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Market View

A monthly market outlook from Sanlam Private Wealth


A PDF version of the market outlook is available.
 

It might be February, but the political and economic landscape is looking anything but dreary. President Trump has his feet under the Oval Office table, and Theresa May has come out fighting on Brexit with a confident, and arguably threatening, stance as a precursor to the UK’s exit negotiations from the EU and the single market.
 
So is it time to look forward to a brave new world, where we can get excited about economic growth prospects, and lay the ghosts of our austerity past to rest? Or is this positive momentum going to prove to be misplaced confidence? Here is our view on the outlook for some of the key asset classes:

Equities

Equity markets have reacted positively to the pro-business policies emanating from the US, and the associated global optimism. There was a palpable change in sentiment by the end of 2016, with real signs of economic recovery and reflation. This positive momentum has been carried into 2017, and prices continue to reflect that. However, when you look at valuations, equities continue to trade at elevated levels given that they are facing declining labour productivity and already high profit margins. Global inflation is also picking up, which puts pressure on labour costs and profitability. Despite this, earnings expectations have increased since Trump was elected as US president, and markets will not react well if those earnings prove to disappoint. Markets also like consistent messages. With an unpredictable US president, and uncertainty around Brexit negotiations – especially leading up to the parliamentary vote on new trade deals – we can expect a degree of nervousness for at least the next 2 to 3 years.
 

Bonds

Thanks to renewed optimism, given the expectations for higher inflation and rising interest rates in the US, global bond yields have been rising. While this will undoubtedly bring the opportunity to invest at more attractive yields, especially within the corporate bond sector, we remain cautious that government bonds are still vulnerable to yields moving even higher.
 

Property

Property prices are also vulnerable to higher interest rates, but we think that much of this is reflected in the valuation of the listed property shares. Property portfolios are generally holding good-quality stock, with much better loan-to-values and capital structures than they have in decades past.
 

Summary

In summary, the economic outlook is improving, and there are reasons to feel optimistic. But given elevated valuations, we are still facing a low-return environment and there is very little to choose between asset classes.
 

The ‘quality’ perspective

When it comes to building our clients’ portfolios, we favour a bias towards ‘quality’ stocks, investing in well-managed companies with strong balance sheets and an attractive competitive advantage. This is a long-term strategy, underpinned by the theory that history will continue to repeat itself. These stocks should offer investors superior shareholder returns, thanks to higher returns on capital, and the ability to distribute excess cash to shareholders rather than constantly having to re-invest in their own business. The chart below shows the performance of quality stocks versus ‘normal’ stocks over the last 30 years. Where the graph shows an upward trend, it means that quality stocks outperformed normal, and vice versa.

 mkv1-(1).PNG

There are two important points to make here:
 
  • Although quality stocks underperformed the index by 5% last year, we are proud that our stock-picking allowed our Global High Quality Fund to marginally outperform the index after fees, maintaining its exceptional track record and proving that solid research, and active management can pay dividends.
  • While investing in quality stocks is widely considered a ‘steady-as-you-go’ strategy, the graph proves that this approach does outperform the broader market over the longer term.

Finding solace in structured products

Recently we’ve been holding an overweight cash position to protect against downside risk, ensuring we are in a liquid position to take advantage of opportunities as they arise. We still hold this view, but are looking at ways of re-investing some of this cash to achieve longer-term returns, while also offering shelter from any market falls.
 
We’re currently researching structured products as they offer an alternative growth strategy for client portfolios throughout this period of uncertainty. It can offer clients the opportunity to gain leveraged participation in say, the first 30% of an index’s return, while also offering same downside protection. In other words, you trade some of the gains if markets were to suddenly surprise to the upside, in exchange for protection in the event that markets fall. It’s important to point out that structured products do not offer a guaranteed income or return, and you could still lose money. The structure aims to minimise the risk of that happening

MKV2.PNG
 

A word from our Chief Investment Officer 

“We expect 2017 to bring similar levels of uncertainty to last year. There remains some doubt around the recovery in company profits and, with so many unknowns dragging on businesses, there’s a real possibility that markets will respond with a sell-off if returns prove disappointing.”
 
Philip Smeaton, Chief Investment Officer

 

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.