Q1 Commentary, April 2019

Q1 2019 Commentary
This is one of the few months where you will have received three commentaries from me so I will keep the words short and reiterate our views via a series of charts so that you can, quite literally, see where we are coming from.

Macro Overview
The charts below show clearly how China tightened policy but have now started to reverse course. Significant tax cuts are in addition to this.

Charts 1 and 2. Chinese policy tightening

Source; Gavekal Data/Macrobond

The following set of charts show the impact of trade tensions in China in terms of both the stock market and currency. As you can see it works both ways and we are hoping some more lasting easing of tension allows for a decent period of calm, enabling businesses and consumers to plan better.

Charts 3 and 4. The impact of trade war tensions on China

Source; Gavekal Data/Macrobond

Much has been made of the recent sharp slowdown in European Manufacturing. Cars are at the epicentre of the issue and Chart 5 demonstrates the weakness was against a very temporary unsustainable spike and has already begun to recover (unlike production as inventories continue to be run down).

Chart 5. Eurozone, passenger car registrations

Source; Gavekal Data/Macrobond

The following chart not only highlights the long overdue (if still moderate) fiscal expansion but also how contractionary European policy has been in aggregate since 2011. No wonder growth was so slow until 2016.

Chart 6. After a decade of austerity, fiscal policy is loosening across Eurozone

Source; Barclays Economics Research

Whilst near term the economy is, if anything, weaker than what was expected during the December swoon in equities, shares across the globe have risen strongly on accelerating Chinese easing, de-escalation of trade tensions, and the capitulation by Central Banks elsewhere. This is best characterised by the Philadelphia Semiconductor Index (SOX). You can see how well it has bounced back year-to-date despite industry components such as Samsung and Infineon downgrading profit forecasts by meaningful amounts. This is because several companies have commented that a turnaround is imminent despite how bad things are now.

Chart 7. 1 year chart of the PHLX Semiconductor Sector Index (SOX)

Source; Google finance, (01.04.18-01.04.19)

Bonds of all types have rallied too – High Yield on the expectation policy shifts will keep the show on the road and government bonds for the opposite reason i.e. that growth and inflation are collapsing. Many, including me, are often baffled by the reaction of German Bunds in times like this (yesterday an auction of 10 year Bunds with negative yields was covered more than twice by demand). The chart below explains why.

Chart 8. Hedging costs change the returns for Eurozone and US investors

Source; Gavekal Data/Macrobond

The beauty of globalisation. Who would have thought Americans could earn a higher return on a bond yielding zero than they could on their own bond yielding about 2.5%?

The table below shows performance of several key asset classes from close on the 31st of December until close on 29th March 2019.

Figure 1. Percentage change in markets and currencies from 31st December 2018 to 29th March 2019

FTSE 100 +8.19% Euro : £ -3.89%
S&P 500 +13.07% Euro : US $ -2.01%
CAC 40 +13.10% Yen : £ -2.91%
DAX 30 +9.16% US $ : £ -1.92%
Hang Seng +12.40% UK 10 Year Gilt Yield – 28 basis points
NIKKEI 225 +5.95% US 10 Year Bond Yield  – 26 basis points
Brent Oil +24.78%

Activity & Positioning
Thus far we have been rewarded for putting money into equities as prices tumbled late last quarter and we have further re-orientated into the UK and Gold as this quarter has progressed.

We can see below both how cheap the pound is versus the dollar and how our gilt yield has compared over time against its US counterpart. There are no prizes for guessing when the referendum was!

Chart 9. ‘Cable’ is still very cheap but sterling/euro is not

Source; Gavekal Data/Macrobond

These charts explain why we prefer sterling based assets and why we don’t like gilts (or European Bonds). It should also be remembered that in both the U.K. and most of Europe bond yields remain significantly below the rate of inflation. This is not the case in the US

Chart 10. UK gilts: the world’s worst investment?

Source; Gavekal Data/Macrobond

Performance has been solidly positive this quarter in absolute but a bit light in relative terms as three aspects of portfolio positioning conspired against us. Firstly, our overweight in Japan continued to hurt a little as investors await a turnaround in economic activity before re-committing to an index with a more cyclical makeup. Although we reduced our Japanese exposure to finance increased exposure to the UK, we continue to like the long term restructuring story.

Secondly, in the mirror opposite of last Q1, gilts handily outperformed cash and we have negligible exposure here for the reasons mentioned above.

The last area of detraction was from the domestically exposed holdings of the Woodford and Invesco Strategic Income Funds. Some of this is attributable to bad stock picking but year-to-date most of it has been due to a small and mid-cap domestic company bias. To put this in perspective, each fund has about 60% of underlying companies revenue sourced from the UK versus only about 27% for the index. It is to be hoped stock picking will return to something close to the success levels of 2000- 2015 and not continue at the poor run rate since. We should know by year end. We have owned vehicles run by Mark Barnett since April 2009 and through early 2016 his Keystone Trust was the best performing UK fund for our RJIS Income clients, outperforming peers by over 60%. We didn’t like the overall hype or valuations of some of his stalwart stocks (e.g. tobacco) when Woodford started and waited to buy until he had sold down tobacco and underperformed peers by 17% from the peak. We first bought the Income Fund in November 2017 and reached our current position after buying in four small instalments, usually after a period of further underperformance. In retrospect this has still been too early. This latest setback is more disappointing as the fund outperformed handily in the downtown during the second half of last year. At any rate I am convinced that there is money to be made in the strategy of buying under-loved UK equities. Either investors will return or foreign corporate buyers will flock to buy cheap assets in a cheap currency. It should be noted that most of our other UK managers have been tilting more towards UK sourced revenue of late but not nearly to the extent of the two funds mentioned. 

Figure 2. Portfolio changes since 31st December 2019 – RJIS

Harpsden Portfolio Strategy Bought Sold
90% Equity 4% JOHCM Japan A Hdg

2% iShares Physical Gold ETC

1.5% Merian Gold & Silver

4% JOHCM Japan A

3% Allianz structured return

1.25% JOHCM Japan A

Growth 3.25% JOHCM Japan A Hdg

3% Woodford Income Focus

1.5% Standard Life UK Equity Income Unc.

2% iShares Physical Gold ETC

1.5% Merian Gold & Silver

3.25% JOHCM Japan A

2.5% Allianz structured return

2% First Trust US Equity Income ETF

3% Woodford UK Equity Income

1.5% JOHCM Japan Hdg

1.25% JOHCM Japan A

Income & Growth 3.75% JOHCM Japan A Hdg

1.5% Polar Capital North America

4% Woodford Income Focus

1.5% JOHCM UK Dynamic

1.5% Standard Life UK Equity Income Unc.

2% iShares Physical Gold ETC

1% Merian Gold & Silver

3.75% JOHCM Japan A

1.5% Allianz structured return

2.5% First Trust US Equity Income ETF

4% Woodford UK Equity Income

1% Jupiter India

1.5% JOHCM Japan Hdg

1.25% JOHCM Japan A

Income 1.5% Blackrock Continental European Income

4.25% Woodford Income Focus

1.5% Standard Life UK Equity Income Unc.

2% iShares Physical Gold ETC


1.5% Allianz structured return

2% Polar capital North America

4.25% Woodford UK Equity Income

2% JOHCM Japan

0-35% Equity 1.5% Woodford Income Focus

2% iShares Physical Gold ETC


1.5% Woodford UK Equity Income


Ethical 4% Sarasin Food & Agri Opps

3% Nordea Glbl Climate & Environment

Sell 7.5% Jupiter Responsible Income

We added significantly to our gold position as Central Banks are ensuring real interest rates will remain low and also as a hedge against market dislocations.

As mentioned above, we are happy we added to equities during the Q4 swoon and will continue to try and add value by embracing rather than being frozen in the face of market volatility.

This may come about as, once again in the mirror image of Q1 last year, profits are likely to disappoint near term despite market strength.

There is the possibility that at the aggregate level political and policy developments overwhelm earnings but I doubt it will be so for all individual companies.

However, despite the likely wobbles in between, I am reasonably confident more money will be made between now and year end. With the obvious, and big, caveat that this is dependent on policy makers behaving themselves.

Best Regards,
Ian Brady
Chief Investment Officer
2nd April 2019

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 you 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.

Copyright © Harpsden Wealth Management Limited 2019 (unless otherwise indicated). All rights reserved.

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