Month ending 31 January 2017
2017 got off to a constructive start, with the “reflation trade” favouring equities over bonds persisting.
In GBP terms, emerging market equities were the strongest performer (delivering +3.2%) followed by Japanese equities (+1.8%), which were helped by currency weakness. Europe and the US delivered +0.7% and +0.1% respectively in Sterling terms. The UK market was the laggard, falling -0.4%.
After bouncing in December, government bonds in main regions recommenced their decline in January, apart from in the US where they regained +0.3% in local currency terms. European government bonds suffered most, falling -2.1% in local currency terms, while Gilts were close behind, falling -1.8%.
Following a period of sustained strength, the US Dollar softened a little in January. As a result, Sterling gained +1.9% against USD, but slipped further versus JPY (-1.8%) and EUR (-0.7%).
Oil reversed some of December’s gains (-1.7%) while Gold rallied +5.8%.
Inflation measures showed greater divergence in December, with a sharp acceleration in the UK, US and Eurozone, and softer data in Asia. In the UK, Consumer Price Inflation (CPI) rose to 1.6% and in the US CPI rose to 2.1%. Eurozone harmonised CPI reached 1.1%
Q4 GDP measures showed improvement in the US (real year on year growth of 1.9%), with UK, China and the Eurozone a touch weaker.
US consumer confidence continued to rebound strongly in December, pulling back somewhat to 111.8 in January. Confidence also improved in December in Japan, Europe and the UK; though the UK’s January reading was a little weaker at -5.1, while Eurozone confidence continued to strengthen.
Purchasing managers' indices (PMIs) continued to strengthen in December; with composite measures up across all regions except the US, where the reading deteriorated modestly in December but strengthened strongly in January. The composite measure remains in expansionary territory in all regions.
Looking ahead, we see reasons for optimism, though we remain cognizant of risks to growth, and event risks ahead.
Given the materially better outlook for growth, we are seeking to be positioned in order to benefit from a recovery in earnings growth, balanced with volatility reducing assets in case sentiment deteriorates.
By holding a well-diversified portfolio of asset classes and companies, we hope to balance long term stability with a cyclical uplift from better economic growth.
Stronger economic growth is supportive of equities – we have modestly increased our overweight allocation to this asset class.
High quality businesses able to deliver superior growth remain at the core of our portfolios. Given the better outlook for growth, we are balancing this with exposure to stocks that benefit from an economic uplift.
We have reduced our exposure to bonds as an asset class due to the likelihood of diminished scarcity value, a faster rate cycle and better economic growth prospects..
Better growth, higher interest rates and lower bond scarcity may also diminish the “reach for yield”, which has seen investors crowd into pockets of the market. We expect market performance looking forward to have greater breadth across sectors.
We have an overweight allocation to the US, and we expect the economy to benefit from the favourable fiscal and monetary policy mix. We have slightly increased our allocation to Europe and Japan; as both have many global companies at attractive valuations which we expect to benefit from an improvement in global growth.
At a sector level, we have increased our positions in sectors that should benefit more from a better growth outlook and potentially higher inflation, and also in those sectors that should benefit from specific policy measures (such as industrials, technology and defence).