How’s The Ugly Contest Coming Along?
Skerritts View - November 2016
Last month we mentioned that we were in an ugly contest, with there being almost nothing attractive to buy in any market. Since then, virtually every market has gone up. Does this mean that we were wrong or, appropriately around Halloween time, have things become just a tad uglier? It’s difficult to say for sure but it was interesting that on a single day towards the end of October, Sanofi and Novo (both in the European healthcare sector) made trading announcements. Sanofi’s news was good, and its shares rose nearly 6%. Novo’s news was bad, and its shares fell by nearly 20%. Does this give an indication about where we are at present – prices are more susceptible to a sharp correction on bad news than they are prone to surging on good?
The table below shows why we have chosen to stay underweight the UK market in our portfolios for the time being. Hands up, we missed the strong rally that we’ve seen from the large cap sector in the UK this year, but we’re not inclined to chase it. It’s quite clearly in higher risk territory right now. On the same basis, global equities are at their highest risk level since 2014.
Source: BCA Research 2016 (Timeframe 1998 to 2016)
Yet, strangely, it’s difficult to pinpoint any specific risk that could trigger a meaningful correction, but this is often the case before one occurs. Sometimes referred to as a black swan event, it’s precisely the element of surprise that sends markets into a tailspin as they try to adjust to a threat, whether real or imagined. A sensibly diversified portfolio appears to be the investment of choice at the moment rather than a strong conviction alternative, regardless of whether that conviction is positive or negative.
After what seems an age, the US election of one of the two least popular candidates of all time is coming to its conclusion. Paddy Power the bookmaker have already paid out on a Clinton victory, and every poll seems to be pointing towards the first woman President as being a done deal. Although it appears inconceivable to most outsiders that Donald Trump could soon be erecting bigger walls around the White House, it is folly to forget recent election results such as those in Austria and the UK which have laid bare just how strongly whole swathes of the population feel that they have not been listened to for years. Two factors could yet trigger an open-mothed reaction from the rest of the world. First, voter complacency resulting in a low turnout. If the electorate think that their vote won’t make any difference they may not vote at all. And one thing that we know is that Trump’s supporters are more likely to make their voice heard. On a similar note, bearing in mind that Clinton is the second least popular candidate ever (second only to Trump) it is not difficult to imagine a high proportion of voters deciding not to vote anyway as they see their vote as an irrelevance. This way they can maintain the moral high ground by rightly claiming that they had not voted for her if it all starts to go wrong.
The other scenario is that Trump supporters have been lying to pollsters. We saw this in the run up to Brexit after the murder of Jo Cox. To admit to voting Leave was akin to aligning oneself to the radical far right, and so Leavers waited until the anonymity of the voting booth to express their true opinion. Political correctness has been stifling free speech over the years and so if one was to support the most politically incorrect public figure for generations, would you let on? Unlikely as a Trump victory appears, Clinton may want to hold on to her deposit for the removal company for a few days yet.
Pontification and speculation are all well and good, but what does it all mean for our investments? In a nutshell, the US Dollar appears to be heading higher regardless of who wins the election. Full employment (or close to it) will lead to higher consumer spending which, coupled with the feed through of lower fuel and energy costs, will ultimately lead to greater inflationary pressure. The perception of higher interest rates will push the Dollar higher, in conjunction with a depreciating Yen, Euro and Sterling. The Bank of Japan (BoJ) has given the Ministry of Finance a blank check by promising to undertake unlimited bond purchases while keeping the 10-year yield pegged at zero. This has not been greatly appreciated by markets yet but it will probably garner more attention as events unfold. Effectively, the BoJ has created the situation whereby the Japanese government does not need to worry about paying any interest on its debt, nor does it need worry about repaying the principal, since the BoJ is buying more bonds than the government is issuing. This should be strongly positive for Japanese assets.
Europe will be watching what happens in Japan very closely as there are similarities between the European economy and the Japanese economy which are more striking than the similarities that draw in the US and the UK. As investors, we remain overweight the European and Japanese markets.
If the Dollar does strengthen, it is very difficult to be bullish on emerging markets and commodities. Emerging Markets are quite tightly correlated with commodities in any case, and so more expensive commodities have an impact on EMs more than they do Developed Markets. Second, the servicing of Dollar denominated debt becomes more onerous as the Dollar strengthens, and it is exactly this kind of debt that predominates in the EM sector. Having said this, preference from an investor’s perspective would lie with commodity users rather than producers in the EM world.
All in all we’re proceeding with caution, but any short term shake-out could create opportunities as muddy waters become clearer.
Sources: BCA Research October 2016
These are our views, as always, and don’t constitute advice in any way.
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