MONTHLY MARKET COMMENTARY

NOVEMBER 2017

UNITED

KINGDOM

Our theme for November is economic paradoxes. One such relates to Giffen goods. Described as goods whose demand rises as their price rises (the opposite of how most goods behave), do we have a current example? Of course we do … If the tulip-mania of the early 17th century or the South Sea Bubble of the early 18th century show us anything, they show us Giffen goods in action. Today, one could easily compare this with the pricing of bitcoin – limited to just 21 million ‘coins’ at inception – or perhaps to premiums occurring in closed-ended investment trusts. The latter do, at least, have potential growth in them from the underlying asset(s). Bitcoin has no traditional valuation metric. Turning to more immediate issues, we do seem to have plenty of potential for equity market volatility at present. Constitutional issues in Spain, an imminent election in Italy (which promises to be divisive), continuing Brexit negotiations (which we see as important not just to the UK but also to the EU) and an increasing belief that many valuations are hard to justify. In the US, it seems very unlikely that the much Trumpeted (sorry, couldn’t resist) tax bill will sail through without significant debate, and as ever this will be good for some stocks, less so for others. Yes, we invest in companies not countries, so to some extent why do political matters away from the UK interest us; should we worry that in Spain, Catalonia and the broader Spanish government are at loggerheads? Well, take a look at the volatility around Spanish bank shares for an insight there … Later in this Commentary you can read about what’s big (news) in Japan, and about the Ancient Greeks, Samsung and classic cars. Even in times of risk (we are quite sure too many investors are too sanguine about the risks around at the moment), there are opportunities. Though the four topics just mentioned don’t exactly make for a balanced portfolio, we continue to believe in diversifying assets, which should stand us in good stead when volatility returns to some of the more ‘traditional’ assets/markets. We have had the much touted interest rate rise from the Bank of England, and yet … this is not a normal rate rise in any sense. Accordingly, it will take more to unsettle the UK economy, though there is plenty ‘more’ out there, potentially. A possible stagnation in politics thanks to recent (more than one) scandal(s) and concerns that our biggest trading partner, the EU, might still have some serious issues of their own, leave us owning relatively modest percentages of UK equity.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

UNITED

KINGDOM (cont’d)

Term or word(s) to watch: care fees … the average cost of a place in a care home is heading for £1,000 per week, and at the same time, what the state pays has been falling in real terms. So why might care fees be words to watch out for in the coming weeks? Well, we do have a Budget on 22 November, and though economic data is hardly strong, we have been promised a ‘revolutionary’ Budget. Care fees have been a serious discussion point for several governments, and various proposals have been put forward, the most recent of which suggested a cap on fees of £72,000 by 2020. This needs a little explanation – the £72,000 refers only to the fees for care, NOT for what are often called the ‘hotel’ or residence costs. We believe this would cover around three to four years in a care home before the state stepped in – similar to the average time a person spends in a care home. Given the furore over the so-called ‘dementia tax’ in the run up to the general election in June, there is no doubt any announcements will have been more carefully thought through this time … and the time could be right to bring in a potentially universally popular (or at least clarifying) policy.

NORTH

AMERICA

The Republican party has finally unveiled their bill to overhaul the US tax code. The early stages of the bill would cut the number of tax codes down to four (from seven) and increase the standard deduction (to grossly oversimplify a tax break given so deductions such as healthcare and charitable gifts don’t have to be itemised). The bill also plans to do away with estate tax and permanently lower corporation tax to 20%. In economics, the paradox of competition is where an action taken by one firm creates a competitive advantage, but if all firms take the same action it can actually be negative. An example may be advertising a brand of cat food. One firm may gain market share if it advertised, but as all firms advertise, this nullifies the advantage and may even cost all firms through having to pay for advertising. Cutting corporation tax to attract new business to a country can fall victim to this, as if all countries lower tax, then everyone has reduced revenues. The full details are still to be revealed, and it seems likely there will be changes, especially if the difficulty seen in negotiating the name of the bill is anything to go by. The bill has eventually been called ‘The Tax Cuts and Jobs Act’, a name chosen over Trump’s alleged preferred name of ‘The Cut Cut Cut Act’. So far in his Presidency, Trump has no major legislative achievements, failing to rally the entire Republican party behind him. In particular, how the cuts will be funded will be a big debate, with the degree of optimism to which the Republican plan will increase growth set to be examined.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

NORTH

AMERICA (cont’d)

From a market context, the tax cuts have been known about for a long time and priced into market expectations. It seems unlikely we will see any large rally in US equities if and when the bill passes, particularly given (already elevated) valuation levels. The make-up of the US index is also skewed to sectors such as technology, which already pay relatively low amounts of tax, so the impact is not as meaningful. Meanwhile, the economy continues to post good growth figures. Having grown at 3.1% in the second quarter, US GDP grew at an annual pace of 3.0% during the three months to the end of September, with disruption from hurricanes Harvey and Irma having less of an impact on the figures than may have been anticipated. US consumer spending remained steady, growing at 2.4%, slowing from the 3.3% reading in the previous quarter, and this is more likely to have been influenced by the hurricanes. This may put pressure on the Federal Reserve to raise rates (more on the Fed in the Fixed Income section). Whilst the economic picture looks strong, we are wary of high valuations. Potential tax cuts are likely priced into valuations, which already look very expensive relative to other markets. Given this, we remain underweight to direct US equities.

EUROPE

European equity markets became giddy on macroeconomic momentum, gaining nearly 2% over the month of October. Earnings were once again the driver, whilst various economic data provided a tailwind. Gross domestic product growth of 0.6% for the third quarter was above expectations, as well as the unemployment rate across the region falling to eight-year lows. Additionally, consumer confidence improved with October’s reading slightly higher than that of September. However, as the month drew to a close, inflation figures looked cooler with the core CPI reading tumbling to the joint lowest in seven months, proving that the market’s precarious highs may not be built on solid foundations. Over the longer term, the outlook for inflation and the economy will depend on whether declines in unemployment eventually lead to an increase in wages and household spending. So far, we have seen no indication that wage inflation is on the cards within any of the developed markets, to the extent that some economists are arguing that the correlation between a low unemployment rate and higher wages has broken down.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

EUROPE (cont’d)

During the European Central Bank’s (ECB) October meeting, Mario Draghi announced that although monetary policy normalisation is still a focus, there will be an extension of the bank’s quantitative easing (QE) programme for nine months. The ECB will halve its asset purchase programme to €30 billion, but it was made pointedly clear that there would be scope for the bond-buying programme to be extended beyond its tentatively scheduled end date of September 2018. This more dovish tone can be seen as an acknowledgement that perhaps the region’s recovery is not quite as robust as eurozone market figures would have investors believe. Europe was once the world’s trail-blazing force of innovation. The Ancient Greeks, for example, are often credited with creating or discovering many objects and concepts that we still use to this day, from the basis of geometry and cartography, to the common alarm clock. It is somewhat paradoxical then that, although Europe can still boast a well-educated workforce and a strong history of academia, they are now trailing in the commercialisation of technology. In fact, the perceived failure of European countries to translate scientific advances into marketable innovations is known as the ‘European paradox’, first described as such in a European Commission Green Paper in 1995. This illustrates our trepidation on the European market; whilst it may look like all the right ingredients are in place, they must be combined using the correct formula for success. Political uncertainty pervades within the region. The Catalan regional parliament unilaterally declared independence from Spain following a secret vote. This prompted the Spanish authorities to trigger Article 155 of the Constitution and assume direct control of the region. Despite the lingering fears over a Spanish breakup through October, Spanish government bonds actually gained 0.9% on the month. The market’s nonchalance towards such volatility is somewhat unnerving and should prompt investors to be cautious on their outlook. We remain resolute in our decision to retain a zero exposure to European equities directly. The ECB has yet to tackle the vast amount of debt lurking within the banking system and have their hands full attempting to balance monetary policy normalisation with the region’s economic recovery. Given that both valuations and political uncertainty are steadily rising, we do not believe now is the time to reinvest in the region.

JAPAN

The Japanese election had caused a few concerns among investors, who had come to think the equity story here was synonymous with Abe remaining at the helm to execute his reforms.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

JAPAN (cont’d)

The relief was unsurprisingly palpable then as Abe’s ruling Liberal Democratic party-led coalition managed to secure a two-thirds parliamentary ‘super majority’ that renewed his mandate. We are now very likely to see continuity in economic policy (Kuroda will be reappointed the central bank Governor), which the market has greeted with open arms, and Abe will probably also use his position to push through changes to the Constitution.

The Nikkei has soared by 10% since the start of October (creating a record winning streak of consecutive daily rises) and has real momentum relative to its peers. The Bank of Japan has since said monetary policy will be on hold as it makes slight downgrades to inflation targets – as a reminder the cap on 10-year bond yields is around the zero level. The combination of an improving economy coupled with a weak yen is making investors see the enduring appeal of Japan and even the remaining bears seem to be attracted to the investment story, further reassured by easing tensions over North Korea (for now at least).

The fact that wealthier countries tend to have lower birth rates than poorer countries may seem to present a paradox of a sort. This appears less so when one factors in mortality rates in poorer countries and the odds of children surviving to adulthood. Anyone who has had children will realise that those countries that have fewer children will save an absolute fortune and possibly become wealthy via this route!

The long-term challenges of both combating the demographic time bomb in the country and slaying deflation are still very real. Everything suggests that the commitment to the cause is absolute, and having recently questioned the extent of our overweight exposure to Japan, we have been delighted by recent developments. Geopolitics in the region will be a lasting concern, but it would probably take a broader Asian issue here to lead us to reduce positions materially, given still attractive relative valuations and the encouraging news flow.

ASIA

Asian markets have continued to perform strongly, and many in the region are now trading around either all-time or multi-decade record highs. The key reasons for this have been technology, the growth of China and liquidity created by loose monetary policy.

South Korea’s KOSPI index is at record highs, closing October above 2,500 for the first time in its 37-year history, even with the sabre rattling from its northern neighbour. Taiwan’s stock exchange is at a 27-year high. Technology has been an important factor for both indices, in particular components used for smart phones.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

ASIA

(cont’d)

Korea’s Samsung Electronics (the 12th largest company in the MSCI All Countries World index by market cap) has been one beneficiary, as has the perhaps less well-known Taiwan Semiconductor (TSMC). The latter is now the world’s largest producer of microchips, having displaced US company Intel earlier this year, and is the 14th largest in the MSCI All Countries Index.

Technology has always been a key driver for Taiwan, with TSMC (33%) and Apple supplier Hon Hai Precision Industry (which trades as Foxconn) representing 41% of the value of Taiwan’s stock market – indeed TSMC by itself has accounted for 45% of the growth of the MSCI Taiwan index since January 2016!

Elsewhere in Asia, both Japan’s Nikkei 225 and Thailand’s SETI are trading at or near to highs not seen for over two decades, and Hong Kong’s Hang Seng is at a decade high. China, which is still targeting 6.5% GDP growth, and Japan have both underpinned the region’s growth, and the improving global economy has also helped exporters. Loose monetary policy has created liquidity for markets through quantitative easing. This has helped boost Asian equities given they are not as highly valued as other markets, most notably relative to the US.

We remain overweight Asian equities, seeing both higher growth potential and relative value compared to other markets. We also have select Indian and Chinese equity exposure in appropriate portfolios.

EMERGING MARKETS

October saw the 19th National Congress of the Communist Party of China (CCP) where President Xi Jinping boldly announced the beginning of a ‘new era’ for socialism in China. Whilst little specific detail was expected, the conference set out the priorities, goals and ambitions of Chinese policymakers into Xi’s second term and potentially beyond.

Economically, the focus is a move to higher quality growth, rather than the high speed growth we have seen over the past decade. Xi also spoke about a more inclusive China looking to address the imbalances that years of all-out growth have created. This includes the challenge of pollution, with China looking to be at the forefront of pollution-reducing technologies.

The Green Paradox was identified by German economist Hans-Werner Sinn and refers to the undesirable effect that environmental measures can sometimes have in exacerbating climate change. An example of this may be the announcement of quotas on emissions that may cause fossil fuel operators to more aggressively extract reserves before the measures come in.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

EMERGING MARKETS (cont’d)

State owned enterprises (SOEs), which have previously attracted concerns over the level of debt, seem likely to be brought under tighter control, rather than liberalised as some analysts expected. Promises to further open overseas access to the country were also made, although we have heard these before and are still yet to see the fruit.

The conclave also saw President Xi Jinping’s political thought written into the Constitution of the CCP, a rare move that puts his status ahead of his two immediate predecessors and behind Mao Zedong. The amendments (or ‘Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era’ to use the official wording) were not the only point of note. Also notable is that he has broken with tradition and not named potential successors, already hinting at the start of his second term that he is planning to go for a third.

The talk around China is less bearish than when a ‘hard landing’ was being discussed at the start of last year, and whilst Xi has consolidated his power, the challenge over debt levels at SOEs will still need to be addressed. We remain positive on China given its demographics, preferring active management to avoid the politically exposed companies in the index.

ALTERNATIVES

Something a little bit different this month with a look at the world of some true alternative investments. Having been the top performing asset in the Coutts index over 12 years since that tracker came into being, classic cars have fallen back in value since 2016.

Years of strong demand from various parts of the world have seen vintage car prices power ahead until recently; now other areas appear to be taking centre stage. Rare musical instruments managed to top the collectibles index last year, though that market sees significant degrees of volatility. Areas such as fine wine and stamps continue to be buoyed by Asian demand (a fairly familiar story across more conventional asset markets too), but the high end part of the global art market – especially modern and impressionist art – registered falls.

As with all asset markets, one has to adopt a discriminating approach; for example, the classic car market may have registered falls as a whole, but there are examples within the market of record prices being reached for certain models, such as the Ferrari 250 GTO.

There might be a slight paradox at work here, where the demand for ‘passion assets’ increases as their price increases, as certain investors seek the prestige of picking up trophy assets.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

ALTERNATIVES

(cont’d)

These areas are very volatile and not suitable for inclusion in conventional client portfolios for reasons ranging from a lack of suitable investment vehicles to extreme volatility. What it does show at least in part though, is the effect that central bank policymakers can have on asset classes across the board – this being yet more evidence perhaps of QE liquidity making the rich even richer.

FIXED

INCOME

Much excitement has surrounded who will be the next Chair of the Federal Reserve as Janet Yellen is entering the ‘end game’ of her tenure. Jay Powell is the Chair-in-waiting, having been a Wall Street favourite and since being unveiled by President Trump as his choice; the question is whether monetary policy will continue to move in the same direction once the transition takes place. Broadly, things are expected to remain unchanged with the economic recovery appearing to be well established, but there will be challenges ahead. Despite investors becoming accustomed to a world of markets only ever moving higher, the Fed will have to contend with the next economic downturn (2018/2019/2020 or beyond?) at a time when many Republicans are increasingly hostile to the stimulus measures that might otherwise be adopted. Nonetheless, Powell has been an exponent of the monetary strategy adopted under Yellen in terms of rate rises and the proposed balance sheet unwind. When more difficult times do hit, as they inevitably will, unconventional policies are likely to once more be advocated given that interest rates are unlikely to rise that much from here. It will also be interesting to see how President Trump will interact (interfere?) with the Fed if it hints at policies that he finds ‘undesirable’ – his firing of Comey and ongoing investigations are not exactly ‘encouraging’ in this regard.

For those who are keen to believe in the omnipotence of central bankers, perhaps a paradox for our times would be whether they can create a bubble in asset prices so large that they are unable to deflate it in a controlled fashion – echoing the paradox of the stone in theology that asks whether an omnipotent God could create a stone so heavy that he would be unable to lift it. Philosophical questions aside, we think central banks may find it somewhat more difficult to extract themselves from the asset price bubbles they have created – if indeed they ever really try.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

FIXED

INCOME (cont’d)

It still seems to us that the fixed income universe should come with a number of health warnings – the risk/return profile is in places awful, and the search for yield has to be carried out in a very measured and thoughtful manner. We think our current approach falls into this latter category and the areas that can withstand rate rises seem to be the best bets – though vigilance over historically sensitive areas such as emerging market debt is always warranted.

COMMODITIES &

SPECIALIST

Historically, the price of copper has been closely correlated with Chinese manufacturing PMI data. It is no surprise that this relationship exists when China accounts for half of global copper consumption growth, making it the largest global consumer of the metal. With Chinese data looking strong and fears abating over a slowdown in economic growth, the copper price has been lifted to over $7,000/t for the first time since 2014. Another demand-side factor is the increased appetite of consumers for electric vehicles, where copper is a key component. The hike in demand could also come from emerging markets, such as India. In 2014, Prime Minister Narendra Modi pledged $1.9 billion to provide an electricity connection to every household. Similar schemes across the developed world could help to sustain demand levels and the recent price strength. Supply levels also provide us with an understanding of why copper prices have risen over 20% since the start of the year. Much of this can be attributed to repeated disappointments over the supply estimates from some of the world’s largest mines. Escondida, the world’s largest mine, has had a series of major production downgrades, and the grade of the copper extracted has been steadily falling. Mining companies have also been struggling to find new deposits in their traditional hunting grounds of Chile and Peru. Some have been forced to search further afield, where infrastructure and political stability present significant difficulties. Countries such as Zambia and the Democratic Republic of Congo hold vast deposits; however, increased reliance on these regions could provide significant supply risk for copper. Historical data also show that as the price for copper rises, so does the number of supply disruptions. In something of an economic paradox, the higher price leads governments and workers to feel as though they have a higher level of bargaining power; these disruptions can send prices higher as investors fear falling supply levels.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

COMMODITIES &

SPECIALIST (cont’d)

As ever, currency has a part to play in the copper price and recent dollar weakness has provided a tailwind. We continue to hold broad mining exposure in more adventurous portfolios. We retain our exposure to gold across the portfolios.

PROPERTY

No one knows how Brexit will ultimately ‘work out’, but there is a reasonable chance that it won’t be good for everyone. There is endless speculation about which European capital might be the main beneficiary in the event of London losing business, and much of it is likely to be wide of the mark. That said, we are, as regular readers know, concerned about the hit London commercial property might take. Despite the record amounts being paid by Asian investors for some high profile London properties, a just-released survey suggests that there is reason for caution. According to responses from the 3,500 investors polled by the property portal Brickvest, a third said Germany was their preferred region to invest in ahead of the UK (which led last time out). Sections of German real estate do offer some attractive opportunities, so the figures aren’t that surprising; it is a warning against complacency. Investors will decide; there are alternatives to London, and a disorderly Brexit could create significant moves. These London concerns make a great deal of sense to us and have already led us to focus our commercial property exposure in less City-exposed areas, away from retail and in the regions where decent opportunities still exist.

CURRENCY

GBP, EUR, YEN, USD … all pretty instantly recognisable. Let’s try a few more on you: LTC, BTC, ETH, BCH. Litecoin, Bitcoin, Ethereum and Bitcoin Cash, none of them more than ten years old, yet all ‘established’ cryptocurrencies, are being joined by numerous Initial Coin Offerings (ICOs) or ‘crowdsales’. Just two months ago, the People’s Bank of China banned ICOs, and more suitable regulation of cryptocurrencies worldwide cannot be far behind. Even in Switzerland, where the use of cash remains very high compared to most of Europe, for example, such matters have to be taken into account. The Swiss National Bank remains cautious on cryptocurrencies, yet Switzerland has hosted four of the top six largest ICOs … food for thought.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

UK INTEREST

RATES

UK interest rates have been raised for the first time in more than a decade, back to the 0.5% they occupied from March 2009 until August 2016, post the EU Referendum. So far, so what? The real news will be if there is another rate rise in the coming few months. And we have an economic paradox that fits in well here. Gibson’s paradox is the observation that the rate of interest and the general level of prices are correlated positively. The term came into use when John Maynard Keynes used it in his A Treatise on Money in 1930. Alfred Gibson, after whom it was named, observed that though the common belief was that when the general level of prices dropped interest rates rose, in fact the opposite was true. Keynes concurred, linking the level of interest rates and the wholesale price index, not the rate at which prices rose or fell. Whether we will see the relationship confirmed over the next few years remains to be seen. We can be sure that, though rates are not about to rocket skywards, there will be further movement, and the next move up will be more closely watched than what might reasonably have been described as this month’s ‘correction’.

MONTHLY MARKET COMMENTARY

NOVEMBER 2017

NUMBERS OF THE MONTH

Our monthly look at numbers that may or may not have grabbed the headlines.

124 90 million 66% The number of months since

the Bank of England raised the

base rate – more than a

decade.

The number of members

of the Communist Party of

China. Roughly.

The parliamentary ‘super

majority’ secured by Japan’s

Liberal Democratic party-led

coalition.

MARKET DATA

Index 31.10.17 1 month 1 Year 3 Years

Dow Jones Industrials 23,377.24 4.34% 28.85% 34.43%

Nikkei 225 22,011.61 8.13% 26.32% 34.10%

M-DAX (Germany) 26,651.52 2.53% 26.03% 65.16%

Hang Seng 28,245.54 2.51% 23.16% 17.92%

Numis UK Smaller Companies 5,935.78 2.82% 22.88% 35.82%

CAC 40 (France) 5,503.29 3.25% 22.04% 30.38%

S&P 500 2,575.26 2.22% 21.12% 27.60%

BSE (India) 33,213.13 6.17% 18.87% 19.43%

MSCI United Kingdom Small Cap 426.54 2.67% 18.20% 38.66%

Bovespa (Brazil) 74,308.44 0.02% 14.45% 36.02%

RTS (Russia) 1,113.41 −2.05% 12.61% 2.01%

Shanghai A (China) 3,553.72 1.34% 9.47% 39.59%

MSCI United Kingdom All Cap 1,407.07 1.62% 9.01% 16.18%

MSCI United Kingdom 2,171.20 1.44% 7.34% 12.57%

IPD UK All Property* 0.59% 4.54% 11.51%

IBOXX UK Sterling Gilts All Mat. 123.35 0.33% −2.10% 6.73%

*Figures delayed by one month

The Monthly Market Commentary (MMC) is written and researched by Simon Gibson, Richard Smith,

Scott Bradshaw and Jonathon Marchant for clients and professional connections of Mattioli Woods plc,

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Sources: www.bbc.co.uk, www.bloomberg.com, Financial Express, www.politicoeurope.com, www.reviewjournal.com,

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