Happy New Year to readers and investors alike.
We commence the year with market indices trading at all time highs and this had grabbed the headlines. But let us be clear, this does not reflect the fortunes of all listed (traded) companies. Far from it. Indeed last year’s price action in reality depicts a dichotomy in performance between the internationally orientated (largely dollar earning) big market capitalisation corporates and those more UK exposed (Brexit linked) which have struggled in the face of general domestic uncertainty and an associated weak pound. So the market appears somewhat binary with more highly rated, (currently) favoured largely overseas earners on the one hand and lowly rated, thus higher yielding, underperforming UK centric plays on the other.
The challenge entering 2018 for UK market focused stock pickers and portfolio managers (seeking performance) will be to assess risk reward potential by scrutinising significantly differing stock valuations which have materialised based on the current consensus projections of both the macro (general) and microeconomic (stock specific) landscape. Put simply, does one continue to hold and buy last year’s outperformers (hoping for further upside) in favour of the laggards, own both or look to be overweight in either. Are last year’s outperformers now in overbought territory, pricing in too much further good news perhaps at a time where corporate earnings are peaking? Will 2018 see funds move towards the more contrarian, underperforming (value) areas simply due to the marked differential in valuations? Will the UK economy fair better than expected this year which means many such UK centric stocks are probably too low? Questions questions.
Right now (and it is difficult to argue) it seems likely that the UK economy will chug along at best, with a relatively low pound continuing in tandem and a central bank raising rates only marginally over the year. Further Brexit negotiations and political disharmony are not helping matters. In contrast, the market expects further rate rises across the pond in the US as the world’s largest economy continues to expand fuelled in the main by tax reform. If this prognosis is accurate, it seems investors would indeed be well placed to back what was a winning strategy last year for this year. But that is before current valuations are fully acknowledged; for here one may build a case for caution. Certain sectors look expensive, fact; perhaps the US market as a whole is. Certain sectors look cheap; perhaps the European market as a whole is (at least relatively).
Money tends to flow in time from outperforming areas to underperforming areas and the cynic is me, having watched markets for over 20 years is struggling to see that making money is that simple: to continue to back what some may call momentum trades. Infact I do wonder if some form of market turbulence is probably overdue as the global economic recovery (now entering its ninth year) becomes more uneven.
One needs to stay alert to these possibilities and at a minimum, try to not have too many eggs ever in one basket (sector or stock). Ultimately most portfolios will own a spread of companies but timing the entry and exit of certain holdings remains the skill. And don’t be against holding a cash balance from time to time in the portfolio.
To remind readers of market legend Sir John Templeton’s infamous and timeless quote:
“Bull markets are born in pessimism, grow on scepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” “If you want to have a better performance than the crowd, you must do things differently from the crowd.”
Whilst it seems fair we haven’t yet experienced euphoria (perhaps we have in the value of Bitcoin), one needs to expect the time will come. And in terms of pessimism, I just wonder whether some of the UK centric underperformers are in this category.
Year end targets
My prediction a year ago that the FTSE 100 would finish 2017 at 7650 doesn’t look too shabby against the actual 7687 level actually achieved. I will predict a finish around 8000 ultimately this year with some dips en route. As I am not a passive (index) investor, I will hope to deliver a better performance than the index by individual stock picking and total return will be achieved by share price performances and dividends received.
Sector to back in 2018 : Financials
While overseas (multi-currency) exposure has assisted the likes of HSBC over the past year, other names to include the UK exposed Lloyds Banking and the UK’s largest insurer Aviva have lagged.
While I do not expect anything significant with respect to monetary tightening this year from the Bank of England, one (possibly two) further lift in this base rate is probable. The current and projected environment thus looks promising for assisting returns for financials albeit that this is somewhat of a contrarian call.
Tax reform in the US should be a useful boost for US banks which should help general sector read across.
This report was written by Philip Scott, Director at SI Capital on 2/1/17 when the FTSE 100 was trading at 7648.