Later this month we will know the identity of the UK’s next Prime Minister. At the time of writing, Boris Johnson remains the favourite although Jeremy Hunt is landing a few blows thanks to questions over Johnson’s Brexit strategy, tax plans and, inevitably, his private life.
Politics will remain the key driver of market sentiment in the UK for the foreseeable future and certainly between now and the end of October when we are once again due to leave the EU. Investors need to consider a couple of issues when weighing up their desired exposure to the UK stock market.
The first of these is the possibility of a snap general election being called, which then raises the related question of what a Corbyn-led Labour government might mean for our personal finances and investment portfolios.
The odds of a general election this year are rising. There are several ways one could be triggered: because a new Prime Minister benefits from a surge in popularity and sees an opportunity to achieve a parliamentary majority; because Brexit grinds to a halt and an election is seen as a preferable route out of the impasse to a second referendum; or following a vote of no-confidence as the new PM tries to drive through a no-deal Brexit against the will of Parliament.
Were a Corbyn-led government to gain a majority, there would be a number of implications, including the prospect of nationalisations in the utilities and transport sectors, possible windfall taxes, pressure on the pound and gilts, even capital flight. The reality is that none of Labour plans would be easy to achieve and impossible in the likely event of a hung parliament. The beauty of political chaos is that it becomes hard for politicians to do anything too damaging!
UK shares are cheap. As a multiple of earnings, they are better value even than the out of favour markets of Europe and Japan. When it comes to dividend yield, investors are spoilt for choice. When I last looked, there were 10 shares yielding more than 7%, in the FTSE 100, another eight with a 6% or better yield. Nearly a third of FTSE 100 constituents yield more than 5%.
Hardest hit have been those stocks with a high domestic exposure or vulnerable to political risk. Goldman Sachs has tracked the performance of a basket of these shares versus the FTSE 100. They have been left trailing ever since the summer of 2016, resulting in some attractive valuations.
Clearly, some of these companies deserve to trade at a discount. But when there is a big sentiment swing like this, many babies are thrown out with the bathwater. Arguably, the areas most likely to be affected by a disorderly Brexit are not captured by the stock market. Listed companies will continue to benefit from overseas earnings, secular trends in technology and healthcare and still pretty robust consumer spending.
The risks for the UK economy are high, less so for the UK stock market. On valuation grounds we remain positive on our home market.
Are we heading for a general election?
Source: Refinitiv, 26.6.19.
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. Please be aware that past performance is not a reliable indicator of future returns. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity.
Select 50 recommendations: The growth investment style has outperformed value in recent years. It may continue to do so, but investors are paying a high price for certainty and contrarian investors will see opportunity in the UK’s bargain basement too. Because of this, investors could do worse than split their UK exposure between the Select 50’s leading growth and value funds: Lindsell Train UK Equity and Fidelity Special Situations.
The last six months have once again supported the adage that you should never bet against the US. Since the beginning of the year, Wall Street has outperformed all its major rivals despite being at the epicentre of the unfolding trade war.
Our base case for the American economy is for weaker growth in the three months just finished followed by a reacceleration in the rest of the year as higher wages and lower mortgage rates boost consumption and financial conditions ease on the back of the Federal Reserve’s swing back to easier monetary policy.
Obviously, a deterioration of the trade situation could knock growth back towards zero next year but the looming Presidential election at the end of 2020 makes this unlikely.
The outlook for corporate earnings is not great thanks to the unwinding of last year’s tax reform gains and the impact of wage growth, cost inflation and higher taxes on the bottom line. But there are positives too. The fundamentals for the US consumer and the US housing market are reasonable.
The big unknown in the US is the political situation. We don’t know who will be standing against Donald Trump in November 2020 so can’t judge how real the Democratic threat to the President will be. What we do know is that increased populism on the left and right makes more fiscal spending likely. Whether this is enough to stay the Fed’s hands when it comes to interest rate cuts remains to be seen.
The big question for investors in the US is when the next recession starts. Despite the worrying messages from the bond market (where a flat yield curve points to a slowdown), recession does not feel imminent. However, stock markets tend to pre-empt a downturn by up to a year, so this is definitely something for investors to keep an eye on.
The other major concern for investors is the relatively high valuations of US stocks. While multiples in Europe, the UK and Japan are below their long-term averages the same cannot be said of Wall Street which looks much more stretched, as the chart shows.
Long-term, US growth is likely to outpace the rest of the developed world thanks to its better demographics and lead in high-growth areas like technology. If a new industrial revolution in nanotechnology or artificial intelligence or some as yet unknown technology lifts global markets to the next level it would be unwise to bet against it emerging in the US.
Those are the long-term reasons to stick with the US. In the short-term, the Fed’s easing cycle is going to support the growth stocks that America specialises in. Put it all together and it is hard to avoid the conclusion that investors should retain a decent exposure to the US market.
US market: valuations looking more stretched
Source: Refinitiv 11.6.19
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. 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.
Select 50 recommendations: For a selection of the big growth stocks that will benefit from a re-acceleration of the US economy, investors could do worse than consider the JPM US Select Fund, with a top five that includes: Microsoft, Amazon, Alphabet, Coca-Cola and Pfizer. We also like the Rathbone Global Opportunities Fund as a play on the US, where it has a material overweight. Only Tencent among James Thomson’s top ten holdings is not a US company.
Mario Draghi may be on his way out of the European Central Bank but his words retain the power to move markets. His recent comments at the ECB forum in Sintra, near Lisbon, were not as significant as his earlier ‘whatever it takes’ bombshell but they did signal a greater urgency to act should the current downward pressures on Euro area growth persist.
The central bank is considering a wide range of options, including further rate cuts and additional asset purchases. Unsurprisingly, markets responded positively to the lower-for-longer outlook with bond yields falling (in the case of France to zero for the first time; Germany is already in negative territory). As far as equities go, the picture is mixed - negative for banks, which struggle to make a profit with yields this low, more positive for growth stocks and for dividend payers, which look increasingly attractive in a low-rate world.
Europe is particularly vulnerable to the impact of trade tensions. Again the impact varies from sector to sector. For those industries where there is a lot of local competition, tariff barriers are a big problem. It’s pretty easy for a Chinese consumer to switch to a Chinese car rather than a VW, for example. Businesses with more unique brands (luxury goods like LVMH, for example) are better placed. So, as ever, stock picking is important.
The good news for investors in Europe is that the bad news is well recognised. European shares trade at multi-decade lows when measured against other stock markets around the world and they are cheap compared with alternative asset classes like negative-yielding bonds and cash. The domestic situation is not bad either, with positive consumer sentiment, retail sales and employment data.
Select 50 recommendation: The Fidelity European Growth Fund is well protected from the three main headwinds in the region - trade wars, Italy and Brexit. Its portfolio is weighted to oil & gas, luxury goods, software and insurance. With banks only 5% of the MSCI Europe index and UK-related profits only 10%, the risks are probably overstated anyway.
Asia and Emerging Markets
Chinese shares have tracked the global trend - terrible 2018, V-shaped recovery in the first quarter and more recent sideways-moving volatility. That reflects uncertainty about the trade situation tempered by the feeling that China’s economy has stabilised after its central bank eased monetary conditions at the end of last year.
Looking forward, China is expected to manage its new relationship with the US reasonably well. Exports to America account for less than 20% of its total overseas sales and, even if a 25% tariff is applied to all its exports to the US, the impact on its GDP would probably only be 1 percentage point this year and next. It could neutralise that with further targeted stimulus.
Probably more important is the impact that the Huawei ban could have on the development of China’s technology sector. It’s bound to at least delay progress. It will certainly lead to more of a focus on consumption-led growth. The best regional fund managers will position their portfolios to reflect these changing dynamics.
The other big economy in Asia has also had an interesting time of it since the last Outlook. The re-election of Prime Minister Modi was a vote of confidence in his promise (so far unfulfilled) to push through a step-change in India’s economy. The first five-year term delivered less than might have been expected on the basis of his 2014 election pledges.
Far from creating 10 million new jobs a year, the Modi administration has actually presided over rising unemployment. The jobless rate is the worst for two years. Graduate unemployment is more than 15%.
But there is good news too. GDP growth is above 7% and faster than China’s. The services sector, accounting for 60% of the economy, is globally competitive. Consumer spending is rising fast and India could within a few years become the world’s third largest consumer market after the US and China.
Trade wars: activity slows
Source: Refinitiv, 15.5.19.
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. Investments in emerging markets can be more volatile than other more developed markets.
Select 50 recommendations: The Asian and Emerging Markets category of the Select 50 aims to offer a range of investment styles. For investors looking for a value approach from an experienced team with a long-term investment horizon, the Maple-Brown Abbott Asia Pacific ex Japan Fund is a good choice.
The time to get interested in an investment is when you can’t find anyone to say a good word about it. Japan is looking like a classic example of this contrarian kind of investment. It has fallen off everyone’s radar; it’s cheap and no-one seems to care.
The scale of Tokyo’s unpopularity with investors has been underscored by its performance both during the fourth quarter collapse in global markets and their subsequent recovery. Japan undershot on the way down and has staged a more tepid recovery on the way back up again, as the chart clearly shows. Overseas investors don’t need much persuading to shed their holdings and they are hard to convince that it’s time to get back in.
There are some good reasons to be cautious about Japan. Although first quarter GDP growth was a bit better than expected, trade was negative and the biggest positive contribution came from inventory build. By its nature that is not sustainable and it doesn’t augur well for the second quarter data due to be announced shortly.
Exports fell in May for the sixth month on the trot, with demand from Europe and China dragging the total lower. Machine tool orders were a notable disappointment. Manufacturing survey data is marginally in contraction territory.
That’s the bad news. On the positive side, the services part of the Japanese economy is in better shape. Domestic demand is resilient. The labour market is tight, with the jobs-to-applicants ratio higher than at any point since the 1970s. Consumption picked up in the long Golden Week holiday around the accession to the throne of Japan’s new emperor.
As we’ve commented before, inbound tourism is a big positive with the figure for May hitting a new record. Easier visa requirements and more flights saw volumes from China up 13%. With the Rugby World Cup and Olympics around the corner, that situation should improve further.
Looking ahead to the rest of the year, the imposition of a higher VAT rate in the autumn is a negative but a number of offsetting measures, including exemptions and new tax reliefs, should limit the fiscal drag when compared with a similar hike in 2014.
From a corporate perspective, the outlook is not bad. Yes, the profit outlook has weakened but we may be close to the trough of those downward revisions. Meanwhile company balance sheets are healthy, with 60% of the value of the Topix index accounted for by cash. Putting even some of that to work will boost returns, even if it is only used to buy back shares, a trend that is already emerging.
Looking at valuations, Japan remains one of the world’s cheapest major markets. Japanese stocks priced in a lot of the trade risk at the end of 2018 when the market fell to little more than 10 times expected earnings. It is still only around 12 times. There is even reasonable dividend support these days.
Japan tests the patience of even the most zen-like investors. I remember one former colleague drily commenting that ‘it’s never too late to short Japan’. However, there really is a price for everything. I think Japan has reached it.
First half rally passes Japan by
Source: Refinitiv 26.6.19, price index rebased to 100.
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.
|Five year performance|
|(% as of 30 June)||2014-2015||2015-2016||2016-2017||2017-2018||2018-2019|
Source: Refinitiv 26.6.19, price index rebased to 100 in USD terms.
Select 50 recommendations: Despite the poor performance of the overall Japanese market, there are still good stock-picking opportunities. That is why our preferred way to play the Tokyo market, Baillie Gifford Japanese Fund, has managed to rise more than twice as much as the Topix index so far this year. We like the market and we like this Edinburgh-based fund too.
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 personal 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. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.