Asset allocation panel still bullish on Europe and commercial property
Anyone who bought UK equities ahead of the election in the belief that a Tory win would drive markets up will now be very disappointed. The UK market's performance has been underwhelming this year, and in June the FTSE 100 had its worst month for three years.
As you might expect, some of our panellists have reacted in contrarian fashion to this trend. Wade has raised his score from 3 to 4.
'It is worth a little upgrade now the election uncertainty is out of the way,' he says. But his enthusiasm is very muted.
Our panel also had its say on the strength of global growth and possibility of a hike in interest rates in September, in: Asset allocation panel wary of timing of US rate rise.
EMERGING MARKET CHARACTERISTICS
He has been arguing for some time that the make-up of the FTSE 100 - with its heavy weighting of energy and raw materials companies - gives the UK market a lot of the characteristics of an emerging market. He says: 'Until we see China and emerging economies returning to their normal growth path, the FTSE 100 is going to struggle.'
Wade argues that, while the UK economy appears buoyant and is holding up well, new moves by George Osborne to cut the deficit through spending cuts 'is going to slow things down next year'. In addition, the Bank of England is expected to raise interest rates. 'Fiscal tightening and higher interest rates are not a great combination for markets,' he says.
Alan Higgins, chief investment officer at Coutts, encouraged by the post-election softness of UK equities, takes the same line as Wade. 'I think we have to respond to the surprise election result and raise our score from 5 to 6,' he says.
Rob Burdett, co-head of multi-manager at F&C Investments, goes along with that argument and also boosts his score from 5 to 6. 'While the market here has underperformed, the news on the economic front seems to be getting better,' he says. 'The downside risks in the UK look quite well protected.'
Chris Wyllie, chief investment officer at Connor Broadley, however, keeps his score at 5. 'UK equities are stuck in a bit of a no-man's land,' he says. 'There are some reasonable valuations around, but the rally in the pound - and its detrimental effect on overseas earnings - has been a major factor putting a cap on the market.'
The two favoured areas in equities remain Europe and Japan. 'We are still locked in a cycle of currency wars,' says Wyllie. 'The countries achieving real economic growth are only achieving it through currency devaluation.
'The weak yen is boosting Japanese growth at the expense of rivals in south-east Asia such as Taiwan and South Korea, while the weak euro is helping the eurozone economies revive and absorb the damage caused by the Greek crisis.'
Burdett has raised exposure to Japan again from 6 to 7. 'Earnings there have kept pace with stock market performance and, as a result, stocks are still cheap,' he says.
'In fact, shares in Japan are as cheap as anywhere, whereas in most of my working lifetime, they have usually been the most expensive. All this is in spite of the Japanese market being one of the best performers over the past few years.'
On Europe Burdett maintains his score of 7, noting that European equities 'have just had the best quarter for earnings growth since 2010'. But Wade has lowered his score for Europe from 8 to 7.
'We still like the sector, but European shares have already gone up quite a lot on expectations of recovery,' he points out. 'Greece is adding volatility to markets, but as yet it does not seem to be derailing the recovery.'
There is continuing bullishness about the UK commercial property scene, which has benefited from the halo effect of the returning Tory government.
Higgins has had a rush of blood to the head and raised his score on the property sector to 9. 'Commercial property fits the bill. It gives the international investor extra confidence in political stability here for five years and an encouraging economic outlook. And it pays an attractive income to international investors looking for bond replacements.'
Since the crash, the yield on the IPD Commercial Property index has come down from 8 per cent to around 6 per cent, but the average FTSE 100 index return is only 3.54 per cent and the return on 10-year UK gilts is a mere 2.1 per cent. This explains why property has emerged as the highest-scoring sector among our panellists.
It is now reckoned that more than 40 per cent of property transactions last year were made by foreign investors. Sovereign wealth funds, big pension funds and, notably, Canadian institutions are among the major buyers.
But Higgins has this warning about property: 'You don't get a high return without risk. And the risk is that UK inflation will rise faster than expected and interest rates have to rise faster. That would hit the property market hard.' At the moment, however, none of the panellists foresees that outcome.
'As soon as UK interest rates start rising, foreign investors may begin to pull money out of UK property,' says Wade. 'But in my view the interest rate rises won't be enough to change the dynamics of the property market.'
All the other panellists keep their property scores at 7 - except for Burdett, who is concerned that the boom may boil over come 2017, when a big jump in the supply of new office space in London is expected.
'Our exposure to property remains skewed towards Reits with high exposure to Europe - particularly residential property in Germany,' he says. He also finds better value in smaller regional property offerings.
COMMODITIES AND EMERGING MARKETS
There are tentative signs that commodity prices may at last be finding a floor. If they do start to recover, it could be the first sign that the pace of global economic growth is about to quicken. Our panel members all record scores of 4 or 5 for this sector, implying no great enthusiasm but a feeling that a recovery is long overdue.
The recent track record is poor. Wyllie admits: 'Commodity prices have gone to hell in a handcart since 2011.' Copper and gold are about 40 per cent below levels four years ago, while platinum is down by a third. 'It's a bit late to be bearish now,' Wyllie says. That alone may explain why the panel's scores are as high as they are.
Aberdeen's deputy head of global strategy Richard Dunbar suggests that the US's pace of growth may be quickening and that we could begin to see a recovery in base metal prices. Meanwhile, the oil price has stabilised at just north of $60 a barrel - well above January's $45.74 low.
Burdett, who scores a neutral 5 for the sector, says he may increase the score in three months' time because there are signs soft (agricultural) commodity prices are improving.
The emerging markets sector would be boosted on the first sign of a commodities recovery. Here, three panel members are in overweight positions - mainly because valuations are low compared with developed market equivalents.
Higgins says: 'We see further scope for Asian equities to recover as global investors are increasingly drawn to the region.' Coutts now has exposure in Russia through a fund managed by French bank BNP, while its stake in China is via Hong Kong-listed stocks.
But according to Schroders' Keith Wade, what emerging markets really need is a recovery in their exports to the West. And that depends more than anything else on faster growth in Europe and the US.