Central Investment Team
Well, Happy New Year everyone, and what a delightful start to 2016 it has been so far. Looking back to December the month was characterised by focus on the Federal Reserve’s decision on US interest rates. After 7 years of exceptionally low interest rates it seemed more likely than not that Janet Yellen and co. would raise rates although there was an element of uncertainty on the basis that minutes of the previous meeting indicated that 9 members voted for no change. Such a volte face indicates that Yellen’s tenure is perhaps likely to be regarded as one in which the separate elements of the committee are possibly less independent than has hitherto been the case- certainly such a “herd mentality” is potentially at odds with the principles of forward guidance that central bankers are at pains to espouse.
In any case, the FTSE 100 started December at 6,420 before dipping to 5,870 mid-month before recovering to close out the year at 6,240. As ever heightened levels of volatility remained a feature of the blue chip index with a hi-lo reading of c. 8.5%
This degree of volatility was not merely predicated on the imminent US rate decision, since market participants were also keenly awaiting the outcome of the OPEC meeting in Vienna. As has previously been the case all eyes were on the production forecasts- any cut to production would be seen as supportive of the oil price. In the event this did not happen, indeed the formal production ceiling was increased although this was really bringing it closer into line with existing output and the woes of the Oil & Gas industry persist. Interestingly one could ordinarily expect production to tail off as less profitable companies go out of business.
As it stands this does not seem to be happening on the basis that with credit so cheap many operators are forced to extract oil, even at a loss, just to meet their interest payment obligations. Similarly any marked increase in rates would in all likelihood force companies into bankruptcy which is something politicians are likely to want to avoid. And there you have it- moral hazard in all its glory: delaying a rate increase perpetuates the conditions which currently decrease the likelihood of a rate increase, in that higher oil prices would certainly add to the measure of inflation while in the meantime the longer the delay the greater the probability of negative ramifications when a sustained attempt to normalise rates occurs.
Meanwhile in the Eurozone the deposit rate was cut a further 10bps (ie 0.1%) to -0.3%. In other words institutions now have to pay for the privilege of lodging cash with the ECB. It would appear that the intention is to further stimulate asset prices and hence support the “trickle down” economic thesis. This was anticipated by the market, although the expectation was that the stimulus package would go further and increase the existing asset purchase program. The announcement made on the 4thdetailed that while QE was extended by 6 months the monthly amount deployed would remain unchanged, although 11 days later Draghi was careful to point out that QE could be increased if low inflation in the eurozone remained sticky, apparently as a consequence of the market reacting negatively.
Further afield the Chinese economy seems to be enduring some growing pains as it transitions from a manufacturing to service based economy. Devaluing the Yuan has been an attempt to arrest the manufacturing slide by promoting export growth. Nevertheless the impact on commodity prices has been significant yet unsurprising given the degree to which the region consumes global production of raw materials. In such a closed economy it can be challenging to find reliable data and get an accurate picture of the prevailing scenario, although we remain cautious of the region and have also addressed areas we feel are unduly sensitive to repercussions from an unforeseen Chinese economic shock.
As you may imagine we have therefore been reasonably active at a portfolio level during the month, with activity being front loaded ahead of the mid-month Fed interest rate decision. As such we have neutralised positions in American and European equity (ie brought client portfolios into line with the target allocation), bought St Modwen Properties, Smith & Nephew, Ashtead, Debenhams, British Land, Standard Life, British American Tobacco, BT Group, Standard Life, Barclays and Pets at Home. In addition to this we have been allowing for US$ strength having a detrimental impact on emerging markets and commodity prices in general and as a consequence have reduced investment in Emerging Markets where appropriate and sold both Aberdeen Asset Management and Aggreko. As ever these transactions would only be carried out in client portfolios if appropriate given investment objective, risk profile and any other restrictions (CGT headroom, ethical preferences etc.)
Looking forward it seems likely that the current volatility endures and it may become a defining feature of Q1. There are plenty of volatility drivers currently in the mix; whether the Chinese economy is due a hard or soft landing and if the current predicament will turn out to be short lived turbulence, OPEC and oil prices in general with the Saudi Arabia vs Iran sideshow also exacerbating the global situation, similarly North Korean military capability and the ongoing territorial disputes in the China Sea, Japanese economic reform and recovery with additional stimulus a possibility, US economic strength and interest rates, European recovery and stimulus measures as well as political changes, UK economic resilience and of course the in/out Brexit debate rumbles on. As a consequence of these myriad factors we will be, for the time being at least, sticking to our investment principles of active asset allocation with a focus on investment in fundamental quality. At times like these it is all too easy to be distracted by market noise- our goal is to remove this from our decision making process as far as possible.
So that’s it for 2015, I hope you all enjoyed some relaxing time off over Christmas and the New Year. 2016 has certainly started with a bang and the FTSE 100 has had a particularly turbulent time so far. Apologies that this is rather late (and lengthy!) and as always don’t hesitate to get in touch if you have any questions or concerns.
Rowan Dartington Central Investment Team