Commentary, January 2020 Asset Allocation

Macro Overview

Not much has happened since the last meeting at the end of November. Apart from the UK election, the assassination of Iran’s General Soleimani by the US, the outbreak of the coronavirus in China, the signing of Phase One of the Sino-US trade agreement and the impeachment of the US President.

And of course a noticeable improvement in forward looking industrial data and management confidence.

One of the most noteworthy developments was the surge in UK related activity numbers in January compared to a moribund Q4. This has resulted in wild swings in expectations with regards to a Bank of England interest rate rise, where the probability went from below 50% to 70% then back down again all in two weeks. In a time of startling numbers UK retailing ended the year with the longest period of no growth since records began in 1957. The FT reported that even online retailers had negative numbers in the latest series. Then in January the CBI Manufacturing Survey recorded the biggest ever quarterly swing since its inception in 1958, as it soared to +23 from -44. London property sales are up 19% so far in January whilst the PWC Survey observed that European CEOs regard the UK as a key market for growth and investment, with its “attractiveness” back to levels last seen in 2016. Chancellor Javid has added to both confidence and uncertainty within days by saying both interest rates are a sign governments should invest whilst also suggesting ‘’not all companies will benefit from the government’s determination not to pursue EU equivalence on all regulation’’!

On a brighter note see below the Man GLG chart showing how the UK Economy grows when a large Parliamentary majority is won;

Chart 1. 1945 – Present: Largest Parliamentary Majorities and Subsequent GDP Growth

Present: Largest Parliamentary Majorities and Subsequent GDP Growth

Source; Man GLG, Lazarus Partnership and Wikipedia. Data as at 31/12/19

Elsewhere, US job growth was strong but inflation a tad below expectations while both Chinese Industrial Production and Retail Sales growth were decent amidst an overall in line 6% GDP growth print for Q4.

The Japanese government edged up GDP growth estimates for the coming year from 0.7% to 0.9% whilst the EU noted a slight diminution in downside risks.

The very cyclical South Korean and Taiwanese economies also reported much stronger growth in Q4 after a prolonged period of weakness.


Equity markets and Sterling had been strong since our last meeting until the virus was discovered, with UK Small Cap and US leading the way. Hong Kong looks to have been the strongest market but this will likely dissipate for a while when it reopens after the Lunar New Year, due to the coronavirus. Since the discovery of the virus there has been a sharp knee jerk sell off in equities, as is normal (this will be discussed in more detail below).

Bond yields have fallen sharply in light of the virus. Up until the outbreak Euro yields had backed up a bit, US had been flat while UK yields had fallen a bit. Weak Q4 data, the PM’s insistence on not extending the December 2020 deadline and openly talking of a Canada-style agreement dwarfed the very strong January data referred to above.

Despite a meaningful rally in both absolute and relative terms from UK domestic shares since Boris announced his ‘deal’ on September 2nd, the chart below from Montanaro shows there is still a considerable way to go to in order to close the post referendum gap. We continue to be positioned for this.

Chart 2. The “Buy the UK exporters/Sell the UK domestics” ended in Q4

The “Buy the UK exporters/Sell the UK domestics” ended in Q4

Source; Montanaro, Bloomberg (Indices). The FTSE UK Local Index includes UK listed companies with >70% sales to the UK.

The following chart from bond specialists Twenty Four Asset Management shows how important starting yields are on subsequent bond returns and where we are now. This, as well as the fact that some parts of the corporate market are displaying higher leverage and lower lending standards, leaves us wary of the sector.

Chart 3. The correlation between starting yields and returns

The correlation between starting yields and returns

Source;TwentyFour AM, underlying data from BAML. November 2019. Yields are of the BAML Global Aggregate Index. X-axis is starting yield, y-axix is holding period return over rolling months

The table below shows performance of several key asset classes since the last Asset Allocation meeting;

Figure 1. Percentage change in markets and currencies from 28/11/19 to 27/01/20

Percentage change in markets and currencies from 28/11/19 to 27/01/20

Activity & Positioning

We added in increments to UK equities both before and immediately after the election, as we have been intimating we would do all year. We also added a little into an Energy ETF as a strong earnings rebound is expected this year on the back of slightly stronger demand growth, higher average selling prices and improved supply discipline. Although it will still grow, shale expansion will slow due to the capital constraints that have contributed to the widespread bankruptcies in the US oil patch this last year. The dramatic increase in ESG awareness of late has probably contributed to the magnitude of the underperformance of Energy shares in 2019. Even the pessimists concede more oil will be needed every year until about 2030 so when the above is considered with the vastly improved capital discipline of oil companies (as well as a step change in the attitude of energy companies towards a greener future), an interesting cyclical opportunity has arisen.

As mentioned in my last commentary, although we are keen on equities for the year we took a little off the table from Japan and the US as all markets have run very fast and we wanted to recycle into other Asia and the UK as opportunity arises.

So in summary, we are expecting a positive year ahead, interrupted by the odd, attention drawing, period of drawdown.

Figure 2.  Portfolio changes since the November Asset Allocation meeting – RJIS

Portfolio changes since the November Asset Allocation meeting – RJIS


2019 was the mirror image of 2018 as dramatic monetary easing enabled strong financial market returns in the face of precipitously falling EPS estimates globally. The strong rise was slowed a couple of times by geopolitical events but all was well in the end.

That leaves us looking at 2020 where neither equity markets nor especially bond markets are particularly cheap but EPS should see a decent rebound.

The unfortunate outbreak of the Coronavirus might, from a strictly investment perspective, be an opportunity as it could give us the chance to buy some of the funds mentioned in my Q4 commentary. We will monitor developments closely.

We are, viruses notwithstanding, confident that world trade and GDP will be a bit better this year than last. We are also of the opinion that at least the Bank of Japan, ECB and Federal Reserve will allow economic growth to accelerate without talking about raising interest rates as quickly as they have done in the past. All have more or less said as much over the last few months.

So despite the big moves in equities last year there should still be some money to be made as profits increase and liquidity remains available.

However, on this last point we should note that the Federal Reserve is due to reduce the amount of Treasury Bills it buys per month around March so this could cause some short term volatility. However, it shouldn’t have a lasting impact on growth and will probably be used as another opportunity to buy.

With the pick up in UK confidence, upcoming fiscal spending and remaining gap between domestics and international earners we are keeping our current UK weighting, especially given that Sterling is still cheap on a Purchasing Power Parity (PPP) basis.

The Charts below from Gresham House show the UK is still cheap versus global equities and within the UK small cap is still at a discount despite the recent rally. As economic growth recovers both these divergences should narrow from current extremes.

Chart 4. Valuations UK, Rest of World (Last Decade Average=100)

Valuations UK, Rest of World (Last Decade Average=100)

Source; Gresham House, Panmure Gordon, Refinitiv 2019

Chart 5. ‘Small Cap Discount’ – Median Small Cap P/E – FTSE 250

‘Small Cap Discount’ – Median Small Cap P/E – FTSE 250

Source; Gresham House, Panmure Gordon, Liberum research December 2019

Similarly, profitability in several parts of Asia looks promising and a further attraction is that markets there have not re-rated as much as their Western counterparts.

With regards to US Presidential impeachment and elections we have the following view. I alas agree with the FT who said the voting for impeachment was almost entirely on partisan grounds and the acquittal will follow a similar path. On the election, it is Mr Trump’s to lose on two counts. One is that, of the last ten incumbents to stand, seven have won and secondly I am not sure Americans are ready to move as far to the Left as either Sanders or Warren are proposing. If Mr Bloomberg surprisingly gets the nod for the Democrats then that would be a closer call.

Markets, particularly in Asia, are very likely to be pressured in the near term by the virus but in the event of SARS the recovery was very dramatic. From the first reporting of SARS in early November 2002 until the peak in March 2003, the Hang Seng Index fell about 15% versus a fall of about half that for the S&P 500 (the end of the Dotcom Crash and looming Gulf War Two were also at play then). By the end of 2003 both indices were up about 25% from November 2002, although again other things were at play i.e. end of Dotcom Crash and early enthusiasm about ousting Saddam.

I enclose a research piece from Gavekal Research below describing their thought process regarding the early stages of the Coronavirus outbreak and how it might evolve;

“At this point, a quick reality check is in order. So far, there is no reason to believe that Wuhan flu is either more infectious, or more lethal, than Sars. Although information about the early stages of Sars is patchy, at least in the initial phases the patterns of transmission look relatively similar.

What is entirely different this time around is the attitude of the Chinese authorities, their degree of transparency, and the level of knowledge and preparedness among health services in China, and across much of the world. When the first case of Sars was detected in the Chinese city of Foshan in November 2002, it went unreported to the local health authority. And when it did become clear that a mystery illness had broken out, all media coverage was rigorously suppressed, with the Chinese government even attempting to block an investigation by the WHO. It was the end of March 2003 before the spread of disease in Beijing was reported in the capital’s newspapers.

The contrast this time around is marked. The Chinese authorities have already sequenced and published the genome of the Wuhan flu virus, and on Tuesday the ruling Communist Party declared that any official trying to cover up infections would be marked as “a sinner for eternity.” What is more, medical services in China—and across Asia—are vastly more sophisticated than 17 years ago. Communication is better, knowledge of viral outbreaks is greater, preparedness to deal with them is higher, and staff are far better trained. In short, unless Wuhan flu proves far more easily transmitted, with a far greater fatality rate than Sars, there are good reasons to believe the current outbreak can be contained much more quickly, and with many fewer fatalities”

So my current stance is this will provide the opportunity to add to Asia despite recognising calling the exact bottom is very unlikely.

Best Regards,


Ian Brady

Chief Investment Officer

28th January 2020

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Current Asset Allocation

Harpsden current asset allocation

Important Information/Risk Factors:

Past performance is not a guide to future performance and investment markets and conditions can change rapidly.  Investments in equity markets will be more volatile than an investment in cash or fixed deposits.  The value of your investment may go down as well as up.  There is no guarantee you will get back the amount invested.  If your fund invests in overseas markets, currents movements may affect both the income received and the capital value of your investment.  If it invests in the shares of small companies, in emerging markets, or in a single country or sector, it may be less liquid and more volatile than a broadly diversified fund investing in developed equity markets.

The views expressed herein should not be relied upon when making investment decisions.  The article is not intended as individual advice and if you require advice or further information you should contact us.

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