2016 – A MIXED YEAR FOR ASSET MARKETS

Generally, 2016 was an another difficult year for most money managers, especially for long only mutual funds. The year was notable for the high levels of volatility, significant policy moves, geopolitical risk, and declining economic growth and other various shocks. We believe the below chart summarises the year and the events that unfolded quite nicely.

Below is a selection of key equity market indices performance for the 2016 year:

The below are the assets that performed well in 2016:

SHORT TERM – HOW WE ARE POSITIONED INTO 1Q17

We believe markets will remain mixed for the 1Q ahead, although consensus longs are for stronger USD denominated assets especially equity indices, on the back of expected inflation and expansionary fiscal policies for the newly elected Trump government. Bonds are expected to remain under pressure as the multi-year bull market comes to an end and with the Fed looking to increase interest rates in the year ahead. Commodity markets remain unloved and a consensus short. However, there may be a time to revisit as a contrarian play some time in the next 12 months.

Overall we remain cautious, although more constructive than we were 6 months ago. It is our view that portfolio outperformance will be more about correct asset selection than previous years where it was all about asset allocation. Nonetheless, we remain vigilant on the risks and see policy risk and central bank movement as once again the key wild card for the year ahead.

Many risks and uncertainties remain. Both geopolitical and economic.

This all means that the quarter ahead is expected to be a bit more eventful than prior years, and therefore we continue to keep a very close eye on the positions within the portfolio as well as being nimble enough to take advantage of opportunities as these arise.

We remain optimistically cautious and are slowly re-allocating capital to only those assets we believe hold the highest promise of delivering out performance as we expect a moderate upwards trend. Overall we are taking a quality bias in our stock selection.

LONG TERM – PORTFOLIO STRATEGY & OPPORTUNITIES – 2017 OUTLOOK

Our Investment Committee continues to expects another difficult and volatile year for asset markets in 2017. The outlook and performance of asset markets will be greatly influenced by the following major areas of focus:

Trump presidency and likely unconventional policy initiatives and announcements.

The start of a normalisation of interest rates and potential inflation in USA.

Continued political risk in Europe with 3 major elections being held.

China continuing to slow and increased government debt programs.

It is now a consensus view that the path of US interest rates is on an upwards trajectory. The market is predicting between a cumulative 50-75bps of interest rate rises this year. The communication as well as the actual pace and extent of USA interest rate rises, will be key for market volatility and pricing of risk. It is interesting to note that, historically global equities are on average 6% higher 12months after a Fed lift off.

With 2016 being a year where we saw votes for both Brexit, Trump, and Italian referendum which saw the resignation of the country’s PM, all eyes are on the other political events where we could see continued populist vote and protest. This is most of concern in Europe where we will be seeing elections from France, Netherlands and Germany. All of which could see seismic changes to the status quo and potential pressure on the Eurozone as well as global economies.

Concerns remain over whether China economy will be able to muddle through a transition into lower structural growth economic growth its currency devaluation will not be too aggressive (at least not compared to its neighbours). There is a real fear that China will be exporting deflation through depreciation of its currency, lower export prices, and overcapacity in its manufacturing and construction sectors. All eyes will be on whether China can achieve a successful transition from manufacturing and investment led economic growth model to consumption driven model. This change and transition is not expected to be a smooth one. Hence we expect a continued period of higher volatility in asset markets in the year ahead.

KEY QUESTIONS FOR 2017

If the above is not enough to contemplate, other key questions to be asked this year include:

Will Japan be able to achieve escape velocity for its economy through continued QE and currency depreciation?
Will OPEC production cuts stick, or will we see continued volatility in energy prices?
Will Emerging Markets be the key loser in a stronger USD environment and will this cause systematic risk in the region?
Are we at risk of inflation and are we entering a multi-year bear market for bonds?
To what extent will political tensions generally in the Middle East and Russia also add to overall volatility?

BULLISH SECTORS

Overall, our Investment Committee’s view is that many sectors will be hampered during the year by earnings disappointments, challenging growth environments, Emerging Market weakness, and risks to the downside. While sector outlooks appear generally cautious, we believe 2017 will be won with selective stock picking and a focus on sector and style rotation.

Our key sector overweight include US financials, infrastructure and healthcare, which are all expected to be beneficiaries of a Trump presidency. While we are neutral on energy prices, we are selectively overweight Oil & Gas sector due to more favourable valuations and strengthening balance sheet and improved pipeline of project development.

The global Financial Sector has historically performed well in a rising interest rate cycle, and remains one of our key sector overweight. Valuations remain attractive and EPS momentum is improving.

We are underweight bond proxy sectors including telecoms and utilities. For REITS and property, we are less bearish as we see valuations supportive and somewhat pricing in the first few interest raises.

MARKETS OVERVIEW

EQUITIES – Becoming Constructively Bullish

Investors have strongly cheered the new Trump presidential win, given inflation expectations rising, expectations of increased fiscal spending, reduced taxes and remove regulatory burdens for business, all spurring S&P to near record highs. However, with valuation multiples looking stretched in most regions, we are selectively Overweight equities over a 12-month horizon as we forecast they still offer the best return prospects vs. other asset classes. We expect 7% global earnings growth, which is consistent with a circa 2.5% GDP growth forecast.

Interestingly, USA equity market appears the most fully priced at 19x forward earnings. However, this market is expected to be the key beneficiary of any continued flows out of Bond markets and into USD denominated assets. We see single digit returns for the S&P this year mainly on moderate earnings growth with limited scope for multiple expansion. Therefore, it will be a stock pickers market and also remaining focused on preferred sector exposures.

At the same time, Europe and Japan equity markets look relatively cheap and are expected to keep their strategic Quantitative Easing and liquidity policies to spur inflation and support their asset markets. While, this is positive for equity markets from a liquidity perspective, we remain cautious on corporate earnings growth in a low inflation environment, as well as still weak underlying GDP and inflation rates, which we consider to still be well below historically desired levels.

Our Investment committee therefore continues to actively monitor a core portfolio of 20-25 securities within our broader watch list. More generally, our preferred e uity exposures are for high quality blue chip dividend yield stocks in USA as well as currency hedged European and Japanese equity exposure. We are more cautious on Emerging Markets (both in local and USD equivalent currencies), also neutral UK equity markets.

BONDS – Bearish

With a rising interest rate environment, and a multi-year bull market and inflows, most Bond markets are looking overbought. Most sovereign bonds are looking especially over bought, with some core countries still offering negative yields. Low grade corporate bonds are also looking expensive from a risk to reward perspective.

If investors need to be positioned in fixed income, we prefer either Inflation protected bonds (e.g. TIPS) or high quality corporate bonds with short duration trading at or near face value.

Our previous view was to use Bonds as an alternative for cash balances which are earning next to nothing. However, in this environment the risks of capital loss on bonds outweigh the potential rewards for trying to get a better than zero percent coupon.

COMMODITIES – Remain Cautious but Valuation Support Emerging

We have remained cautious on commodities across the complex for some time. However, with prices remaining low for so long, new supply continuing to be constrained, and a move to more inflationary and fiscal spending policies for USA and other developed economies, could 2017 be the time for commodities to finally shine?

For investors wishing to take a more contrarian and perhaps longer term view, we would prefer to invest in blue chip high quality listed producers rather than explorers or ETF on the physical commodities. It is interesting that many large cap blue chip mining companies are currently showing good balance sheet and dividend paying ability.

We are overall neutral on Oil and energy markets at current levels, although see some potential earnings upside should the Trump government remove regulation and speed up on project development.

We are still (counter consensus) relatively cautious on Gold and believe this 20-year cyclical commodity is now on a long term downtrend. Gold however, has been a difficult asset to price and has also caused some volatility in the portfolios over past 18 months. Hence, we are preferring to position in assets where we have a clearer view of the risk and rewards in the current environment.

CURRENCIES – Consensus Bullish on USD

We expect the US dollar to continue to perform well against most currencies, especially JPY, EUR, AUD and Emerging Market currencies.

Interestingly USD is now the most consensus bullish call from the investment community for the second year in a row.

We still believe that countries that rely on export growth will try to devalue their currencies in order to compete globally, i.e. “currency wars”. The main driver for US dollar strength will come from the US interest rate rise, as well as increased expectations of inflation (which are often more important driver than inflation itself).

Currencies most at risk are many of the Emerging countries that have trade deficits and borrowings in USD.

ALTERNATIVES – Bullish

We are generally positive on Property markets, with a preference for commercial over residential. Our favoured countries for exposure include: Australia, UK, South East USA, and Vietnam. Please ask for more information on some of the projects we are currently working on.

Our positive view on property markets is despite an increased interest rate environment in USA, as we feel any interest rate rise will be stimulatory (initially at least).

We are also positive on Private Equity, as we see better growth opportunities at lower valuations than compared to most local equity markets, especially as private market multiples are coming back down to more attractive levels, after a bit of mania especially in the tech sector over the past few quarters.

Importantly, one has to recognise that PE also has relatively higher risk (execution risk, liquidity risk, etc).

HOW WE MANAGE RISK – PORTFOLIO PROTECTION, HEDGING & TAKING PROFITS

As opposed to just going to cash, we prefer alternative strategies such as hedging via options and option writing strategies to smooth out portfolio volatility. We also actively monitor profits using trailing stop losses with the view of protecting and locking in gains.

CONTACT

Please let us know if you would like to hear more about our Discretionary Portfolios and how we consistently generate an additional 0.5% to 1.5% per month using our Options Overlay, we would be more than happy to have an informal chat about these and the other services we offer as well as the current opportunities we are looking at.

THANK YOU

We would like to take this opportunity to thank you for you for your support during 2016 in what was a difficult year, and look forward to working with you in the year ahead and growing your portfolios and net worth!