Investment Report for December 2015

OVERVIEW

Yes, it has finally happened! After a seemingly endless wait, the new Star Wars film has opened. Oh, and the US have raised interest rates by 0.25%. Janet Yellen, the Chair of the Federal Reserve and its rate-setting committee, the Federal Open Market Committee (FOMC), must be delighted by the markets’ response – calm, measured and with a moderate but clear rally for risk assets.

No one was surprised by the move itself but the details were pored over for signs of the FOMC’s future intentions. The word ‘gradual’ featured prominently in the accompanying statement and in Mrs Yellen’s press conference. She also emphasised that even after this rise, policy remains highly accommodative. However, there were three hawkish features in yesterday’s announcements:

• First, the absence of dissent: the vote to hike was unanimous.
• Second, the Statement of Economic Projections, which includes a forecast of interest rates, was little changed. The committee continues to project that it will raise rates four times in 2016; the market is discounting only two.
• Third, the tone was one of confidence about the economy. Upside and downside risks to growth are now ‘balanced’ whereas previous comments had been tilted to the downside. After the worries surrounding China a more cautious approach might have been expected.

The UK stock market fell by -2.4% during December as investors digested the start of the end of the era of cheap money as the US raised interest rates. In the US the S&P500 fell by -0.8%, taking the news better.

The European markets suffered a large drop, falling by -6.2% over the month. A significant part of the fall was due to a drop in the value of the Euro, which weakened due to an announcement by the ECB that its QE policy would be expanded. Additional QE simply confirmed that the Euro region continues to be a mess.

Asian markets put in a decent month, with the index gaining +0.9% and recovering some of the ground that was lost earlier in the year.

Fixed Interest securities made modest losses, falling by -0.8% on average as the higher interest rate environment took its toll.

UK Commercial property put in another positive month with the index gaining +0.7% including rental payments.

STOP PRESS

Unfortunately markets have headed south at a rate of knots from the get-go on the 4^th of January. Once again, it’s all about the Chinese.

At the start of the New Year investors were faced with severe drops in the main Chinese market with falls of up to 8% occurring over short periods of half an hour or so. The Chinese market has various “brakes” that can be applied if falls are too severe, but in the end the authorities took the view that people were so desperate to sell before the brakes were applied that it was making matters worse. Thus, the brakes have been removed!

Most professionals feel that ructions in the Chinese markets are a side-show. The reason for this is that investors in the West cannot invest directly in the market and the level of the market is manipulated by the Chinese authorities through various mechanisms, including the direct purchase of shares by the Government. What is of more significance is the level of the Yuan on foreign exchanges and the underlying strength of the Chinese economy.

As with all things Chinese the reality is often quite different from appearances. The level of the Yuan is managed by the Chinese Government, but it is clear that this is slowly falling, even after (or perhaps because of) Government intervention. Weakness in the Chinese currency (which is a measure to boost competitive strength in export markets) puts other countries under pressure and aggravates international relations.

The other issue is the fundamental strength of the Chinese economy. I suspect it is far weaker than the official statistics say. The Government quotes growth of 7.0% but many commentators say that this is actually in the 3 to 4% range. I fear it could be even less than this – particularly in the manufacturing sector. The upshot of weak growth in China is a major contribution to the slump in commodity prices that we are seeing now and a reduction in economic growth around the globe, with the obvious impact on share prices.

All one can do is hang on to your hats. Our portfolios generally suffer far less in severe market falls than the main indices and we hope that this time will be no exception.

Here is the chart of the FTSE 100 index for the last six months to the year end:

…and the last five years, which puts this into perspective;

FUND PERFORMANCE

Short-term Performance

Long-term Performance

(Source; Parmenion Capital Partners LLP)

PORTFOLIO REVIEW

All Portfolios

All portfolios made a little money in December apart from the Income Portfolio, which was down a fraction of a percent.

Income Portfolio

The Income Portfolio lost -0.4% in December and just out-performed its benchmark (the average mixed investment (20-60% shares) fund) which lost -0.5%.

The portfolio was weak due to under-performance of the UK market compared with overseas markets, which appreciated a little due to the weakness in Sterling.

There were no changes to the portfolio during the month.

Balanced Portfolio

The Balanced Portfolio gained +0.3% in December and out-performed its benchmark (the average mixed investment (40-85% shares) fund) which lost -0.3%.

Our overseas investments in both the US, Europe and Asia contributed to the out-performance.

There were no changes to the portfolio during the month.

Tactical Portfolio

The Tactical Portfolio gained +0.9% in December and out-performed its benchmark (the average Flexible fund) which fell by -0.3%.

The out-performance is attributable to our increased exposure to Asia and the Emerging markets and holdings in smaller company shares, which have served us well over the year to date easily out-performing the main FTSE 100 share index.

There were no changes to the portfolio during the month.

OUTLOOK

Rather than pontificate regarding to the future level of markets in 2016, we think it better to highlight what some of the main issues may be that will affect the investment scene;

The US Election?

We suspect this may well be won by Hilary Clinton and we can rapidly forget all about Donald Trump.

If Democrats also take back the Senate then the US Government could be back in action again after being hamstrung during the “Obama years”.

Britain to leave the EU?

David Cameron is under pressure from all sides and faces a delicate balancing act in attempting to renegotiate an acceptable UK membership settlement with the EU.

We reckon that we will vote to stay in the European Union. Not with any sense of enthusiasm, but because the innate caution of British voters ultimately will prevail. Forget the technical arguments about whether David Cameron manages to secure a good deal in his renegotiation or whether the UK gets back its contribution to Brussels in increased investment and trade. In the end voters will choose between the calm logic of former Prime Minister John Major and the populism of UKIP’s Nigel Farage. Our money is on Mr Major. If we are wrong, Britain faces truly turbulent times.

Will the Bank of England finally raise interest rates next year?

We reckon no. The Bank of England will flirt with rate rises through much of 2016. It has good reasons to avoid a decision. Inflation will lift off from zero very slowly, wage growth is weak; oil prices are weaker; and deficit reduction will prevent a boom. The consequences of a spell of higher than target inflation are also limited.

Later in the year, the Bank of England might decide to act, but even if it did, it would not make much difference. As far as interest rates are concerned, Britain is in what governor Mark Carney says is a “low for long” world, for some time longer.

What of China in 2016?

China has been roiling global markets all summer as its authoritarian leaders tried to stop a huge stock bubble from bursting and its slowing economy from stalling. What happens in China now has a major impact on global markets, so it’s worth discussing the outlook for the Chinese economy in depth.

In 2016 the story will not be about a slowing economy. As recent industrial production numbers indicate, measures to stimulate the economy are starting to have an impact. Investment is picking up in response to stronger infrastructure investment. State-owned enterprises have also been investing more heavily.

This represents a return to the old investment-and-export-led growth model from which Beijing was trying to escape. When confronted with a slowdown earlier this year that far exceeded their expectations Communist party officials changed course, no doubt fearing that high unemployment in older industries would lead to social unrest, that could pose a threat to the party’s grip on power.

Next year will provide conclusive evidence on whether plans to rebalance the economy towards consumption and continue with financial liberalisation have gone out of the window.

Chinese industry has been struggling with an uncompetitive exchange rate. That problem has been exacerbated by the renminbi peg to a soaring dollar. The decision earlier this month to switch to managing the renminbi relative to a basket of currencies helps the transition to a more market-determined exchange rate. But it also provides a smokescreen for the People’s Bank of China to bring about a depreciation of the renminbi. At the same time a sharp fall in producer prices is contributing further to the real depreciation of the currency.

Cheaper imports from China would be a useful spur to increased consumption, coming on top of a decline in the oil price that has boosted consumer incomes. A sharp depreciation, perhaps prompted by further resort to competitive devaluation by Japan, might be another matter, especially if it unleashes a protectionist impulse in the US in a presidential election year.

Will Jeremy Corbyn still lead Britain’s Labour party a year from now?

We reckon yes, and for several reasons. The first is that a majority of the party, if not its MPs, want him to. Despite Labour’s weak showing in the opinion polls, the rank-and-file seem happy with the direction the party is taking. Then, there is the congenital loyalty of Labour MPs. Unlike the Tories, the party has never excelled at character assassinations.

What of the oil price in 2016?

The oil market in 2015 was brutal for anyone trusting in a rapid rebound from the previous year’s crash. The tenacity of the US shale industry and surges in output from Iraq and Saudi Arabia meant the world was awash with crude. Early in 2016, the lifting of sanctions on Iran has brought yet more oil to the market.

Still, the financial stresses of oil producers worldwide are forcing them to cancel projects and cut drilling programmes, curbing future supplies, and the impact will become apparent. Brent crude below $50 per barrel is too low for the industry to make the investments needed to meet growing global demand. Providing the world economy does not skid into recession, this looks like being the year that the oil price heads back to more sustainable levels – but it may well head lower first.

Will George Osborne scrap tax relief for pensions in his March Budget?

I think yes. The UK chancellor put off making a decision on the matter at November’s Autumn Statement. But he sent a strong signal that far reaching change is coming. Upfront tax relief on pension contributions currently costs the exchequer nearly £50bn a year. A mooted “Pensions ISA” would slash this bill as workers would accumulate savings out of their taxed income instead, with the guarantee of withdrawing it tax-free upon retirement. The change would take years to implement.

And what of the markets?

It’s difficult to find cheap investments. However, we note that an investment in the FTSE 100 share index yields nearly 4.0%. With interest rates looking more, rather than less likely to hover at their current depressed levels, long-term investors really have no choice other than to buy shares; regardless of the outcome for the market in 2016.

The falls we’ve seen at the start of the year presage what we think will be a tough year for long-term investments – but this could well throw up opportunities, which we think we could take advantage of.

We wish all customers a happy and prosperous New Year,

PS Don’t forget the usual risk warning for all long-term investments: “The value of units can fall as well as rise, and past performance is no guarantee of future performance. The value of income payments from investment funds is not guaranteed and can fall as well as rise”.