A break in the clouds: Kleinwort Hambros’ economic outlook


02-05-2019

Mark Sinclair, Head of Kleinwort Hambros Cambridge, gives his economic outlook for Q2 2019: “During the first quarter of the year, global equities made a sharp V-shaped recovery from the late 2018 meltdown, and while global economic growth is still decelerating, green shoots of expansion have emerged. Moreover, monetary policy has turned more supportive for global equities, compared to the end of 2018.

"Major central banks, led by the US Federal Reserve (the Fed), have become more dovish and Chinese authorities have stepped up stimulus measures in response. In time, this will gradually translate into firmer activity and a more positive stance, but in the short term, markets are likely to remain volatile due to political uncertainties.(1)

“With the 29 March Brexit deadline having been missed, ‘Deal or No Deal’ remains the question. Fatigue has well and truly set in after almost three years of Parliamentary debate. Nonetheless, the FTSE 100 is up 30% since 22nd June 2016, the day before the Brexit vote, in total return terms to the end of Q1 2019. Many will argue this is due to large multi-nationals hardly being “British” companies; the plummeting pound helps their repatriated profits. Inconveniently for that line of argument, the FTSE 250 – more suitably “domestic” – is up 21% in that time. It is all-too-easy to draw the conclusion that one’s asset positioning should be defensive during times of heightened conflict or stress.

“Indeed, while Brexit does pose new and unexplored questions for the UK, similar questions were asked through World War II, the loss of the British Empire, the downgrade of the UK’s status as a pre-eminent global military and cultural power and dizzying social, demographic and technological changes over the last 100 years. None of them caused UK equities to lose their long-run return potential – and there is little historical evidence of these tectonic political transitions being useful markers for investment decision making. Indeed, financial history teaches geopolitics rarely impact equity markets over the long-run and investment decisions should not be based on political transitions. Since 1900, UK equities have averaged 6.7% per year after inflation. And while equities tend to be volatile and can lose value dramatically – UK equites were down 57% in 1974, its worst one-year performance – over any 10 year period, the asset class tends to deliver returns far outpacing all directly competing investments (i.e. cash, bonds).

“Rather than geopolitics, investors should fear excessive, double-digit inflation or overvaluation, which are much more strongly linked with losses. Fortunately, for UK investors, neither are significant worries. Inflation in the UK is at its lowest point in two years (~1.8%), and with demographics feeble and productivity frail – and with monetary policymakers armed with both powerful tools and a strong public mandate – this worry is minimal. Similarly, valuations for equities in the UK are arguably cheap, with the FTSE 100 currently offering a dividend yield near 5%.

“Ironically, a greater risk at present for Sterling-based investors may be from non-UK assets. While portfolios should always be well diversified geographically, Sterling-based portfolios are subject to foreign exchange fluctuations (i.e. if Sterling appreciates by 5% versus the US dollar, all US dollar holdings would be worth 5% less in Sterling-terms, all else being equal). These fluctuations have been largely beneficial over the last five years – and especially since the UK’s referendum to exit the European Union in mid-2016 – as Sterling has depreciated over that time, adding a tailwind to Sterling-denominated performance. However, the opposite may well be true going forward. Sterling is trading at historically low levels (£1 = ca. $1.29*) and is undervalued versus the US dollar on most measures of purchasing power parity, a proxy for “fair value”. We would recommend trimming foreign currency exposure in Global, Sterling-referenced strategies either via “hedging”, or perhaps increasing exposure to UK assets.”


(1) Full Quarterly House View Q2 2019 as of March 30th 2019

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