Fiducia Market Commentary
In contrast to last year where markets rallied strongly over the summer months, this year markets have experienced the opposite with the end of July proving a turning point for risk assets. Investor confidence was high in the first half of the year as markets shrugged off several significant events from the nuclear crisis in Japan to unrest in North Africa. Initially bailout packages provided enough liquidity to divert attention from the more challenging questions of the solvency of several EU members. Investor sentiment changed as growth and earnings downgrades and reductions in sovereign credit ratings across developed nations, even the US,pressured markets lower.
In the ‘risk off’ environment over the past twelve months fixed interest funds have performed strongly, with the largest gains from Index Linked Bonds. Persistently elevated levels of inflation and expectations of future inflation have helped Index Linked returns reach over 17% in the past year. Conventional Bonds have also performed well in this environment despite the historically low yields offered. This is a trend which could easily reverse in the absence of a more robust solution to the EU crisis.The cost of borrowing for Italy, Spain, Portugal and Greece is unsustainably high and edging higher, increasing the risks to these Bond funds.
Other assets considered ‘high risk’, such as Private Equity and Emerging Markets, have performed poorly over the year with both sectors losing near to 10 percent.Contrary to the sector performance, our two Private Equity funds have both posted gains over the year. Our core UK and Global Equity funds tell a similar story as gains have been positive over the year compared to negative sector returns on average. Absolute Return funds have struggled to keep pace with Bond funds but on the whole have delivered returns in excess of cash, thus preserving capital values in what has been a challenging year.
The FTSE and other leading stock markets have recovered ground over the past couple of weeks, but we still maintain our cautious stance which we have held for some time. The fundamental differences in policy between Germany and France have to date prevented agreement and a solution to the Euro crisis. As a result, Bond markets have priced in a 30%chance of a break up of the Euro with spreads between German Bonds and those of peripheral nations now at their highest since the ERM debacle in 1992. Greece,Italy and Spain all now have new governments which are attempting to reduce their respective national debt by even greater austerity measures.
We continue to expect a Euroland solution to be agreed which is likely to involve further quantitative easing and encompassing a restructuring of existing debt. The recent intervention of leading Central Banks to make it easier for commercial banks to borrow will go some way to ease the liquidity issues that have been arising in the banking system. We also view the moves by France and Germany to create a fiscal union as very significant and, as a consequence, should pave the way for the ECB to assist Italy and Spain in particular.
There are more positive signs across global equity markets with corporate earnings projections and valuations becoming more attractive, particularly in emerging regions such as India, China and Brazil.While growth has been slowing in these regions, the GDP figures are relatively strong and there are early signs the inflation has peaked which should leave scope for monetary easing, and in fact it has already begun.
Japan impressed with GDP growth of 1.5% in Q3, is undervalued and offers diversification from other developed economies. The latest data also suggests that monetary stimulus appears to be working in the US, with noticeable improvements in the money supply. However, we expect market sensitivity to news flow to remain high in the coming months. We also believe that Bond values are in “bubble territory”,and therefore we will continue to reduce Bond exposure in the lower risk portfolios. In addition, our equity exposure is still focused on defensive,dividend paying global companies. The asset protection mode of our portfolios which has proved effective throughout a very challenging year will, therefore,continue.