4newsletter Q1 2016

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10 MARKET UPDATE: APRIL 2016 This regular quarterly overview of the world’s financial markets is kindly provided by the Cornhill Management Advisory Service (CMAS) team. To find out more about the CMAS team and the service they offer please read the article in this edition of View from the Dome or go to www.1cornhil.com The start of 2016 saw market expansion enter its seventh year; U.S. GDP grew for the 20th straight quarter and continues to expand despite increasing volatility. Equity markets in the US and UK are now back to levels seen at the beginning of the year, Europe remains slightly down and Asian markets appear to be stabilising. In March we saw the majority of major markets range trading, as uncertainties started to recede as a result of further stimulus from the ECB and Janet Yellen’s dovish tone. The Fed’s further embracement of a more holist view of international factors surprised and mollified the markets, as did the firming of oil prices and reports of lower capital outflows from China. As U.S. inflation and employment trend higher the Fed appears to be taking on a third data dependent view as it focuses its attention on international factors such as global growth, the strengthening US dollar and Chinese growth. On this basis we believe that the Fed will take a cautious stance with further increases in interest rates in 2016. The more holistic view may though come at a cost, as the factors that affect global growth are difficult to manage and uncertainty and unpredictability on the global stage will mean investors must also be cognitive of non U.S. domestic factors that may affect U.S. interest rate movements in future. It is apparent that the global economy is still in recovery mode and central bank policy around the globe is critical for financial conditions and risk appetite in general. With central bank support recession risk remains low for now, as the severity of the last recession was so severe that it is taking longer for economic excesses to build up. This situation is likely to continue as we see a period of low inflation and subdue growth though 2016 /2017. For global growth to get back to trend supply side structural reform needs to be undertaken e.g. deregulating product and service, reforming labour markets, supportive fiscal and monetary policies to offset any dampening effect in the short term. Growth friendly fiscal policy should also be adopted, which shifts the composition of revenue and expenditure by increasing the efficiency of public expenditure, Infrastructure and innovation investment. Lastly, continuing monetary policy, which has been supportive of the global recovery, however it is clear that monetary policy can no longer be the alpha and omega to recovery. Indeed, it will be much more effective with support from structural and fiscal elements along the aforementioned lines. Whilst we remain optimistic that valuation will be supported by the central banks we are wary that current nominal growth is too low and valuations are too high to ignore worsening financial conditions and increasing tail risks. The U.S. and Europe look set to grow slightly above trend, but persistent weakness in emerging markets (EM) will weigh on global growth. The good news is that the worst of the EM contraction is likely behind us; but equally, excess global capacity and debt continue to subdue markets. It is likely that we will see broad valuations in developed markets capped near to current levels and therefore sector and geographical allocation will be more important in 2016 / 2017 than in previous years. Asian and EM will need further signs that the Chinese economy is stabilising and both manufacturing and service growth targets are been met, before we will see a major change in market sentiment in these markets US MARKETS US manufacturing has been fairly weak overall with the manufacturing survey signalling contraction since the latter part of 2015 and industrial production actually contracting. However, if you exclude the parts most exposed to the oil price collapse the manufacturing numbers are relatively strong. We have recently seen new orders component of the ISM manufacturing survey bounce back into positive territory and regional manufacturing surveys have also shown some signs of improvement. It should be noted manufacturing only accounts for 14% of U.S. GDP and, importantly, the non-manufacturing new orders component of the ISM survey continues to indicate expansion in the much larger services sector. The low U.S. unemployment rate does, however, suggest we are getting closer to the end of this economic cycle, even if it looks unlikely to end this year. Investors should be mindful of a deterioration in the labour market numbers and housing market as they are fairly good indicator that the cycle may be ending.
11 Currently though there still appears to be plenty of room for recovery in the housing market which leads us to believe that we still have some time to go before we see the cycle end. Are view on U.S. market is overweight with a bias towards large cap stocks as SME’s are likely to underperform in a rate tightening scenario. Sector allocation is important and we therefore favour technology, consumer consumption and healthcare with a view of quality vs cheapness and relative value. US - We are overweight US Large Cap EUROPEAN MARKETS The worst of the eurozone crisis is probably behind us. Greece has made it clear it doesn’t want to leave the euro, allowing investors to focus on the improving European economy and company earnings. The European Central Bank (ECB) has committed to printing EUR 80 billion a month, has cut the deposit rate further and is now buying corporate bonds. After a long period of stagnation, company earnings now have plenty of room to rise as the economic recovery gets under way, aided by low borrowing costs, the weak euro and the lower oil price. European equities have sold off sharply since their 2015 peak, however, if you exclude the impact of the fall in the oil price on energy company earnings, European earnings have continued to rise strongly and there is still room for further earnings growth. Company margins are well below historic levels and those seen in the U.S. Any European revenue growth should be amplified into robust earnings growth as margins expand. With lower borrowing costs European equities should benefit from the continued economic recovery. Unemployment is falling in Europe but given it is still high; it has plenty of room to fall further. The market already knows unemployment is high so continued falling unemployment should support both the economy and markets. Retail sales and industrial production data is also recovering, showing that the recovery is broad based. Currently there is no sign of a tightening in European lending standards which tend to tighten prior to recessions. Recent surveys have identified an increase in demand for loans as the economy grows and the cost of borrowing falls. Loan demand tends to leads the economic cycle and any improvement in lending normally indicates that stronger economic growth in the future is likely. With increased demand for loans and the ECB ensuring a very cheap and plentiful supply of money for banks to lend, lending to firms and households should continue to improve, which should further stimulate the eurozone economy. We are overweight European Equities with a bias towards SME’s
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