Emma Wall: Hello and welcome to the Morningstar series, Ask the Expert. I'm Emma Wall and here with my today is Shaun Port, Chief Investment Officer of wealth manager, Nutmeg.
Hello Shaun.
Shaun Port: Good morning.
Wall: So, I thought we'd talk today about what exactly is going on in markets. There's so much noise, at the moment, some of it is very positive, like the economic data from the U.K. this morning and some of it quite negative like everything that's been going on in the emerging markets over the last couple of years, really. I thought, we'd start by looking at quite an interesting piece of data, which is, in the U.S. in the first three months of this year, bonds actually outperformed stocks, which sort of goes against what people would believe is going on in the market at the moment.
Port: Yes, that's very interesting. If you compare it last year, we had a very big selloff in government bonds in the U.K. We lost almost 5% in government bonds, and from a safe asset like gilts that's quite a surprise. So, I think it comes on the back of big losses last year and investors were very much positioned towards that continuation of losses from treasuries and actually because of that, we saw some weaker economic numbers, and bit more risk being priced in particularly from the Ukraine and that really gave a big rally to bonds and some positive returns.
At the same time on the equity side, there's quite a lot of rotation. The big winners from last year are being taken out and people are looking at other sectors. Utilities are doing very well, which was a big loser last year. So, there's a bit of rotation going on. A bit of, sort of, risk aversion if you like, but not full scale panic at the moment.
Wall: Do you think those three months are indicative of what's going to play out for the rest of this year? You mentioned that there is a little bit more negativity surrounding us than there was this time, this last year.
Port: Yes, I think, last year was all about margin expansion, about price-to-earnings expansion, the valuation's going up in stocks and largely because we're taking out all the bad news, thinking there's going to be a Eurozone collapse, some of the big events in emerging markets didn't really come to fruition, we didn't see a contagion in emerging markets. So, some of those big risks were sort of moved aside and now, we're pricing in a few more. So, for example Ukraine and also possibility of a Chinese banking issue. Whether that's big or small we don't know, but there are issues in the Chinese banking sector and the economy at large.
So, it's pricing in some of those risks again, back into the market, but overall, I don't think that the past three months is really indicative of a trend. Some of the strength that we've seen in equity markets, will come back, particularly in mid-cap stocks and small cap stocks, maybe not in the biotech stocks that had pretty much a bubble that's bigger than the original internet bubble, but certainly I think we'll move back to this very strong economic growth story where bonds are going to be under pressure.
Wall: So, how as an individual investor do I approach that with my portfolio? Is it time to sort of bump up my bond exposure again or is it just time to sit tight?
Port: I think it's to sit tight on bonds. You can have some big losses on bonds from these levels. The yield is around 2.6% in U.S. treasuries for 10-year and U.K. similar. You can have some big losses on bonds if bonds normalize to 4%. That is still someway off, but if we get an early interest rate hike for example in the U.K., if expectations of the U.S. rate hike are pulled forward, that could have big losses for bond investors.
We know that central banks are no longer buying in the way they were buying. In the U.K. the Bank of England owns 40% of gilts. There's not really an obvious buy to come forward and buy all these extra bonds coming to the market.
Wall: What about then developed market equities as a whole? Obviously U.K. has done very well. Euro has been mixed and U.S. has done exceptionally, then where should we be looking to find value?
Port: Well, we like Continental Europe and particularly austerity Europe and we've been quite big investors of Italy of late. We had Spanish exposures through last year. That was a really good story, because the economy was recovering.
Competitivism has improved massively in Continental Europe, and even in periphery, we're seeing good growth. Italy, a bit of a disaster from the politics – there’s always a disaster in Italian politics, but valuations are really compelling. In November, we saw Italy, the valuation was cheaper than Egypt and Thailand. Both countries with big political issues, and yet Italian stocks are very, very cheap, and a recovery stories. There are pockets of value now in austerity Europe as we like to call it and I think the growth in Europe is coming back from a very, very low base. So it's the change that's really positive rather than the absolute level.
Wall: I can't have you in here without talking about emerging market I'm afraid. I know that you haven't been very positive on it in recent past. Is there a glimmer of hope or are you still standing fast?
Port: Well, I think it's good to see that we have no widespread contagion. The ‘fragile five’ haven't really sort of gone further, haven't seen a collapse in some of those currencies as we've seen interest rates hikes have stabilized those markets which is positive; but the structural problems with emerging markets is still there.
Chinese growth is downshifting, not the 10% average we saw before the credit crisis in those 10 years, now we're downshifting to 7% growth or lower really and that has a problem for all of the emerging markets that are dependent on Chinese growth particularly in commodity trade, and the structural issues in emerging markets haven't really been resolved.
So don't really look at emerging markets over the last 10 years. You need to look beyond that to look at emerging markets and it's a much more subdued growth environment. So the short answer is, no, we're not really reallocating back into EM. There're some pockets of interesting countries like Mexico, and Indonesia – it needs to sort of turn into consumer society there, credit growth is very slow. That's really interesting. That's a long-term story for the next six, 12 months. I don't think EM, broad EM is certainly a play you want to be involved in.
Wall: Shaun, thank you very much.
Port: Pleasure.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
