The conclusion we must draw from these events – and we need to include the Brexit debate here – is that nations are moving against centralisation and increasing numbers want more autonomy, not less. This could have profound effects on the volatility and valuations of markets.
In 2011, at the time of Draghi’s “whatever it takes” speech, Greece was apparently hovering on the edge of leaving the EU and stock markets understandably wobbled. In 2017, we will have a string of considerably more existentially threatening national elections. It will continue all year, and arguably the Brexit is just a forerunner, after all, we are not part of the euro.
Cause for optimism
The obvious question is what can investors do to protect themselves against an apparent torrent of uncertainty that could batter the markets? On top of the approaching political events, we may also be reaching the end of the line for quantitative easing in all its various guises.
One of the reasons to be relatively relaxed about the fears of a Brexit effect on the FTSE 100 is that 75% of the earnings of the constituent companies come from overseas. This might help explain why the FTSE 100 has moved in line with its developed world peer group, and stayed there even after the referendum was announced – the FTSE 350 is broadly similar. It does not look like an index in a relative to peer group crisis.
The flipside to this dearth of volatility is that following any remain vote there will be limited relative upside. What we might even see is a boost to all European markets as the short-term worriers finally move off the issue of the failing EU and on to the Trump situation in the US.
In the coming months, we will continue to be overweight in European stocks relative to the US. The US is expensive compared with much of Europe and is likely to be raising rates while the European Central Bank dreams up ever wackier schemes to achieve growth.
All other things being equal, and if the wheels have not already come off, then towards the end of fourth quarter we would expect to move back to a more neutral weighting in Europe. At this point we will have certainty in the post-election US, and, following any market relief rallies, we would again look to reduce our equity weighting and other risk assets.
The backdrop to our concerns remains, above all, valuations. During our numerous manager meetings in 2016 we have never once heard a manager refer to their asset class, or even sub-asset class, as cheap. Over our many years of managing model client money there have always been at least some areas that offered potential value relative to history, or growth that was not already factored in to the price.
Ease down the road
What has been keeping many assets artificially high is quantitative easing, and we are running out of road here. We have had conventional and non-conventional, and now we seem to be heading toward the wackiest kinds of experimental, such as ‘helicopter money’. We would never presume to know whether or not this will work, but the risks from unintended consequences will rise exponentially.
This would be concerning enough with a backdrop of political stability, but we firmly believe that period, in Europe at least, is coming to an end. With the EU national governments (and often the ECB and the International Monetary Fund) struggling ever harder to stay on the same page and keep disputes from spilling over into public spats, the uncertainties will rise. This will not be a good environment for risk assets, especially in the short term.
What it will bring, however, is the opportunity to purchase assets at much more attractive levels. We expect to remain almost exclusively in actively managed funds as beta will be difficult to attain. As for the passive versus active arguments, we remain agnostic.
We were using a UK tracker earlier this year when we felt that the FTSE 100 had been oversold on the oil story. Periodically, some assets can look incredibly cheap and this was one of those times. More usually, we would expect to use active managers and, in the UK at least, we have added considerable alpha by using them.
We are not bothered by the debate, or all the largely US-based research, which says active managers cannot outperform.
In the aforementioned set of conditions we like the highest-conviction managers, such as Margaret Lawson at SVM, the Franklin Templeton team on the UK Focus fund and the Unicorn Outstanding British Companies manager Chris Hutchinson.
