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Q4 2016 Equity Review

Wednesday 21st December 2016

Political events have once again dominated the quarter under review and global equity markets have moved dramatically since the election of Donald Trump as US President. Despite the initial fears that a vote for him would be a vote for chaos, markets took cheer from his conciliatory comments and the belief that the focus on the domestic economy would boost US GDP in 2017. This has led to both the US and European markets rising by around 8% in local terms on the quarter. The UK has significantly lagged this move only rising 1.5%, whilst in Japan the weaker Yen has seen the equity market rally sharply, up over 17%.

The UK economy has started to experience upward inflationary pressures and this is likely to squeeze consumer’s real incomes into 2017. We have stated before the difficulty of the uncertainty surrounding Brexit and another three months down the line we are no closer to greater clarity. Capital expenditure plans remain curtailed and there will be a time lag before the increased Government infrastructure spending kicks in. From an equity perspective, the UK is defensive and this could also be an unhelpful point in the cycle.

Our view on US equities has continued to be the wrong one, with more strong gains driven by the Trump ‘euphoria’. It is interesting to note that the sector performance has been very concentrated with Financials performing very strongly. Relative valuation levels remain high and the strength of the US Dollar will act as a meaningful headwind into 2017. Margin pressures remain a problem as the labour market tightens further, offset to some extent by the proposed taxation measures. US interest rates are also on the rise, with an estimated three upward moves in 2017, as bond yields rise this could impact further the relative valuation levels.

Europe has benefitted in recent months from the bounce in global economic activity, although export growth has only picked up modestly. German manufacturing orders have accelerated to their highest level since 2007 but other structural issues remain, notably the lack of credit demand. Since 2011, if you exclude mortgage lending, there has been no growth in private sector credit. ECB forecasts have reduced inflation expectations, such that in 2018 only 1.5% has been pencilled in, still way below the 2% target. A number of general elections in the region next year will add to volatility.

The outlook for Japan has arguably improved significantly in the last quarter with inflation finally getting entrenched in the system. The current weakness in the Yen will aid Japanese industry and the Central Bank will shortly confirm the improved situation. The equity market has the benefit of cyclical exposure and valuation levels remain at material discounts to other territories. We also believe the market will be supported by foreign buying which acts as an important swing factor.

China has continued to see improving growth but the credit imbalances within the economy have only got worse. The credit problem is mostly focussed on the corporate sector, so there is scope for Central Government to increase its debt. The authorities have been trying to proactively squeeze the speculative housing activity. Overall equity valuation levels are attractive.

In the US, the S&P 500 index has risen 4.5%, whilst the Dow Jones is up a staggering 8.5% with the NASDAQ lagging this quarter, up 2.8%.  The Financial sector has led the rally on hopes of reduced regulation and as yield curves have steepened, whilst industrials and cyclical sectors have also been in focus as they are perceived as standing to benefit from an incoming Trump administration. Risers have included Goldman Sachs up 48%, Bank of America up 44% and Morgan Stanley up 35%. Decliners have include TripAdvisor down 27%, Newmont Mining down 19% and Amgen down 12%.

In the UK, the FTSE 100 has gained 1.8%, with the more domestic focussed FTSE 250 declining nearly 1% on Brexit fears. It now appears that interest rates will be on hold for the foreseeable future with generally robust retail sales a reflection of the health of the labour market. Positive performers for the period have included Barclays up 34%, Glencore up 25% and Tullow Oil up 20%. Fallers once again included CMC Markets down 40% on fears of greater spread betting regulation. Other stocks on the decline included Fresnillo down 39%, Capita lost 26% and Aberdeen Asset Management fell 22%.

Continental European markets were also in positive form with the Euro Stoxx 50 up nearly 9%. In Germany, the DAX was up 8.7%, in France the CAC 40 was up a similar amount, Italy saw a strong rally up 16%, whilst Switzerland only eked out a 1% rise. Major gainers also focussed on the Banks with Deutsche Bank up 53%, Societe Generale rose 52%, Credit Agricole was up 36% and Unicredit was up 35%. Other gainers included Saipem up 34%, ArcelorMittal up 30% and Randstad up 29%. Fallers included RWE down 26%, Ericsson lost 13% and Danone declined 10%.

Asian equity markets were more mixed with Japan up strongly on the weaker Yen, the Nikkei gained 18.5% on the quarter. However in India there were fears on the GDP growth rate in the wake of the currency overhaul and the BSE Sensex fell 6%. Despite reasonable economic data from China, the Shanghai Composite saw muted gains of 3%, whist the Hang Seng in Hong Kong fell nearly 7%. Gainers on the period included Nomura up 63%, Sumitomo Heavy up 55%, Samsung Electronics was up 44% and Petrochina was up 15%. Fallers included Cheung Kong Property down 14%, Newcrest Mining fell 21% and Telekom Malaysia fell 12%.