Moving sideways: shares are not stretched

Source: Thomson Reuters Datastream, 5.6.18 in local currency

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

We have been neutral on equities since last autumn, which may have been a fraction early but has subsequently been justified by volatile and sideways moving markets in 2018 to date. The feeling that the first quarter may have been as good as it gets in terms of economic and corporate earnings growth is now widely held.

The investment fundamentals that we keep an eye on have all deteriorated during the first half-year. Growth has disappointed, notably in Europe. The US has decoupled thanks to the pre-Christmas tax breaks but even here the leading indicators are less encouraging. When it comes to inflation, the rise in the oil price is the principal concern. Interest rates are still going up and overall policy easing looks like peaking this year.

Unsurprisingly this has led to more volatility in equity markets and investors have been less willing to shrug off other concerns like the rising dollar, trade war fears, geo-political instability in the Middle East and Korea and, most recently, political uncertainty in Italy. 
The response to better than expected first quarter earnings reports was instructive. Growth at more than 20% in the US was stellar, especially at this stage in the cycle, but investors were more interested in what companies had to say about the outlook. Any sign of caution (Caterpillar was the prime example) has been hammered.

The counter argument is that stock markets tend to peak six to nine months ahead of the onset of recession and there is currently no sign of this. The tax cuts may well extend the economic cycle even further, giving the equity bull market one last hurrah. It is too early to turn negative on shares as an asset class, not least because it is hard to identify a plausible alternative. After the first quarter earnings hike, valuations are also close to the long-term average. Finally, with the exception of the US, as the chart shows, equities have broadly moved sideways over the past 20 years. They are not stretched.

All of that said, we are a bit closer to the end of the post-crisis bull run and investors should be taking advantage of the extension to position themselves more defensively. In particular, the outperformance of cyclical sectors looks to have run its course. Return of capital is, at this stage, just as important as return on it.

Select 50 picks: The best way to play the equities class as a whole is via a global equity fund. The Select 50 has three growth-focused funds and two income specialists. We particularly like the Fidelity Global Special Situations Fund and the Rathbone Global Opportunities Fund.


Making the case for higher rates

Source: Thomson Reuters Datastream, 5.6.18

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

The cases for and against bonds are pretty balanced at the moment. The bearish argument is easy to make. Growth remains on a pretty strong footing, especially in the US where tax cuts are adding fuel to the already smouldering fire. The fiscal deficit is set to increase steadily, necessitating the issue of growing volumes of Treasuries. Inflation is on the up and could reach 2.7% later in the summer. It is unsurprising in these circumstances that the yield on the 10-year government bond should have risen above 3% for the first time in several years.

But little of this is new news and the counter argument, for lower yields and higher bond prices, is persuasive. While the hard data is still positive, forward-looking surveys are less convincing. The rise in yields so far has clearly had an impact on financial conditions and equities and corporate bonds have responded accordingly. This shows how sensitive the economy is to higher financing costs. Clearly yields cannot rise too far too fast before they start to have a negative impact on growth. Further uncertainty in Europe or the Middle East could see a flight-to-quality boost to US Treasuries.

Overall, this means the lower-for-longer thesis remains intact. The secular themes of a still massive debt overhang and ageing populations seeking to generate a safe and predictable retirement income will keep yields in check.

Investment grade credit still remains the sweet spot for fixed income investors, with the gap between government and corporate bond yields wide enough to provide a safety cushion for investors. However, returns have been disappointing as sovereign yields have risen, offsetting a marginal tightening in spreads. As monetary support begins to evaporate, we should expect volatility to rise.

High yield bonds issued by less robust companies have been more resilient. Corporate fundamentals remain strong, with low default rates, but relative valuations look a bit stretched for this stage in the credit cycle. By contrast, emerging market debts may offer some interesting opportunities after sentiment was hit by the rise in the dollar and wobbles in vulnerable countries like Argentina and Turkey. The risk/reward balance is better in emerging markets than in high yield.

Select 50 picks: As ever, we recommend a broad-based approach to investing in fixed income. A strategic bond fund can move around the bond universe at will, picking up the best opportunities. The Select 50 has a number of these flexible funds to choose from. The Fidelity Strategic Bond Fund and Jupiter Strategic Bond Fund are both worth a look while M&G Optimal Income has the added bonus of being able to invest in equities too if the manager chooses.

Important information: There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall..


With income remaining a scarce commodity, commercial property continues to be attractive to investors. This is particularly true in Europe as investors become concerned about rising interest rates and stretched valuations in North America. Even in Europe, however, concerns are increasing about the length of the current cycle of falling yields and the weight of money that has fuelled the market in recent years.

For now, the still supportive European Central Bank, with no rate rises expected before the middle of next year at the earliest, and continuing healthy tenant demand mean the fundamentals of the market justify the fund flows. Supply has also lagged demand in most places as new developments have been snapped up. That’s the good news.

The more worrying picture for investors is that property is an inherently cyclical business and this is now one of the longest cycles in recent history. At this mature end of the cycle, the potential for mis-pricing is significant and the risk/reward balance for investors is increasingly unattractive. The spreads between primary and secondary property yields remain above those reached at the previous peak but the compensation for greater tenant default risk is pretty thin today.

In the UK, the picture is even more worrying as the uncertainty around Brexit makes delaying a big property decision an easy one for many companies. The retail sector, a big part of many investors’ real estate portfolios, is suffering at the same time from a seemingly unstoppable assault from online retail. As the chart shows, retail sales are in the doldrums and many retailers simply cannot remain profitable at today’s rents. Something will have to give.

Important information: Funds in the property sector invest in property and land. These can be difficult to sell so you may not be able to cash in the investment when you want to. There may be a delay in acting on your instructions to sell your investment. The value of property is generally a matter of a valuer’s opinion rather than fact.


Commodities have been a mixed bag so far in 2018. While oil has continued to rise sharply, industrial commodities have been volatile and gold remains a disappointment. A key driver of all prices has been geo-political uncertainty. While that has been a boost for oil, the threat of trade wars has held key metals like copper back. Gold has been reined in by the strength of the dollar.

The fundamentals of the energy market remain positive. Multiple factors point to the oil price holding onto its recent highs above $75 a barrel. Production restraint by OPEC and Russia has combined with a real supply shortfall in places like Venezuela and the threat of one in Iran to keep prices rising. Shale still has the potential to be the swing element in the global supply/demand equation but until the distribution network catches up with the drilling capacity then it will struggle to put too much downward pressure on the price.

The other key factor for oil, of course, is demand. This remains strong, rising by more than 1.5m barrels a day in 2017 and likely to do the same this year. China is a key contributor to demand growth and the health of its economy has surprised on the upside.

The main threat to commodity prices is the dollar. Strong growth in America, boosted by fiscal stimulus, gives the Federal Reserve little excuse not to raise rates steadily. Of course, a rising dollar would squeeze other assets, gold included. 

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