Headline asset class statistics for Q3 2018 (GBP returns):
Equities: FTSE 100 -0.7%, S&P 500 +9.0%, Europe ex UK +3.0%, MSCI Emerging Markets +0.1%,
Bonds: FTSE All Gilts Index: -1.7%
Currencies: GBP/USD -1.3%, GBP/EUR -0.7%, GBP/JPY +1.3%
Commodities: Gold -3.7%, Bloomberg Commodity Index -1.5%
Third quarter (Q3) markets review
This quarter was a good reminder of why investment diversification is important; equity markets made gains overall, but there was a wide dispersion in returns. The FTSE All Share (-0.8%) bobbing in the ebb and flow of good and bad Brexit news recorded a small loss, with the humiliation of Prime Minister Theresa May in Salzburg a timely reminder that even close economic allies will always pursue their own political interests over your own.
The ongoing news from US President Donald Trump’s Chinese trade tariffs has hit sentiment in the Pacific ex-Japan region (-0.1%), as a slowdown in China (-6.4%) would have a knock-on impact on those economies. Emerging markets (+0.1%) were flat, but with China accounting for 31% of the index this has overshadowed gains made in Latin America (+6%) and Eastern Europe (+8.2%), where buoyant oil prices are helping improve company profits and share prices.
Other parts of the world performed better; US Q2 gross domestic product (GDP) was confirmed at an annualised rate of 4.2% and the Federal Reserve’s (Fed’s) continuing normalisation of monetary policy is being well received by the market. The S&P 500 gained 9%, and in August marked 3,453 days without a 20% correction; the longest recorded. Japan (+4.9%) also performed well, following the release of GDP data that showed economic growth of 0.7% in Q2.
Bonds continue to have a dull period of performance, with modest capital losses from rising yields outweighing the income from coupons. 10-year Government Bond Yields in the US (3.05%) and UK (1.58%) are at the top of their one-year range, signalling that the market expects more interest rate rises over the coming months. Smart Portfolios are still positioned very cautiously in this respect and we continue to wait for better opportunities to re-invest at more attractive levels.
Overall commodities are struggling a little, and gold has declined by -5.5% year to date. As a non-income bearing asset, rising bond yields have made it relatively less attractive to own, but it continues to offer an important role as portfolio protection should the pound weaken from here.
Smart Portfolios review
In absolute terms it has been another good quarter for IG Smart Portfolios, with returns starting from +0.3% in the Conservative profile, +2.3% in Balanced and +3.0% in Aggressive. The exposure to the US really helped drive performance, accounting for around 2.5% of the Aggressive portfolio’s quarterly return. Without the US, exposure returns would have been very modest, yet it is our belief that the other regions will have their time to shine in quarters to come. US markets have made exceptional returns over the past five years, and this is likely to come to an end as higher interest rates and a stronger dollar work their way into company profits.
We continue to actively monitor the risks within portfolios, but there were no changes to asset allocation over the past three months. Nevertheless in the first days of October we made a very modest change to the exposures within our Conservative profile, slightly reducing risk by temporarily trimming exposure to emerging market bonds.
After launching in early 2017, IG Smart Portfolios now has more than 18 months of track record and it is living up to our high expectations. The most recent quarter’s benchmark data will be confirmed later in the year, but portfolios continue to build on the previous track record of BlackRock and are ahead of the ARC Private Client Indices peer group from a combination of lower fees and robust asset allocations.
(Note: The return data shown before 28 February 2017 is reported by BlackRock, gross of fees. Monthly return data after 28 February 2017 is reported by IG, net of fees. ARC PCI data may be subject to later revisions. Past performance is not a guide to future returns)
The strong dollar has started to put a strain on emerging markets, while China has reacted in its usual way to a decelerating economy; increased spending on construction and slightly easing bank lending standards to shore up domestic growth. While this points to continued strength in the US, it would be unwise to place all bets on continuing equity outperformance as valuations are at a significant premium to other countries and the market may begin to worry that a strong US dollar will feed negatively into future earnings growth.
The longer this economic cycle goes on, the more predictions appear in the media that a recession is just around the corner. Due to the status of the US economy, the old adage that, ‘when America sneezes, the world catches a cold’ looks unlikely to change; but is the US about to sneeze? Recent research from asset management giant Invesco looked to analyse the necessary conditions for recession. They pinpointed three key factors, i) falling business investment, ii) declining profits and iii) less helpfully, a falling equity market.
On the balance of probabilities, though we are long into this economic upswing, accommodative monetary policy and Trump’s tax cuts should prolong the investment and profits cycle long enough to rule out recession next year and possibly the year after too.