Markets are always guided by what's in the rear view mirror, and we've certainly passed through a particularly picturesque patch. Following a period of profits recession, earnings are forecast to hit new highs led by the rebound in energy and material companies. The key global economic blocks are all chiming in unison and this has lifted global GDP expectations to near 3% for 2017. Tax cuts in the US, solid growth in Europe and a pick up business and consumer confidence are all acting to create an air of heady expectation. Strong investment returns will provide clients with warm feelings as they review their portfolios but experienced professional investors have seen this particular movie many times before. We know all too well how quickly the script can switch from 'feel good' to 'a weepy'.
The S&P 500 is on 26x historic earnings and nearing 30x on Shiller p/e. The market is bifurcated between the cheap financials and anything that provides a steady earnings stream with a sound business model, many of which are now on 30+p/es. The bulls argue that this cycle can be extended through fiscal policy. Well it might, but when government budgets are already in deficit and labour markets tight, crowding out and higher inflation seems a more likely outcome. The Snapchat IPO highlights investors' festive mood. Such a debut will encourage other companies to list and together with the upcoming Saudi Aramco listing, this will increase the supply of equity to markets.
Meanwhile Trump is hurtling around like a drunken bull. So far he has managed to offend half the world; the other half are awaiting their turn. Even a US President is not immune to global censure, even if he appears to inhabit a deluded bubble. Higher standards of behaviour can be found amongst even the most deluded of X Factor contestants. Politicians are unused to this approach but they will swiftly develop ways to contain and confound Trump. Fortunately, Trump by all accounts appears to be surrounding himself with sage and sensible councilors, nevertheless the risks of some serious blunder occurring must have risen. Germany, China, North Korea?
At the same time, the discount rate is on the rise. US Treasuries have paused for breath momentarily but the Fed has set its course and will continue to lift rates. In previous tightening episodes, equity markets have been happy to digest two or three rate rises before the bellyaching begins. Starting from such elevated valuations, once the solids hit the air conditioning unit, we could end up with a train wreck. This will be a global market event and there will be few if any hiding places. However, the market clearly wants to go up in the short term and there seems no reliable catalyst to trigger a reversal of direction. We are of course spoilt for choice with unreliable ones, ranging from the current resident of the White House to European political events.
Global warming or not, 'sell in May and go away' appears particularly apposite this year. We are keenly watching the exits now, exposures to UK and US equities have been reduced in our grid, but we aim to delay the sales while the market momentum is so positive. We may require an interim TAA meeting sometime in Q2.
UK Property. The shift in investor patterns in the UK funds market has led to a much greater uniformity in fund demand. This matters little except in the potentially illiquid commercial property sector. It was striking to observe the homogeneity in key investors actions during 2016 and stands in stark contrast to how institutions behaved. This led to a suspension in dealings in many funds. As a result, we need to tweak our investment process and extend our forecast horizon to two to three years. Today, property yields are well underpinned by gilts yielding a tad above 1% and appear reasonable value in comparison. However, it does not appear fanciful to expect gilt yields to climb back to 3% over the next 2 to 3 years. This would severely undermine the valuation case for the sector, and with the Brexit journey about to be unleashed, we have no wish to be encumbered with a troubled asset in our portfolios.
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