Estate Capital portfolio selections – Summer & Autumn 2019

We see global growth slowing as this prolonged business cycle keeps running. The US continues to outperform other markets with emerging markets and Asia being supported by the recent fiscal and monetary stimulus in China. Global monetary policy is expected to remain loose as the Fed is expected to cuts interest rates this year as well as ending quantitative tightening (QT). We expect interest rates in the Eurozone to remain negative. This on-going low interest rate position supports equity investment.

Equities have performed very well so far this year, as the main concerns hitting markets back in Q4 2018 have eased. Some suggest the global economy is back in the ‘Goldilocks’ position of not too hot to create inflation but not too cold to depress growth.

Inflationary pressures in the US have reduced from last year with CPI coming in at 1.9% in March, which is 1% lower than it was in the summer of 2018 when the Fed was rising interest rates each quarter. With the Fed stepping back on interest rate rises, markets have moved higher.The Purchase Managers Index (PMI) of global confidence has been in the green, indicating a generally confident outlook. Only countries affected by China’s slowdown were in the red, namely, Germany, Italy, Japan, South Korea and Taiwan. China’s outlook has now improved and should aid other Asian economies. A slowing global economy is now starting to have an impact upon PMI confidence levels.

A possible threat to growth is the potential rise in oil prices due to OPEC’s production cuts and the Iranian sanctions coming fully into force with the end of the waivers. If oil does move up to US$80pb, this could add inflationary pressures and hit consumer spending. However, analysts are predicting an average oil price of US$65pb this year.

The on-going dispute between US and China over trade and tariffs is still not resolved and could spill out into an extended period of protectionism. Both sides and the rest of the world have a lot to gain and lose here. We hope a resolution is forthcoming before markets get nervous.

Another headwind is the potential squeeze on profit margins due to lack of pricing power in a low inflation world with rising wage and energy costs. Analysts are expecting a 6% rise in US profits this year, but reducing to 4% in 2020. Previous bull markets have been supported by healthy profit and earnings per share growth. We are mindful of future pressure on margins and the impact this has on the growth of stock values.

However, we are feeling a little more confident than we did last December in that the global economy can remain in a late-cycle phase for longer and avoid a recession in 2019 and possibly 2020. There are no signs of the US economy overheating or inflationary pressures in the US so monetary conditions should remain. The Chinese stimulus will feed through to improve the global outlook. Risk assets can perform well late in the cycle but are, as we have witnessed in Q4, prone to volatility. All of this underscores our view of balancing risk and reward through a diversified portfolio of mixed assets.

Again, opinion does differ on the prospects for 2019. There are analysts who see strong economic fundamentals such as good corporate earnings, high employment, low inflation and low interest rates, supporting global growth for at least the next year. Others see slowing economic growth and protectionism through tariff wars as being issues that could tip the global economy into an early recession. We remain cautious.

In January 2018, we first started underweighting bonds and introduced an overweight in cash. Then in June 2018 and January 2019, we progressed this position further as US interest rates increased. Through the year we harvested the growth in funds when available but protected portfolios from the worst of the stock market losses in Q4 2018. Our portfolios were far more robust in limiting losses as compared to the national benchmarks that we measure our performance against. We did however fell behind these benchmarks in Q1 when a higher equity exposure would have improved returns.

We are now a little more confident with the general outlook and have reduced our overweight cash holdings, increased our fixed interest holdings, and generally maintained our underweight positions in equity. We are more comfortable with fixed interest assets since the Fed ended its rate rising policy and now expected to cut rates. We see short duration bonds and global inflation linked bonds as a counterweight to our main equity exposure in the UK, US, Asia and emerging markets.

We have maintained our US positions but moved some of the focus from growth stocks to value stocks. We have slightly extended our overall China, Asia and emerging markets holdings due to the level of Chinese stimulus, low interest rates, low inflation and slightly weaker US$ values. Growth in China is likely to come through in Q2 and Q3. We have low expectations in Europe and have sold our direct holdings. We are now only exposed to European assets through global funds.

We are very conscience that the Brexit Withdrawal Agreement may yet have a difficult path ahead. Despite this uncertainty, UK stocks look attractive as they are undervalued and offer good longer-term prospects, particularly the high dividend paying UK multi-nationals with global reach. We have slightly increased our otherwise underweight UK holdings due to the value UK equity now offers, but remain mindful of the chance of a disruptive Brexit later this year.

We have maintained our full geographic and sector diversification by retaining holdings in healthcare, infrastructure, technology, insurance, financials, gold and global commercial property. This diversification along with a style move to some value focused funds will aid portfolio stability and growth.

We have continued with our exposure to gold and gold mining stocks but no more than 2% in any one portfolio. Gold remains a volatile asset but has performed very well in the past year. While the US$ is strong, inflation growth is at acceptable levels, and there are no near-term serious stock market corrections expected, then it is not worth holding a great deal more at this stage.

As far as fixed interest holdings are concerned, we have focused on short duration global high yield bonds, US Treasuries, global inflation-linked bonds and extended duration investment grade corporate bonds. We have therefore selected bond managers who accommodate this focus. Our bond holdings have risen now that interest rates are not likely to rise at the expense of cash. Our overweight cash holdings were only intended to be temporary until volatility and interest rates stabilised. We are holding a significant position in short duration global corporate bonds, extended duration investment grade bonds and US treasuries as an improvement on cash but without raising risk significantly.

We have again seen our UK bricks and mortar property funds add expensive entry charges for new investment at a time when property values are stretched and performance flat lining. It is therefore time to reduce our direct UK property holdings and move to global property securities instead.

In Edition 30, we took the decision to reduce the overall risk content of each portfolio’s underlying assets. This de-risking strategy was temporary and in early March we moved some cash back into risk assets in order to fully participate in the equity market recovery. Overall, our portfolios were far more robust in limiting losses in Q4 as compared to the national benchmarks we measure our performance against, but fell behind these benchmarks in Q1 when higher equity exposure would have improver returns. Our recent performance has however been very much back on track.

As far as this 31st Edition is concerned, we have increased our fixed interest holdings through reducing cash and have maintained an underweight position in equity. We are still maintaining relatively defensive positions. We hope you are in agreement and comfortable with our actions.

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