Investment Newsletter - March 2016

Mike Deverell Investment Manager

Politics, Polls & PortfoliosThe recent announcement of the European referendum has brought political risk sharply into focus for many investors.

Naturally, many clients are interested in how we are positioning portfolios ahead of the referendum. The short answer is we are being cautious and holding less equities than usual, and in particular we typically have a smaller amount than normal in the FTSE 100. There are a number of reasons why we think this position is the right place to be, with the referendum being just one of them.

In the run up to the referendum we think the pound could be weak, and indeed it has already fallen. This is actually a positive for overseas investments and for those UK companies who make their profits overseas. However, it is a negative for UK companies who import goods. In aggregate, a weak sterling is probably a minor positive for most portfolios provided it does not turn into a disorderly sell off.

We also feel we could see volatility in the UK market as we get closer to the date, in particular in the shares of those companies who make more of their profits from the EU.

In general, an “out” vote would probably be negative for portfolios at least in the short term, as this would lead to greater uncertainty and therefore potentially prolonged volatility. Conversely, a “remain” vote could see stockmarkets and the currency bounce strongly post referendum.

However, it is quite difficult for us to position portfolios for the referendum. Firstly, the outcome is uncertain and therefore it would not be sensible to position portfolios too heavily skewed towards one outcome or the other. Most polls are showing a small lead for “remain” but the margin is slim.

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Investment Newsletter March 2016

Having said that, the betting markets and most analysts put the odds much more strongly in favour of staying in the EU than the polls. The predictions website www.predictwise.com, which takes data from bookmakers as well as polls, currently gives the likelihood of the UK remaining in the EU at 69%. This has been pretty consistent over time:

Of course, the Brexit poll is not the only major political event this year, with the US presidential elections in November arguably even more important for investors. If Donald Trump were elected that would be viewed extremely negatively by the markets.

Luckily for your portfolios, the chance of this looks pretty low. Predictwise believes Trump has a 70% chance of achieving the Republican nomination. However, as his odds of being nominated increase so the odds of the Republicans winning reduce. Predictwise put the current odds of there being a Democrat in the White House at 68%:


Trump Card?


Another reason it is difficult to position for the referendum is that there are far too many other things going on!

Right now markets are allowing us to position cautiously. We feel that this is the right place to be given other factors affecting markets.

However, a month or so ago we had an “overweight” position in equities in most portfolios, holding more shares than usual. This is because stockmarkets had sold off and we felt it was right to top up. We have now typically moved to an “underweight” position, selling equities as markets have recovered somewhat.

If we see a sharp sell-off in markets for any reason then most likely we would increase equity exposure, regardless of the upcoming referendum.

Incidentally, the same website gives Hilary Clinton a 93% chance of being the Democratic candidate, so I make that a 63% chance of Clinton being the next president!

Of course Trump is not the only politician with extreme views making waves. Left wingers Syriza gained power in Greece and Podemos are making waves in Spain. In France, the far right National Front won 28% of the vote in December’s regional elections, although interestingly Predictwise thinks Marine Le Pen only has a 12% chance of becoming president.

Political risk always plays a very important part in investment returns. In a recent survey of economists by Oxford Economics, most of the major perceived risks to the global economy have some sort of political element:


Black Swans


Of those risks, the catch all “Geopolitics” is perhaps the most unpredictable. The war in Syria and the resulting refugee crisis is clearly having a major impact in Europe as well as the Middle East. Meanwhile, North Korea claims to have nuclear warheads capable of being fitted to ballistic missiles, and has threatened an indiscriminate nuclear strike on the US and South Korea.

In investment terms, risks such as these are always present. This time last year we were all worrying about Greece. The details may change but there are always potentially major world events which can throw a spanner in the works of the most well thought out strategy. In fact, the biggest risks to investment returns are the so-called “black swan” events that come from nowhere.

The biggest defence against such risks is to invest in a diversified portfolio. It is also important to remember that all these issues are well known by the markets and already factored into current prices to some extent. That means that if any of the issues are resolved or turn out to be “less bad” than expected, markets can react very positively.

What do you see as the top three downside global economic risks over the next two years?

Percentage of respondents citing as a top 3 risk

Source: Oxford Economics

Market Views March 2016


General Economic OverviewThe global economy remains sluggish but continues to grow. The emerging markets remain weakest, particularly those who are big producers of commodities. However, a small rebound in commodity prices has eased the pressure, along with a stabilisation of economic data from China.

Inflation will increase as the effects of the oil price fall start to drop out of the calculation. However, we do not believe the Bank of England will increase rates this year, though the US Federal Reserve will probably increase rates further later in 2016.

Asset Class

These represent Equilibrium’s collective views. The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser.

Asset class key+ positive - negative = neutral (normal behaviour)

+5 strongly positive-5 strongly negative

A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5% means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.

Our score has reduced to -2 from neutral last month after a strong bounce in stockmarkets. Markets look around fair value based on valuations but earnings growth is weak and economic risks remain. We continue to prefer Japan and smaller companies in the UK.

Equity Markets

Our score for fixed interest is -1, higher than it has been for a while. The “spread” between the yields on corporate and government bonds is higher than it has been for some time. The European Central Bank has also announced it will begin buying corporate bonds as part of its extended quantitative easing.

Fixed Interest

Commercial Property

Our score has reduced to -3 from -2 last month. Commercial property returns are steady but growth has slowed and we expect returns primarily from rent and rental growth. Property continues to provide attractive diversification to equities and bonds.

With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.

Cash

For a typical balanced portfolio we are underweight fixed interest, equity and property. This is balanced by additional holdings in defined returns, alternative equity and tactical cash.

Balanced Asset Allocation

-1

-3

-2

-5

Score

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Investment Newsletter - March 2016