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19/10/2016

KB Events: Investing in uncertain times

Wasn’t it ever thus?

Every year the political and macro-economic backdrop looks increasingly difficult. Our role is to navigate markets and monetise opportunities. Last week, at our Investment Update, hosted at the Wallace Collection in London, Mouhammed Choukeir, Kleinwort Benson’s Chief Investment Officer and Eric Verleyen, SGPB Hambros Group Chief Investment Officer provided insights into our investment thinking which allowed our guests to obtain greater clarity on the rationale behind our current strategic positioning.

Given the current position in the economic cycle, we are cautiously optimistic. There is much negativity, not only in terms of the outlook for the economy, but also for earnings. It is quite evident that we are in the latter stages of a long bull market. Financial markets, in general, bottomed in March 2009 and since then they have been climbing the wall of worry. Interestingly, this is the second longest bull market in history and has now endured over 90 months. As a result, our enthusiasm is somewhat tempered.

Overview of Asset Classes

Equities in general offer a degree of value. If we look at and analyse other historic market peaks, they tend to coincide with a surge in M&A and IPO activity, coupled with general euphoria. This is evidently not the case at present. Government bonds continue to act as a diversifier within the context of multi-asset class portfolios, notwithstanding the fact that they appear expensive on most metrics. Commodities are an asset class that we have avoided for a number of years and they remain 50% off their post 2008 highs. Latterly we have instigated a position as momentum appears to have swung in their favour. We retain a higher than normal allocation to cash as it has a role to play in providing optionality in case of a broader market set-back

Geopolitics

We discussed Brexit, the US election and a European perspective on the Eurozone; looking at the expected economic impact and market reactions to each event.

Brexit

Following the decision of the UK to exit the Eurozone, economists put through a raft of downgrades. Economists’ forecasts for UK GDP range from +2.5% to -1.4%. There is a huge dispersion. Expectations for German GDP range from +1.9% to +0.9%, a much narrower band. In terms of the currency, GBP has fallen 20% and the equity market has rallied to record highs. Following Black Wednesday in 1992, when we exited the ERM, the currency fell 20% and 12 months later the equity market had rallied 25%. Given the sharp drop in the currency, we would anticipate a marked pick-up in inflation. Interestingly, looking at history as a guide, in 1992 inflation actually fell and the economy grew at 3% annualised thereafter.

We are seeing inflation feeding through to the petrol pumps and the supermarket shelves. So much so that Tesco and Unilever are having a spat over input prices for staples such as Marmite. Love it or hate it, for 24 hours Tesco refused to stock it. This position has subsequently been resolved, but expect to see more of the same over the coming months.

Geopolitics is dominating the news and financial media at present. We have done extensive analysis of the 16 most significant geo-political events over the last 50 years and the average gain, 12 months after the event, was 12.9%. On 12 out of 16 occasions the market was higher. The key outlier was in 2001 when the market was down over 34.9%, but the Gulf War coincided with the deflating of the dotcom bubble.

US Election

At present, in the polls, Clinton is leading Trump by 47.5% to 42.9%. The bookmakers are forecasting an 86% probability of a Clinton victory. It is arguably “hers to lose”. These are the two most hated presidential candidates of all time. So what are their respective policies?

Trump is planning to slash taxes and abolish inheritance tax, implementing massive stimulus, coupled with a dramatic surge in public sector debt. Clinton is planning to tax the wealthy. In terms of trade, Trump is planning to renegotiate trade deals with China, while Clinton has implemented a U-turn on policy and indicated there is scope for re-negotiation of trade terms. They both plan to spend on infrastructure.

If we look at historical trends the surprise is that the S&P has delivered, on average, twice as much under the Democrats, than with Republicans at the helm.

The Eurozone

The ECB is not concerned about the risk of a simultaneous default within the banking system. The credit and operational risks within the banking sector are not flashing amber at present. There is a risk that the DBRS ratings agency will downgrade Portugal to high yield on 21st October, which will drive up its funding costs. Italy has gone to the polls to change the constitution: 31% want to change it, 36% want no change and the remainder are undecided. Germany continues to remain a bright spot within Europe with growth forecast to be 1.9% in 2016 and 1.7% in 2017. 2017 is, however, an election year. If Merkel or ‘Mutti’ is re-elected, her time in power will equal that of Helmut Kohl who was in power for 16 years. The German budget surplus is running at €20 billion for the first six months of 2016. At some point they may start spending this. The outlook in France remains challenging and the French also face an election in 2017. This may prove a catalyst for a more positive general backdrop for entrepreneurship.

In short, all of the major European countries are going through significant political change at present. Negotiations with the UK will be unlikely to progress until they have political clarity at home.

The headline level of markets has been driven by a combination of factors, but quantitative easing (QE) has been a key driver. This antidote is most likely being pared back over a period of time. Market volatility has been highly correlated with political uncertainty. As QE becomes less of a factor driving markets, we would expect corporate news flow to become more of a factor, which will lead to further outperformance of active as opposed to passive stock selection.

The evening was a great success, guests enjoyed canapés and music from Orpheus Foundation harpist, Olivia Jageurs, in the beautiful surroundings of Hertford House, home of the Wallace Collection.

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