A good quarter for investments and IG Smart Portfolios

The headlines may have focused on the market risks, but equity markets actually recovered sharply in the second quarter of 2018. Read our investment review and the outlook for your investments.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results

Headline asset class statistics for Q2 2018 (GBP returns):

Equities: FTSE 100 +9.6%, S&P 500 +9.9%, MSCI World +8.2%, MSCI Emerging Markets —2.1%,

Bonds: FTSE All Gilts Index: +0.2%

Currencies: GBP/USD —5.8%, GBP/EUR —0.7%, GBP/JPY —1.8%

Commodities: Gold +0.6%, Bloomberg Commodity Index +6.7%  

Second quarter markets review

If the first quarter (Q1) of the year saw elements of semi—panic among equity investors, then Q2 was more or less a resumption of what investors have come to perceive as normal service. Corporate earnings updates largely exceeded expectations, which helped equity markets recover sharply and end June roughly flat year—to—date.

While the main indices made gains, it has not all been plain sailing, with Italian elections resulting in significant market volatility while US President Donald Trump continues to surprise investors with North Korean peace talks (good) and the announcement of further trade tariffs on China and the rest of the world (bad).

It is this latter topic that has been the main cause of market uncertainty, and along with a strengthening US dollar, has contributed to a weakening of sentiment in emerging markets (EMs), down 2.1%, with falls in both equities and currencies. Those with large current account deficits — Brazil, South Africa, Turkey — came under pressure as capital outflows put strain on already shaky economic fundamentals, but the double digit sell—off in the China A—Share market in June was a reminder to us all that EMs may have good growth prospects, but the road can be a rocky one. 

Having placed much political capital on equity markets going up in the first year of his presidency, Trump’s latest rhetoric around tariffs (which most economists believe might harm parts of the US economy rather than help it) appear starkly at odds with this earlier goal. Whether this is bluster or a genuine policy approach, the very threat of tariffs gives the US administration a strong hand to negotiate from at the next North American Free Trade Agreement (NAFTA) and World Trade Organisation (WTO) talks, and it is possible that some of the measures will be reversed, potentially providing the next leg—up to the bull market

While equities made gains, fixed income continues to make little headway. Rising yields in the US and signs of tightening from the both the European Central Bank (ECB) and Bank of England (BoE) are putting a brake on returns. 

Fixed income allocations are usually designed to act as a volatility cushion within portfolios, however, with bonds looking particularly poor value in the UK (the 10—year government bond yields just 1.3% and will fall in value by 8% if the yield rises to 2.3%), their usual protective qualities continue to look unattractive.

Smart Portfolios review

Our five IG Smart Portfolio risk profiles continue to perform as hoped for, experiencing significantly lower peaks and troughs than individual equity indices. They have managed this by combining a broad asset allocation with less equity exposure than a market index (the Aggressive portfolio has an 86% allocation to equities). The net of fees client composite was flat in Conservative, rising to a gain of 4.2% in Aggressive, bringing portfolios back to their beginning of year starting values. You can visit the website to see portfolio performance in more detail. 

We made some changes in May, increasing exposure to equities, reducing allocations to bonds and overseas currencies to balance sterling risk. On the balance of probabilities, rising corporate earnings should help equity markets to make gains from here, while a slight pickup in inflationary conditions should be negative for fixed income. As portfolio managers, this stance requires extra vigilance; seeking extra returns comes hand in hand with raising the risk within portfolios and we will continue to monitor this closely.

While we would never promise to shield any portfolio from losses, we are confident that our asset allocations can act as a core investment to safeguard clients from the worst of any future market gyrations, while taking on enough risk to meet their long—term goals. 

Outlook

The world economy is still providing a favourable tailwind for equities, even though recent economic data has started to cool from strongly expansionary territory. The Trump tax cuts have been a gift for US markets and (assuming they are not reversed) they should lead to sustainable increases in earnings for some time. US unemployment continues to fall, indicating no recession in the immediate future.

The UK continues to polarise opinions; on the one hand it is quite cheap, but on the other there is (still) the great unknown of the Brexit talks. Recent political activity suggests a ‘Brexit—lite’ outcome, with little fundamentally changing, but there is always the outside chance of a ‘no—deal’ scenario which is being reflected in sterling (GBP/USD being down 5.8%). The FTSE 100 is well insulated from this, but small and mid—cap companies have less exposure to overseas earnings and could underperform.

Aside from some bond markets and notable tech names, the bubble—like valuations that can be seriously injurious to an investor are largely absent from today’s markets; most stock exchanges are reasonably priced with the ability to absorb interest rate rises.

The US, with its superior earnings growth, is most expensive, trading on 17.4 times forward earnings, compared with 13.7 times for Europe and 12 times for EMs. These starting points should give investors the comfort to make long—term investment allocations. After all, stock markets had significant sell—offs in 2011 and 2015 to no long—term ill effect.

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This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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