With only one month left in 2017, asset prices look set to deliver stellar results for the year. In fact, equities are due for their best calendar year result since at least 2013, and quite possibly 2009, with emerging markets increasing 30.0% year-to-date in local currency terms and developed markets up 18.6%.
This is having a meaningful impact on investor sentiment, with the “lifting of all boats” pushing confidence measures to new highs. In fact, our global sentiment scorecard is now resoundingly positive – a sign of potentially unwarranted optimism – among the majority of key asset classes, marking a profound and potentially complex period for investors.
Underlying the strength in sentiment, we have also witnessed a rather dramatic shift in currency markets. The US dollar has continued its fall relative to the other majors, now down against the euro, sterling and yen by 13.0%, 9.6% and 4.2% year-to-date respectively to the end of November. The impact of this should not be underestimated, as the plight of European and UK investors is increasingly different from that of the US. For example, defensive holdings in the UK and Europe have experienced negative returns this year due to currency strength, whereas US investors experienced gains, reinforcing the need to manage global diversification holistically.
The Road to Interest Rate Normalisation
November was a relatively uninspiring month that saw mixed results across the investment universe. While the US dollar notably fell further against global peers, a lot of the market noise resided in a few recurring themes. These themes predominately circulated around European politics, Brexit speculation, the normalisation of interest rates and OPEC-led oil supply cuts.
In Europe, strong economic data was offset by German political tension, with Chancellor Angela Merkel failing to form a coalition and raising the potential for another German election. This was largely obscured by ongoing speculation surrounding Brexit, with varied opinions existing about whether meaningful progress is being made, although one EU official stated that a deal between the UK and the EU is “90% there”. While a sensitive topic for UK investors, concrete measures are still lacking and further reinforces the perils of political forecasting.
More broadly, the so-called path to normalisation continues to gather press around the globe, as the Bank of England raised interest rates for the first time in 10 years and joined the Federal Reserve in increasing short term borrowing costs. While markets have also largely priced in a December rate hike in the US, long term interest rates as measured by the 10-year government bonds stayed stubbornly low. Consequently, the yield difference between short- and long-dated bonds has narrowed to the lowest level since 2007.
Lastly, two dozen oil-producing nations met in Vienna at the end of the month to discuss the extension of OPEC-led oil supply cuts. The agreement resulted in the oil price rising another 5%, a two-and-a-half year high and approximately double the commodity crisis lows from February 2016.
Japan and US Outperform
November price moves were broadly subtle, although quite sensitive to currency shifts. For example, US dollar investors achieved significantly better outcomes than UK investors, as the rise in sterling dragged on local returns.
For equities, Japanese and US equities were the relative outperformers, while the UK, Europe and emerging markets lagged. Furthermore, consumer-based companies performed reasonably strongly, as did telecommunications, whilst, in a change for prior months, technology and materials dragged on relative returns. Somewhat surprisingly, energy companies failed to fully benefit from the 5% jump in oil prices, performing roughly in line with the broader market.
Within fixed income, the month also delivered mixed results by region. Higher-quality government debt generally did better than lower quality corporate debt, whilst inflation-protected debt failed to add value.
Rising Returns Means Higher Risk
Investment markets may have momentarily paused, but they continue to look stretched according to most valuation metrics. In this sense, the analogy between investing and weight loss has relevance, with a simplified process of inputs and outputs showing the underlying state of health. All else being equal, you can’t consume 20% more calories and not expect to put on weight, just the same as you can’t enjoy 20% price growth and not expect risk to rise.
With this comes a simplified formula for investment success – find assets that are fundamentally healthy and ideally undervalued in a long-term context. While easier said than done, if one can do this in a pragmatic and repeatable manner, then an opportunity exists to maximise reward for risk at a portfolio level.
