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Research & Strategy

FYI Winter 2016-2017

FYI: For Your Investments. Winter 2016-2017

In brief

WELCOME TO FYI WINTER 2016-2017

A little under a year ago markets were fretting about the weakness of the oil price and its impact on the energy and financial sectors. Major mining companies appeared to be in considerable difficulties. Markets thought that interest rates would be raised too sharply in the us and serious concern was being expressed that Chinese demand was destined to remain very weak. At the time you would have got very long odds on a bet that the British would vote for Brexit, the Americans would vote for for mr trump and the Italians would reject a referendum on the reform of the Italian Parliament.

As we now know the economic worries were misplaced and the political surprises all happened. More than that, markets enjoyed the journey.

At this point, 2017 looks likely to deliver fewer surprises than 2016. Demand looks more firmly established and markets have accepted calmly the Federal reserves expectations for steady monetary tightening in 2017.

Inside track

THE TRUMP EFFECT

JOHN BIRDWOOD, Group Head of Discretionary Portfolio Management

"I have a very simple rule when it comes to management: hire the best people from your competitors, pay them more than they were earning, and give them bonuses and incentives based on their performance. That’s how you build a first-class operation."

 

From ‘the Art of the Deal’ by Donald Trump

 

Mr Trump continues to attract a lot of attention, but some obvious points are being missed. For example, he is assembling his cabinet remarkably quickly. By mid December, according to Wikipedia, twelve of his fifteen cabinet members had been announced. Whereas Mr Obama, when he was at this stage, had announced seven members and Messrs Bush, Clinton, Reagan, Carter and Nixon had announced no names at all. So much for the weakness of the transition team and the absence of a plan. Having, in effect, defeated two political parties to become President, Mr Trump is choosing a cabinet with some serious, and independent, intent.

The votes for Brexit, Trump and the Italian referendum are usually attributed to populism. If so, what was it that was unpopular with the electorate? Slow growth must be part of the answer. Part of the new administration’s solution to slow growth involves deregulation and the cabinet choices in, for example, education, energy, the environment, and labour provide a pretty clear indication of the direction of travel.

Headlines suggest that infrastructure spending will rise by $1trillion over the next ten years. There are several points to note about this. First, that is the goal of the stimulus not the increase in government spending. Secondly, public spending on construction has averaged just under $300 billion annually in this decade. However, a considerable boost seems likely, no matter how much ends up being spent. Thirdly, the choice of projects and their returns are unclear. To take two British examples: the crossrail project is a very important  addition to London’s transport infrastructure and will no doubt be very heavily used. By contrast, HS2 adds capacity where existing demand is more than adequately covered and one wonders whether there will ever be any return on investment.

Tax reform is the third part of the plan. The final shape remains to be seen, but there are some very radical ideas around. For example, in the House Republicans’ proposed bill there is a move towards a “destination-basis” tax system designed to counteract the effects of foreign value-added taxes on us trade. In other words, goods and services exported from the us will not be subject to tax, while imports will attract tax. Whether or not this turns into law remains to be seen (its proponents believe that it would not contravene World Trade Organization rules) but it illustrates the scale of potential change. For the time being, the protectionist threats made in the campaign seem to be o the agenda.

The tax rate would fall from 35% to perhaps 15%. Corporate tax raised, however, would probably increase quite sharply and pay for cuts and simplification in personal tax rates.

These changes are all designed to be pro-growth and come at a time when demand is firming and inflation is moving a little higher. Not surprisingly, bond yields have shot higher and the US stock market has risen in the short term. The bond market has got a little head of itself as government stimulus and higher interest rates will probably come through slowly. In the longer term, the trend towards higher rates looks secure and will probably spread to other countries. So far, bond yields have not risen far enough to jeopardise the equity market which is being supported by the prospect of higher corporate earnings, but this is an area which will need close scrutiny in 2017.

The Organization of the Petroleum Exporting Countries (OPEC) managed to put a deal together. Previous deals have been undermined as members have wriggled past their quota and non OPEC members have taken advantage of higher prices to increase production. The United States looks like the being the biggest winner. A deregulatory mood will see new pipelines installed which will give inland producers better access to markets; the producers in the Permian basin are already looking for annual increases in production in 2017 of 20% or more. They are also highly competitive. A recent presentation by Pioneer Resources showed a break-even rate of below $30 a barrel for the horizontal drilling in the Permian basin in Texas.

The markets have reacted very calmly to the Italian referendum result. For once, the opinion polls were correct and perhaps we have learnt that shocks can be positive. The weak point in the argument is the banking system which needs recapitalising. The current plans do not look large enough and the market’s optimistic interpretation must rely on the assumption, which is probably correct, that capital will be found and that the European Central Bank (ECB) will continue to support Italian sovereign debt.

In many countries (Britain, Japan, much of Europe, China) demand looks likely to be more robust in 2017 – something that has looked unlikely for most of 2016 – and we look forward with cautious optimism despite the world’s many unresolved problems in the Middle East, for example, or dealing with the financial consequences of ageing populations.

 

CHANGES IN MAJOR INDICES

*BofA Merrill Lynch Japan Corporate Index
Source: Bloomberg as at 13 December 2016

Indices are for guidance purposes only. Equity percentages are based on capital returns in local currency. Bond percentages are based on total returns in local currency.

Past performance should not be seen as an indication of future performance.

 

ASSET ALLOCATION*

*In relation to the SGPB Hambros benchmark allocation, as at 6 December 2016
Source: SGPB Hambros as at 13 December 2016

 

Actual weighting and investment allocations are subject to change on an ongoing basis and may not be exactly as shown. Investors should understand the different asset classes which make up the strategy as they have different risk characteristics.

Insight

EQUITIES

CHANGES IN MAJOR INDICES
(30 September 2016 – 12 December 2016)

Source: Bloomberg as at 13 December 2016
Past performance should not be seen as an indication of future performance. Indices are for guidance purposes only.

 

UNITED KINGDOM

TARLY BOLLA Senior Investment Manager

UK equity markets rose following the surprise election of Donald Trump as the US President, expecting higher rates of government infrastructure spending and lower taxes to provide some impetus to global economic growth.

This has also proved a boost to the FTSE 100 Index during the final few weeks of the year, although there were clear winners and losers from a sector perspective. Bond proxy sectors and defensive areas of the market, such as tobacco, utilities and beverage companies sold off as bond yields rose, whereas financials and more cyclical sectors, including industrials and miners were strong outperformers.

Corporate news has been led by third quarter results from the oil companies; BP reported a near 50% fall in third quarter profits compared to the same period a year ago, citing a weaker price and margin environment; Royal Dutch Shell posted an 18% rise in profits for the same period, but also identified the ongoing challenge of lower oil prices and an uncertain outlook.

The sector rotation and reflation trade seen in late 2016 is likely to continue this year, although the more domestic-oriented companies may struggle due to the upcoming Brexit negotiations.

Past performance should not be seen as an indication of future performance. Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments. Your capital may be at risk and you may not get back the amount you invest.

 

UNITED STATES

JAMES PEARSON Senior Portfolio Manager

It seems the US Equity market likes Trump. After the doom and gloom that was anticipated with a potential change of regime, the market has decidedly shrugged off the protectionist fears and focussed on the largesse to be doled out when the president-elect takes office from early next year. A series of new highs in equity markets has been led by the banks and industrials, as hopes of deregulation and infrastructure pervade the market.

Historically, new highs in the US are bullish. This is showing in the year-end strategies from the investment banks, as the views are firmly aligning that one should be overweight in equities in 2017.

If enacted by Congress, an earnings-boosting corporate tax plan mooted by Trump will be highly supportive for stocks. The market is now pricing in the chance of the corporate tax rate being cut from 35% to 15% at some point next year into earnings expectations. This tax cut looks to be the most likely of Trump’s proposals to be implemented.

Past performance should not be seen as an indication of future performance. Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments. Your capital may be at risk and you may not get back the amount you invest.

 

EUROZONE

IAN LEVERINGTON Senior Investment Manager

European markets were significantly stronger in the last quarter of 2016, led by the continuing recovery of the financials and energy sectors.

European bank stocks have rallied hard since making year lows in July, a recovery supported by the backup in government bond yields. The European Central Bank (ECB) was rumoured to be considering easing back on bond purchases, a first step in the long road to normalising interest rates – something banks crave. In the event Mr Draghi, as President of the European Central Bank, managed to please most investors in his speech on 8 December, announcing a tapering of bond purchases, but only after April 2017, and with the programme extended to the end of next year. European banks still offer compelling value, but are not for the fainthearted.

The energy sector has been strong everywhere. Saudi Arabia appears to have relented in its efforts to squeeze the life out of the US shale markets and may have convinced other non-OPEC producers to follow its lead in cutting production. European oil services companies in particular have been beneficiaries of these announcements.

By contrast, the laggards in the fourth quarter were those more defensive sectors perceived as bond proxies – utilities, consumer staples and real estate. Rising bond yields would highlight the relatively unattractive valuations on offer across these segments of the market.

 

JAPAN

JENNIFER YU Investment Director

After hitting a near three-year high against the dollar in August, the yen has pulled back sharply in the fourth quarter of the year, as the market anticipates multiple rate hikes in the US going foward. Subsequently, the Japanese stock market advanced further this quarter with TOPIX and NIKKEI stock index rising 16% and 17% respectively, as a weaker yen is good news for exporters and the Japanese market is heavily reliant on export earnings. Cyclicals such as materials, industrials, and financials were the best performers, whilst defensive sectors like healthcare and telecommunications underperformed the index.

One day after the Fed’s decision to raise interest rate, the yen hit a 10-month low of 118. It is expected that the weakening trend of the currency could continue next year as the Fed signals multiple hikes in 2017. Looking ahead, companies with earnings that benefit from a weaker yen and a moderate increases in long-term yields, like banks, manufacturers, would likely to do well.

Past performance should not be seen as an indication of future performance. Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments. Your capital may be at risk and you may not get back the amount you invest.

 

EMERGING MARKETS

JACKY NG Senior Portfolio Manager

After performing incredibly well in the first three quarters of the year, as commodity prices rebounded from their lows, emerging markets faced new headwinds in early November as Donald Trump unexpectedly won the US election. His rhetoric towards globalisation in general, and in particular his attitude towards Mexico, caused a sharp sell-off of the emerging market debt, equity and currency.

Although a strong USD environment is clearly a headwind for emerging markets as a whole, overall we are cautiously optimistic about the region’s prospects. There are several reasons for this. Firstly, commodity prices have stabilised compared to last year and we see this trend continuing, as commodity supply is constrained by China’s renewed effort to tackle its environmental issues. Secondly, fear about a Chinese economic meltdown is subsiding, as several economic indicators, such as retail sales, steel output and fixed asset investments, all surprised on the upside in the latest reading. The market is further supported by relatively cheap valuation, in areas such as Hong Kong, Korea and Brazil.

At present, our preference is to get exposure in emerging markets through hard currency debt, as the balance sheets of many EM countries are robust. Also they have diversified the risk of a strengthening USD by utilising local currency debts as methods to raise capital. Many of these countries are still generating large current account surpluses and that should provide a solid foundation for their ability to meet coupon payments, even in USD. We are also getting over 5.5% yield which will compensate for any short-term volatility that we see from day-to-day news flow. For equity markets, we still prefer Asia over Latin America.

Past performance should not be seen as an indication of future performance. Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments. Your capital may be at risk and you may not get back the amount you invest.

 

BONDS

CHANGES IN MAJOR INDICES
(30 September 2016 – 12 December 2016)

*BofA Merrill Lynch Japan Corporate Index
Source: Bloomberg as at 13 December 2016
Past performance should not be seen as an indication of future performance. Indices are for guidance purposes only.

 

BONDS

JEFFERY WOODRUFF Fixed Income Adviser

The US government bond market remains unloved with calls for the end of the 30-year bull run. This may be a slight exaggeration, but there is no denying that US treasuries have taken a bit of a beating since the US election.

The main catalyst behind the recent sell off that has pushed up 10-year yields to 2.4% and steepened the yield curve by 130 basis points is rising inflation expectations in the US . President elect Mr Trump has promised to ramp up fiscal spending to reinvigorate American infrastructure. In response, treasury yields are at the high end of their range for 2016. Once Mr Trump is sworn in as president his promises will switch to policy. We anticipate treasury yields will rise more in 2017.

In Europe the credit and interest rate story is a bit more benign. Euro-denominated bonds rallied as the ECB expanded its balance sheet. However, the ECB scaled back the pace of its corporate bond-buying programme in December by EUR 20 billion, suggesting the Eurozone has perhaps seen the worst of its economic woe. This recent scale-back decision could result in a widening of corporate spreads from current levels if market participants believe the ECB will continue to reduce bond purchases.

The UK bond market is still fixated on the Brexit issue. UK gilt yields reached a low in August as investors rushed to the safety trade after the Brexit vote in June. Since then, yields are up around 60 basis points as macroeconomic data comes in better than expected. We expect the next issue for the UK will be the timing and pace of the Bank of England’s rate policy in 2017. The Bank says it is willing to tolerate above target inflation of 2% for a while. After that, look for short-end rates to go higher.

Past performance should not be seen as an indication of future performance. Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments. Your capital may be at risk and you may not get back the amount you invest.

 

CURRENCIES

TONY ABREU Senior Investment Manager

We have been advocating a strong US dollar all year, supported by the prospect of stronger US growth and tighter US Federal Reserve (Fed) policy. Incoming US President Donald Trump’s promise to deliver fiscal stimulus means the Fed will continue to re-price higher, so the potential for continued dollar strength remains. Additionally, rising rates (and US dollars) will make it harder for non-US borrowers to refinance a wall of USD-denominated debt. Scarcity could push the USD to new cycle highs.

Sterling was badly beaten up post Brexit referendum. However, since the lows of October we have seen a decent recovery against USDs 1.21 to 1.27, and EUR s 1.10 to 1.19. We believe the Brexit jitters may return, but unlikely to deliver too many surprises over the next few months.

Political uncertainties have kept the euro soft. EUR and USD continues to hold above the key 1.05 level. Many are calling for parity or lower going into 2017 as a combination of political uncertainties regarding election outcomes in France and Germany, coupled with continued ECB stimulus weigh on the currency.

Past performance should not be seen as an indication of future performance.
Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments. Your capital may be at risk and you may not get back the amount you invest.

 

COMMODITIES

NEIL BRUCE Investment Adviser

OPEC and non-OPEC producers reached their first deal since 2001 to curtail oil output. A pact designed to reduce a global oversupply of crude, lift prices and lend support to economies hurt by a two-year market slump.

On top of the 1.2 million barrels a day in cuts already agreed by OPEC, the deal removes a further 558,000 barrels a day from non-OPEC countries. The bulk of the cuts – 300,000 – have been pledged by Russia. The combined measures amount to a total of almost 2% of global oil supply.

Since April, crude has traded between $40 and $50 a barrel, but the agreements have pushed the price to above $53.

With the deal finally signed after almost a year of arguing with OPEC countries and mistrust in the willingness of non-OPEC Russia to play ball, the markets focus will switch to compliance with the agreement.

Gold
A Trump victory was supposed to be good for gold. However, November was the worst month for gold since 2013, falling 8%.

As Mr Trump managed to calm initial fears, sentiment switched to risk on and perceived safe haven assets struggled. However, it is Mr Trump’s outlined policies which are the real driver. His call for substantially lower individual and corporate income taxes, energy independence for America and up to $1 trillion in infrastructure spending over the next decade would likely lead to higher inflation and gross domestic product growth. A rising oil price is adding to inflation worries. With bond yields rising to compensate for expected inflation, the opportunity cost of holding gold becomes greater. Gold provides no yield.

Additionally, Mr Trump has favoured a higher-interest rate environment. He can not alter the course of monetary policy, but his suggestion that rates should be higher, at a time when the Fed is expected to raise interest rates, is increasing the perceived opportunity cost.

Past performance should not be seen as an indication of future performance.
Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments. Your capital may be at risk and you may not get back the amount you invest.

Informed

COMPOSITE BENCHMARKS 

JOHN BIRDWOOD, Group Head of Discretionary Portfolio Management

Recent months have seen rising bond yields in both the UK and the US. In the US, stronger labour markets and the prospect of interest rate rises from the Fed have been the drivers. In the UK, falls in the value of the pound have increased inflation expectations. This has meant that lower-risk benchmarks have suffered, but equity markets have held up, helping higher-risk benchmarks. For the GBP benchmarks, the equity components have benefited from the falls in sterling.


Data to 12 December 2016

Source: Datastream and Bloomberg

 

Hedge fund returns are estimated based upon HFRX data as of 9 December 2016.

The data for the final month, December 2016, is provisional, so the benchmark numbers presented may not agree with those on valuations.

SGPB Hambros calculates composite benchmarks appropriate for different investor objectives, based upon MSC I Equity indices, Bloomberg/EFF AS Bond Indices, Merrill Lynch 1-10 Years UK Gilt, Merrill Lynch 1-10 Years Sterling Corp, Overnight LIBOR cash rates and HFR X Global Hedge fund indices. The proportions vary according to strategy and are available on request.

 

Past performance should not be seen as an indication of future performance. Indices are for guidance purposes only.

Investments may be subject to market fluctuations and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.

All information is based on current tax legislation, which can change. SGPB Hambros Group does not provide tax advice. The level of taxation depends on individual circumstances and such levels and bases of taxation can change. You should seek professional advice in order to understand any applicable tax consequences.

 

 

Please read - Important information

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Private Equity

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• SG Hambros Bank (Gibraltar) Limited (“SG Hambros Gibraltar”) is incorporated in Gibraltar under company number 01294 and its registered address is situated at 32 Line Wall R oad, Gibraltar. SG Hambros Gibraltar is authorised and regulated by the Gibraltar Financial S ervices Commission for the conduct of banking, investment and insurance mediation business. S G Hambros is a participant in the Gibraltar Deposit Guarantee Scheme and the Gibraltar Investor Compensation Scheme. You may be entitled to compensation from these schemes if we cannot meet our obligations. This depends on the type of business and the circumstances of the claim. Further details of these schemes are available on request or can be found at www.gdgb.gi or www.gics.gi respectively.

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All rights reserved. 03/16

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John Birdwood Group Head of Discretionary Portfolio Management SGPB Hambros