Spring Investment Update

Investors looking at the quarter-end equity market return may be forgiven for thinking that Q1 2016 has been rather dull. However, this has masked a period of elevated volatility which saw broad equity markets fall 11%, before staging a recovery from these lows to end largely where they started. Sterling investors enjoyed better performance numbers for the quarter where they had global equity exposure as the pound weakened in the face of Brexit concerns.

The volatility is driven by a nervousness among market participants and has challenged many an active manager over the quarter. Long term investors or those who took advantage of the sell-off to cautiously add to long term portfolios will have finished the quarter in reasonable shape.

At the start of the year we outlined our expectations for 2016, and central to this was the view that the US would not enter a recession. Whilst recent economic data points to relatively lacklustre growth, it continues to support our ‘o recession’ view and in fact the data has improved modestly over the past few months. Economic cycles are typically curtailed by central bankers being forced to tighten monetary policy as overinvestment and overheating leads to inflation. We do not see evidence of these developments at present. In fact, the US Federal Reserve has adjusted their stance to a more dovish one, forecasting only two rate increases this year against the four initially anticipated. We also see other central banks, most notably the Bank of Japan (BoJ) and the European Central Bank (ECB), continuing to use monetary policy tools to help stimulate their economies. Despite their substantial efforts, inflation remains elusive and growth sluggish. There are now some question marks over the efficacy of these tools, in particular negative interest rates, and this could present a challenge for the BoJ and ECB in the coming months.

In addition to concerns about how the financial sector will contend with negative interest rates, recent announcements have counterintuitively led to Yen and Euro strength, rather than the weakness being targeted. In the UK, we see increasing levels of uncertainty surrounding the upcoming referendum in June on Britain’s membership of the European Union. Whilst the polls suggest that the vote to remain will hold sway, the exit campaign has been gaining momentum and we anticipate increasing levels of volatility with respect to Sterling as we approach June and further weakness should the polls tighten and an exit seem a more likely outcome.

At the end of 2015 concerns about Chinese growth were elevated, but in the past few months these have moderated, helped by Renminbi appreciation. As we’ve noted before, China has a material influence on the global economy, and yet the opacity of information makes it very difficult to assess. We see significant structural challenges which need to be overcome (in addition to ongoing political risk), but also opportunity. The structural issues include high levels of debt and the challenge of transitioning the economy from manufacturing and infrastructure-led to a more consumption driven model. However, a consumer base with growing spending power should provide ongoing positive support to global growth, and Chinese authorities have significant reserves to provide economic support if required.

So what of the outlook? Well as for much of the recent past, we are faced with an interesting mix of positives and negatives. Monetary policy remains very accommodative and whilst the US has moved to start tightening policy, we anticipate a slow and cautious approach to future rate increases. Growth, despite much monetary policy assistance, remains tepid which doesn’t provide great support to the fundamentals underpinning equity markets. However while oil and commodity prices remain low, it is positive for the consumer and also helps keep a lid on inflation and eases the pressure on the Fed with respect to rate increases.

In short, no major change from our core view that we are not heading for recession in the near term but growth will continue to be sluggish and returns relatively low. The outcomes are unlikely to be hugely exciting but unfortunately with so much uncertainty around we may suffer more quarters like the last where the journey is more dramatic than the end destination. With the EU referendum coming up, this will be particularly relevant in the next few months – hold onto your hats!