there is a cost to others in lower production revenues and associated taxes. Stock prices have weakened as considerations of rising US interest rates and a stronger Dollar draw attention away from local investment. Regarding the recent market falls in China and the apparent economic slowdown, our view has been that growth in China over the past few years would not be sustained indefinitely, and that a slowdown was inevitable.  There may be further short-term weakness across Asia and continued volatility in investments exposed to the Chinese slowdown.  Nevertheless, opportunities remain in the wider sector for long term investors, due to cheaper valuations across emerging markets compared to developed markets, as well as higher expected growth rates in emerging markets, and strong dividend yields in Asia.

Following a long period of underperformance, we feel that commodities may offer greater attraction in the medium term than they have for some time, although we may not quite be over the worst, due to concerns about oil prices potentially falling further in the short term.  Utilities are also expensive on current valuations.

Although we are sensitive to current valuations, we believe that healthcare and technology offer significant growth prospects, due to demographics and developments in technology.  We are also positive about continued consumer demand, and industrial manufacturing sectors, with demand supported by low oil prices.

With the timescale for interest rate rises being continually pushed back, the outlook for fixed interest remains difficult to predict.  Gilts have provided a rollercoaster ride in 2015, despite their theoretical status as “safe havens”, and yields remain low.  Bond funds positioned for earlier rate rises have seen lower returns, but will be in better shape if and when rates eventually begin to rise.  Diversification and flexibility appear key.

As always, it is important to have a well-diversified portfolio invested in all the major asset classes, in line with objectives and attitude to investment risk.  Any changes in asset allocation should be gradual, because of the difficulty with precisely timing the markets.  Past performance is not a guide to future performance. The value of investments and the income therefrom is not guaranteed and can fall as well as rise due to stock market and currency movements. When an investment is sold, the proceeds may be less than the sum originally invested. The value of overseas securities will be influenced by the rate of exchange which is used to convert these to sterling. 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.

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.