LGT Vestra Q3 Market Review Summary

Tuesday 16 October, 2018

The summer months have been unpredictably volatile for investors, particularly for those with allocations to Asia and Emerging Markets. A combination of disruptive actions by Trump in stepping up the trade wars rhetoric and following through with tariff action, the sustained rise of the value of the US dollar, a bounce back in the oil price and some isolated political crises in Turkey and Argentina amounted to a difficult period.

Outside of these regions, the US continues to benefit from the clear momentum that has carried technology sector valuations higher, but we have also seen earnings come through to justify them. Investors who have been under allocated to the US, and specifically to technology, have suffered in relative performance terms as the majority of other developed markets regions have experienced a fairly benign few months in markets. As inflation continues to come through and the economy continues to chug on, we anticipate the Federal Reserve to continue on this path to 'normalise' the interest rate cycle. Despite a volatile political landscape, our view of equity markets has not changed a huge amount as we continue to focus on the evidence of strong macro fundamentals and try not to put too much weight on the background political noise.

Equity Review
 

Uk Equity

The FTSE All-Share Index fell just under 1% over the quarter. We believe that the UK equity market looks increasingly appealing, with a prospective price to earnings ratio for the next year of 12.5x and an average dividend yield of 4.5%, at the time of writing, on the All-Share Index. This compares very favourably with a muted 1.48% yield on a 10 year gilt. The equity market has also been well supported by sterling's slide, given that a significant amount of revenues comes from overseas. However, with greater clarity needed with regards to Brexit and its potential impact on the currency and equity market, we have remained neutral at this time.

Europe ex UK Equity

The Euro Stoxx 50 Index is up slightly over the quarter in Sterling terms, as the Eurozone continues to see a slight weakening in economic data. However, despite this, some indicators now suggest a moderate pickup in the region for the final quarter of 2018. Germany's economy accelerated in Q2, with robust consumer confidence, a further drop in the unemployment rate and rising income expectations. Solid economic data was also seen in France, suggesting that the rest of the euro area experienced a muted month in August as survey data for the Eurozone as a whole showed little change. In contrast, during the quarter, the ratings agency Fitch revised its outlook on Italy from 'stable' to 'negative', reflecting its fiscal and political woes. In response, markets have been concerned about the Italian government's efforts to put a budget together. This has pushed Italian bond yields to their highest level since 2014. European banks have been under pressure in recent months, principally due to concerns about their exposure to troubled emerging markets like Turkey. Despite ongoing levels of uncertainty in the Eurozone, valuations in the region remain attractive and therefore we feel a neutral stance is appropriate.

US Equity

Economic data from the US continues to come in at robust levels, with survey data near multi-year highs. The first two corporate earnings seasons of 2018 have been impressive, buoyed by Trump's tax reforms and disregarding of trade war concerns. Economic data continues to impress with the consumer confidence and ISM surveys showing that growth is likely to remain robust. The US remains the market that we feel is home to the most high quality companies who can sustainably compound growth over the longer term. Whilst there is likely to be more volatility this year, this continues to be our preferred market and we maintain our positive stance.

Japan Equity

We have been positive on the equity market since the back end of last year given Abe's policies towards improving corporate governance, dividend pay-outs rising, earnings improving and sustained economic growth. We see particular appeal in the excess cash flow and dividend growth story. Extended terms for Prime Minister Abe and Bank of Japan Governor, Kuroda, have further reassured us on the long-term attractiveness of the Japanese market. Japan is less affected by trade wars than its global peers because many of its manufacturers already have factories in the US.

Asia ex Japan Equity

We have a positive stance on Asia ex Japan but believe that a selective approach is key. The region continues to benefit from the cyclical global upswing and earnings momentum within the region. Our particular preference within the market is India, where we see an attractive long-term growth story. Prime Minister Modi has unleashed India’s potential with far-reaching reforms and we believe that the clock will not be turned back. GDP growth should be high and sustainable for many years to come because of population growth, rising incomes, reforms, infrastructure investments, and the rapid adoption of digital technologies. This supports our bias towards India within the region. Asian equities were weak over the period only up 2% in Sterling terms with China and Hong Kong as the weakest countries due to an escalation in US-China trade tensions. India has also been affected by the trade war, with its currency hitting its weakest level on record against the dollar. However, the surplus that India has with the US is roughly 1% of India's GDP, allaying concerns over this matter. We continue to believe that long-term prospects for the Indian market are good and that there is an attractive long-term growth story on the back of Prime Minister Modi's reforms.

Emerging Markets

Concerns over trade wars and a crisis in Turkey weighed on global equity markets through the quarter, with indices in the UK, Europe and Emerging Markets all down. Sharp declines in the Turkish lira pushed Turkey into an economic crisis at the start of August, threatening the country's banking system. President Erdogan has accused the West of waging economic war on Turkey and his rhetoric has inhibited the Turkish central bank from raising rates. To make matters worse, Trump imposed sanctions against Turkey after they refused to release a detained American pastor who was arrested after the failed 2016 coup. Looking to other emerging economies, Argentina has been hit hard and a 50% fall in the Argentinian peso this year has helped to push the economy into a deep recession. Austerity measures by the government weren't enough to regain confidence so it has asked the International Monetary Fund (IMF) for an emergency bailout of $50bn. Despite this and the world's highest interest rates of 60%, Argentina's crisis is getting worse as markets worry about potential for political backlash against the austerity programme. The Brazilian real has also been affected by the rising US interest rates and by the upcoming election uncertainties, at a time when the country is facing a contraction. On the other hand, other countries within the Emerging Market space have focused on domestic reform agendas that could result in longer-term growth prospects. Given the size of the fall across these markets, we believe that selective opportunities are starting to appear and there is potential for us to turn more positive in the months to come.

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