Equities – a regional perspective



US wage growth creeping higher

Source: Thomson Reuters Datastream, 15.3.18

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

The first quarter of the year has been a roller-coaster ride for US equities. The early February correction saw the S&P 500 lose around 10% of its value after a storming first month of the year. Half of the fall has subsequently been recovered. That leaves the US benchmark around 3% up year to date.

So, the optimistic view of the recent shake-out is that it was a necessary release of pressure which has put the US market on a more sustainable path. With some strategists pointing to a year-end target for the S&P 500 of 3,000 there is still a worthwhile upside for investors.

The positive case for US equities focuses on the continuing health of the US economy and an absence of the usual signals that a recession is imminent. Bull markets rarely end in these conditions. In particular, Credit Suisse notes that: job creation remains strong; the yield curve (difference between 2-year and 10-year bond yields) is still upward sloping; business surveys are actually more optimistic than at any time in the past few years; the housing market remains healthy; and corporate earnings and bank loans data continue to be reassuring.

On its dashboard of recession signals, only one is currently neutral - wage inflation - and even this became less alarming when the latest figures showed a slowdown in wage growth from 2.9% to 2.6%. History shows that accelerating wages tend to squeeze corporate profit margins, worry the Fed and lead to higher interest rates and, in due course, recessions. This looks like being tomorrow’s problem, however, not today’s.

Other positives include the ongoing impact of the Trump tax cuts and de-regulation programme. With the President demonstrating a willingness to follow through with his campaign promises - both good and bad from a market perspective - we can also expect to see his infrastructure spending plans come to fruition at some point too.

The negatives for Wall Street remain valuations, the narrowness of the market’s technology leadership, rising interest rates and early signs of America First protectionism. Valuations certainly continue to look full when compared with other developed markets. Indeed, the trailing PE ratio in America has continued to rise while those in Europe and Japan for example are actually lower than they were three or four years ago.

The technology-driven rally also makes the US look vulnerable. The FAANG surge could be de-railed on a whole host of different fronts if Governments around the world act on their increasingly vocal concerns about data privacy, tax and the perceived abuse of tech companies’ dominant market positions. As for trade wars, as discussed elsewhere, these are unequivocally a bad thing. The President is wrong to suggest that they are easily won.

So, the scorecard on Wall Street remains evenly balanced for me. A portfolio without a decent exposure to the US would be a bold call at the moment, but I wouldn’t want to be overweight when there is clearly better value elsewhere in the world.  

Select 50 pick: Ian Heslop’s Old Mutual North American Fund is a solid way into the US market. If the FAANGs do wobble then Angel Agudo’s Fidelity American Special Situations Fund might look relatively attractive.


Dividend income: a uniquely British attraction

Source: Thomson Reuters Datastream, 15.11.17

Past performance is not a reliable indicator of future returns.

This is probably the worst moment of all to generalise about the UK stock market because it is undergoing a significant rotation that will not be apparent to anyone looking simply at the headline indices. The rotation is from the defensive bond-proxy stocks that have enjoyed such a good run for so long into the more cyclical value stocks that have endured a long period of underperformance.

In a low-growth, low-yield world, reliability of income and earnings growth became the principal focus for investors and the consumer staples stocks, in particular, that offered this combination were an obvious target. This was a great environment for quality-focused investors like Nick Train and Terry Smith. In today’s world of returning growth and some inflation, companies that respond well to an improving economic backdrop are coming back into fashion. Areas like financials, some leisure stocks and industrials are beginning to look more interesting, helping contrarian value investors like Alex Wright.

Almost arithmetically, this rotation into cheaper cyclicals and away from expensive defensives will make it difficult for the market as a whole to move forward. A sideways-moving market looks a distinct possibility. But within the market there will be plenty of opportunities for active investors to pick the new winners and avoid the new laggards. This is a stock-picker’s market, one in which passive market trackers will look increasingly unattractive.

For investors to thrive in this environment they will have to remember some old lessons that they may well have forgotten in recent years. For example, it will be essential to focus on companies with pricing power. In an inflationary world, this is key. We are already seeing the problems that some commoditised sectors like mid-market restaurant chains are facing as costs rise, consumer spending power stagnates and it becomes clear that many players have nothing to distinguish them from their rivals.

Investors may well need to adjust their attitude to corporate debts. In an inflationary environment, a more geared balance sheet may make sense if the real burden of borrowings is eroded by rising prices. It’s a return to the world I grew up in where the conventional wisdom was to take out the biggest mortgage you could possibly afford in the knowledge that in time it would become more manageable.

So, this is an interesting time to be investing in the UK but not an easy one. The next 12 months promise plenty of uncertainty over Brexit. The level of the pound may well fluctuate on the changing news-flow. The Bank of England may also find it harder to resist raising interest rates if inflation persists.

But much of this is now priced into a market which is only 10% or so higher than it was five years ago. Valuations are no higher than they were then while the dividend yield on the FTSE 100 looks very attractive compared with that in other major markets. With an active investment approach, investors can look forward to decent returns in their home market.

Select 50 picks: In a sideways-moving market with some growth and inflation, the contrarian approach of Alex Wright’s Fidelity Special Situations Fund looks interesting.



Japanese economy: getting back to work

Source: Thomson Reuters Datastream, Q4 2017

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

The Japanese stock market has had a tough start to 2018 after two years in which it performed extremely well. The correction at the beginning of February hit Tokyo hard, coming as it did on top of a significant strengthening of the yen, which often bears the brunt of any increase in risk aversion.

The correction in the Nikkei this year probably represents a decent opportunity to get back into the Japanese market because the fundamentals continue to look impressive. Manufacturing surveys and industrial production are both improving as they have steadily in recent months. Indeed, the latest quarterly growth in GDP was the eighth on the trot, the first time this has been achieved since 1989, the peak of the Japanese economic boom.

Japanese companies are responding to the better conditions by increasing their capital investment which now stands at an all-time high. Spending is broad-based, looking to improve production efficiency, and represents a U-turn from the previous offshoring trend. Investing at home is putting an ever-tighter squeeze on the Japanese jobs market and unemployment of 2.4% is the lowest since 1993. The jobs-to-applicants ratio is actually higher than at any point since the 1970s. Employment income growth is running at more than 2% and consumer confidence is at historic high levels.

The combination of loose monetary policy - which looks likely to continue with the reappointment of Governor Kuroda - and better economic growth is finally leading to a gradual uptick in inflation. This is a real turning point for Japan after a generation of deflation and augurs well for a more normal economy in the years ahead. In fact, the four key measures that the Japanese government tracks - inflation, GDP, the output gap and labour costs - have all turned positive for the first time in 25 years.

A telling anecdotal indication of how deeply entrenched the deflationary mindset has become - and what a shift it will be if it is finally overcome - was a notice I saw recently from a parcel delivery service which apologised profusely to its customers after it raised its delivery charges for the first time in 27 years!

The other consequence of the strengthening economy is a sharp recovery in corporate earnings which are standing at record levels, alongside profit margins. Interestingly, the link between corporate profits and the exchange rate has broken down over the past year suggesting that Japan is no longer quite so dependent on exports for its growth. The health of Japanese companies has not been better in years, with profits, cash holdings and shareholder returns (in terms of buybacks and dividends) all standing at multi-year highs.

Despite this obviously improving picture, Japanese shares continue to be less highly-rated than those in Europe, the rest of Asia and notably the US. Investors in the Tokyo market can now gain exposure to world-class companies benefiting from the synchronised global upturn at attractive share prices. We remain positive on the Nikkei.

Select 50 pick: Growing advancements in automation and robotic technologies are a major competitive advantage for Japan. The Baillie Gifford Japanese Fund is a good way to play this theme.


The Euro: a headwind for Europe

Source: Thomson Reuters Datastream, 15.3.18

Past performance is not a reliable indicator of what might happen in the future. When investing in overseas markets, changes in currency exchange rates may also affect the value of an investment.

We continue to view European equities in a positive light thanks to the helpful combination of strong economic fundamentals, attractive valuations and still supportive central bank policy. Europe is further behind the rest of the developed world in the economic cycle and is a more cyclical market than the US so stands to benefit from the synchronised upturn in activity. Earnings growth should hit double digits this year.

All the economic numbers are pointing in the right direction. Service sector activity is stronger than at any time since the financial crisis while recent factory output was the best since 2000. Unemployment in the region is still high, especially among the young, but it is falling.

Politics was the dog that didn’t bark in 2017. Everyone was concerned that the series of elections in the region’s most important countries would deliver anti-establishment, anti-EU parties to power, so when they failed to make the expected gains investors were happy to push markets higher. This year the electoral agenda is less busy but already the Italian election has shown that politics has the potential to unsettle markets.

Compared to the tightening bias in US monetary policy, the outlook for interest rates in Europe remains benign. Mario Draghi has made it clear that rates will not start to move until quantitative easing has fully tapered away. That means another year of super-easy policy which will continue to support markets.

It is just as well that policy is so loose because the Euro is strong enough as it is. In fact, the strength of the currency is probably the biggest headwind for European shares. That and the threat of a further ratcheting up of trade tensions with the Trump administration. Other than that, valuations are reasonable although no longer quite the bargain that they were 12 months ago when sentiment was on the backfoot.

Select 50 pick: For value-focused investors we continue to like Stephanie Butcher’s Invesco Perpetual European Equity Income Fund. The FP CRUX European Special Situations Fund would suit those with more of a growth bias.

Asia and Emerging Markets

Perhaps the most significant event in the Asia Pacific region in the past three months was the approval by China’s People’s Congress of Xi Jinping’s bid to extend his leadership beyond the usual 10-year limit. This is a seismic change for the country, a throw-back to the unchallenged dominance of Mao and a move that has been widely criticised.

From an investment perspective, however, a much more positive gloss can be put on the change. Xi is a reform-minded leader, particularly with regard to China’s financial markets. The opening up of the A-share market, more flexible exchange rates, the development of a broader bond market - all these are positive changes that are more likely to be embedded under a strong and stable leadership.

An extended Xi tenure also makes it more likely that the elephant in the room, China’s debt problem, can be effectively managed. This is clearly recognised in Beijing as an important issue and sorting it out will be a multi-year project. Again, stable leadership will help.

Against this backdrop, the ongoing consumption story with a growing middle class and opportunities in a wide range of sectors from airports to technology and financial services looks appealing. China’s increasing dominance of the region, while a geo-political threat, also has a silver lining. Asia Pacific is increasingly becoming an autonomous region which can shrug off Donald Trump’s protectionism and still thrive in a less open world.

Elsewhere, the Indian story remains a long-term positive. The economy is overcoming some short-term hurdles such as the recent demonetisation measures and the harmonisation of taxes across the country. Companies held back on investment while these were pushed through, but GDP growth is strong and there is scope for significant infrastructure improvement.

South Korea performed well last year despite the rumblings from north of the border. Any resolution of the stand-off with Kim Jong-Un would clearly be a positive for sentiment. Taiwan looks less interesting as the Apple product cycle looks to be past its peak. The country is heavily dependent on the US tech company.

Select 50 pick: Ian Heslop’s quantitative investment approach has performed well in both North America and Asia. We picked the Old Mutual Asia Pacific Fund out for the 2018 ISA share picks.

Important information: Please be aware that past performance is not a reliable indicator of what might happen in the future. The value of investments and the income from them can go down as well as up, so you may not get back what you invest. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in small and emerging markets can be more volatile than those in other overseas markets. Reference to specific securities or funds should not be construed as a recommendation to buy or sell these securities or funds and is included for the purposes of illustration only. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.

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