The last year has been an unusual one for investors in that economic recovery in the USA, the World’s largest economy, has been coupled with a degree of volatility in both global fixed interest and equity markets in the second half of the year.
Factors behind this include the impact of geopolitical tensions, for example in the Middle East and in the Ukraine, while raw materials have fallen sharply in value, in a way totally unforeseen, with oil and iron ore prices both tumbling by around 50%. Currencies have also been volatile, with Sterling rising strongly in the middle of the year and subsequently falling back against the US Dollar in particular. Further, anticipated increases in interest rates in economies not damaged by commodity price falls have simply not happened.
Factors lying behind the commodity situation include concerns over reducing Chinese consumption of raw materials and turbulence following Opec’s decision to maintain oil production at previous levels, despite there being a supply glut (in good measure as a consequence of oil from shale in North America). These factors have led to the potential for deflationary pressures to emerge, a trend which if established and maintained for any length of time, is economically very damaging, increasing the real value of debt which remains high as a percentage of global GDP, and pushing economic activity into reverse.
The FTSE 100 share index has declined a little over the last year: it is however worth remembering that it is a quirky index as around one quarter of its constituent companies are raw material focussed operating in large measure outside the UK while a number report profits and pay dividends in Dollars providing additional scope for volatility as a result of currency moves. US equity markets have risen in part, analysts believe, because of upward pressure arising from substantial share buyback schemes that have been in place and because the US is seen as a safe haven. Rather more speculative Chinese equity markets have also performed well but markets in less stable areas, in particular those linked to raw material production focussed economies, and others facing political uncertainties, (in some the two are very much linked) have fared badly.
One great change is that global investors became more judgemental on risk: this is perhaps best reflected in interest rate differentials. Thus the ten year US Treasury yield ended last year at around 2%, the UK ten year Gilt yield at around 1.65%, mainstream Eurozone ten year Government bonds at around 0.5% and their Japanese equivalent at 0.8%. In contrast, Greek ten year Government bonds offer nearer 10% while Russia, in the middle of December, increased its overnight rates from 10% to 17%, along with a number of other crisis measures, in an attempt to take pressure off the falling value of the Rouble. This variation in rates reflects the market’s views of risk (e.g. Russia and Greece) the timing of likely next steps in official interest rates (in the USA and the UK) and the likelihood of quantitative easing in the Eurozone.
While equity markets have been mixed and volatile, fixed interest markets in the Western world have remained firm as the timing of interest rate rises have been pushed into the future. Thus mainstream fixed interest funds have generally maintained value and the real surprise has been a continuing upward trend in the value of index linked holdings. Perhaps counter intuitively, index linked gilts have gained value while at the same time inflation has fallen and it is important to remember that index linked holdings are, in the short term, valued by markets in a way that reflects both inflation and interest rate expectations so that if the latter fail to rise, indexed investments can hold their ground or advance to an extent, even in a low inflation environment.
The last twelve months have been broadly favourable for commercial property funds. In the UK, the economic recovery spread well beyond London and the South East in 2014, benefiting property values.
As we move into 2015, it is clear that the fall in raw material prices provides a boost to consumers while costs facing businesses and manufacturers will reduce. The downside is that such a large collapse in these key prices surely suggests that assumptions around the rate of global growth are being questioned. With inflation low, or heading into deflation in a number of economies, and in particular the Eurozone, interest rates are likely to continue to stay lower for longer while pressure on raw material producing nations will remain fierce. On the other hand, economies of Japan, the UK, the USA and the Eurozone eventually will benefit from cheaper input costs. In the Eurozone, the introduction of a full blown quantitative easing programme looks highly likely although it needs to be accompanied by structural reforms if it is to be effective. At the same time, geopolitical problems remain ever present, and are unlikely to be quickly resolved while political uncertainty in the Eurozone (for the moment surrounding Greece’s forthcoming election), not to the mention the UK’s election in May, combine to leave plenty of scope for political uncertainty.
It may be that as we move further into 2015, we can expect both equity market volatility and fixed interest market relative stability. There are however favourable factors and in the case of UK based equities for example, the fall of Sterling against the Dollar in recent months is clearly helpful while wage settlements look set to remain relatively modest and of course raw material price falls can only help the profitability of most UK based companies. We expect to see this translate into further dividend growth, still exceeding inflation but perhaps by a reduced margin in this coming year and we believe that UK equities offer reasonable value. In the US, valuations look more stretched, while Eurozone and Japanese equities appear comparatively inexpensive. All of these comments are made from the perspective of longer term investors, rather than shorter term speculators, and, broadly, it is our view that any market setbacks will represent sound buying opportunities.
Fixed interest markets will certainly remain sensitive to actual and potential interest rate changes, the current levels often reflecting “crisis” conditions (e.g. in the Eurozone, in Japan and in the commodity producing countries). On this basis, UK and US ten year yields, which still look very low by historical standards, perhaps offer a more stable opportunity, but recovery appears to be more entrenched in the USA while the UK’s growth rate may be slowing a little.
Our conclusion is that at this stage equity markets generally reflect, and to an extent discount, volatility risks, offering reasonable value while in all of the more stable economies, fixed interest markets perhaps understate medium term risk. Our investment approach at this stage therefore broadly reflects these key considerations.
A great many pension reforms are in the pipeline and we expect a lot of further information to become available as proposals move from initial pronouncement to detailed sets of rules. As the changes are complex, and affect different types of pension schemes in very different ways, we will advise clients of anything that is particularly relevant to them on a case by case basis throughout the year. However if you have individual pension related questions that you may wish to discuss further in the meantime, please do not hesitate to contact us.
Over the last couple of years there have been an increasing number of changes within the world of fund managers. These include the takeover and consolidation of fund management groups with, for example, Schroder’s acquiring Cazenove’s fund management business – name changes (for example Skandia are now known as Old Mutual Wealth), while a number of groups have also consolidated the range of funds that they run, merging two or more into one where the objectives are broadly similar. Another significant change results from a simplification of, and often a reduction in, fund charges. This has resulted in the creation of new classes of units in an existing fund and many clients will have noticed that the number of units shown on their valuations has changed, as have prices to compensate, so that there is no change in the value of holdings other than that driven by normal market movements.
We always monitor these developments and, in future, rather than writing to clients both when our recommendations changes and indeed when it doesn’t change, we will get in touch with clients only if we consider that a particular change is detrimental. However, if a proposed course of action by any fund managers causes you concern, do please get in touch and we will advise you further.
You will notice from your next valuation that there is a change to the format. In order for us to be able to provide you with a fully accurate valuation in the future, detailing specific amounts of units and unit prices, we will no longer show a detailed transaction history. As you are aware the main purpose of your valuation are for us to keep you fully informed of the current value of your investments and to enable an ongoing assessment of the suitability of your portfolio’s asset mix. This concept remains unchanged.