Q4 Commentary, January 2020

Macro Overview

Economics mattered in Q4 but not that much. Politics and Policy that investors deemed will make 2020 better than 2019 mattered much more. This included no Corbyn in Downing Street, meaningful fiscal stimulus in the UK, a rekindling of formal QE in Europe, informal QE in the US, some progress towards a Sino-US trade deal and a slew of interest rate cuts and other stimulus measures across Asia.

More evidence of stabilisation in the manufacturing economy appeared and this was accompanied by a pickup in confidence.

The two charts below highlight this;

Chart 1. Manufacturing recovery underway

Source; BMO Global Asset Management/JPM/Minack Advisers as at 31 Oct 2019

Harpsden Manufacturing Recovery

Chart 2. Baltic dry index and global manufacturing PMI

Baltic dry index and global manufacturing PMI

Source; J.P. Morgan, Markit, Bloomberg. Note; the Baltic Dry Index is a proxy for global shipping and trade.

This could become a virtuous circle but work remains to be done to ensure it pans out this way. There is some concern that the US will up the ante on European trade as soon as a China trade deal is signed. This will not be a welcome development. With regards the UK, Mr Johnson followed up his gracious speech to “rentier” new Tories “Up North” by putting into law a December 2020 deadline for leaving the EU. This was not what the majority of UK businesses wanted to see (even if the majority of the electorate did) as it throws up the spectre of a hard Brexit again. Sterling immediately sold off significantly after the PM proposed this Bill.

So it is unclear to what extent business leaders around the globe will take a glass half full view as opposed to a glass half empty view. I still expect 2020 to be better for the industrial economy than 2019 but the more predictable the outlook for global trade becomes the more meaningful the improvement will be.

Riots, as per normal in France but much more serious in both Hong Kong and India, had marginal impact on most financial assets and (thus far) not as much as headlines would have suggested could have been the case. Still, citizens in many parts of the world are more restive than they have been for a while and this does bear monitoring, as it could lead to radical shifts in policies and/or regimes.


Sterling gained as Labour waned while assets that benefit from a stabilisation in trade rose. Bonds and bond proxies struggled as yields backed up.

I said way back in 2010 that we would probably make more money over the next decade than we had in the preceding ten years but have a lot less fun doing so. This year encapsulated that sentiment well with the wall of worry seeming at times like a never ending mountain range with ever higher vertical faces to scale.

However, surmounted they have been with Central Banks and Governments supplying the adequate equipment to get the job done.

In the commentary I sent out last year I said investors would end 2019 feeling a lot happier about economies and markets than they had been feeling at the end of 2018 and I reduced cash accordingly to put to work in equities. However, the way we arrived here was not quite the route I was expecting as both Brexit and US-Chinese trade talks took an unexpected twist in May.

The good news is that the negative hysteria of the August low seems to have been misplaced, at least for the foreseeable future, thanks to policy actions.

However, what that means, at least at the index level, is that a lot of the undervaluation (in my estimation) has been worked off and 2020 at the index level will not be as rewarding in terms of returns as 2019 has been. Given the yield premiums of equities over bonds of all types and the growth potential of corporate dividends, returns can still be positive. However, I would be (pleasantly) surprised if indices across the board posted significantly positive returns this coming year.

The other thing to be careful of in 2020 is that the rhetoric of Central Banks seems to be changing, in that they are giving the impression they will be slow to take steps to rein in an accelerating economy, should such an uptick occur. There is also increasing anecdotal evidence that several of the big Central Banks, whilst happy with low rates, want to try and engineer steeper yield curves. Sweden are the first European country to formally abandon a negative interest rate policy and the US Fed are buying short term bonds – much shorter duration than under their prior formal QE policy. No one can say when or if they will be successful in this goal but I am sure even the attempt will cause some interesting ramifications for investors. The way I have thought about this is that QE was originally designed to be used like a monetary version of a defibrillator (kick start a stopped system) but has ended up being implemented as if it were a stent (longer term solution for lack of flow of money into the economy). Increasingly policy makers are adjusting to the view that fiscal policy will be a better and more politically viable stent.

The table below shows performance of several key asset classes during Q4 2019;

Figure 1. Percentage change in markets and currencies in Q4

Percentage change in markets and currencies in Q4

Activity & Positioning

Given my view expressed above that indices have moved a lot these last twelve months (albeit off of a low base) I am going to give several examples below of funds we own and markets we are looking to add, where all of valuation, dividends, balance sheets and profits imply the odds of making positive absolute returns over the next twelve months are quite positive (alas nothing guaranteed in investments).

The first is the Fiera Magna Emerging Markets Dividend fund. This fund is forecast to deliver earnings growth of 10.5% compound for the next three years, has a forecast dividend yield of 4.5%, and has an average anticipated Return on Equity of 25%. Yet it trades at an undemanding 12 PE ratio for 2020. The strategy description claims “we wish to invest in quality companies, with strong managements and sustainable growth prospects, at attractive valuations.” This is on top of 10% EPS growth delivered in 2019, which was much higher than the growth delivered by the MSCI Emerging Market index, or indeed any of the developed market indices.

The second one is the Fidelity Asian Smaller Companies fund. After outperforming as anticipated in the tough market conditions of 2018, this fund lagged badly in 2019, as it did in the racy market of 2017. You can see from the chart below (which refers to the very similarly constituted Investment Trust run by the same manager) this is due to a big de rating (from 14 to 9) in the valuation ascribed to the fund. This is despite the Return on Equity of the fund actually exhibiting a slight rise off of an already decent level (see accompanying table). If the companies keep on delivering in the manner they have then I am confident that the fund will regain a higher valuation, to the benefit of holders.

Chart 3. Fidelity Asian Values PLC portfolio lookthrough PE multiple falls to the lowest levels since portfolio restructuring

Source; Stifel, Fidelity company data

Fidelity Asian Values PLC portfolio lookthrough PE multiple falls to the lowest levels since portfolio restructuring

Figure 2. Fidelity Asian Smaller Companies vs MSCI AC Asia Pacific ex Japan Australia 10% Cap USD

Fidelity Asian Smaller Companies vs MSCI AC Asia Pacific ex Japan Australia 10% Cap USD

Source;Fidelity. Note; Ex Financials and cash.

Jupiter India is a fund we added to last year, off of a small initial position. Again, the fund lagged quite significantly due to a relative and absolute de rating of medium and particularly small companies in relation to their mega cap Indian counterparts.

Chart 4. Daily relative Price/Book Value to Large Caps: Small and Mid Caps

Daily relative Price/Book Value to Large Caps: Small and Mid Caps

Source; Alquity Asset Management (Updated until 8th December 2019)

Even the overall Indian market lagged developed peers last year despite delivering mid teens EPS growth that far outstripped the zero to very low single digits achieved in Europe, Japan and the US. This is because the macroeconomic numbers disappointed as the recovery from the crackdown on the shadow financing sectors and tax avoidance has taken longer than expected. The authorities have since enacted a series of tax cuts and interest rate reductions and we expect a rebound of sorts in both GDP Growth and investor confidence (good for small and mid cap stocks).

Two other areas within Asia that we are also interested in are Vietnam and Chinese Smaller Companies. There is evidence to suggest that Chinese smaller companies offer the same liquidity as smaller companies in the US. They are also much more exposed to the structural areas of growth such as consumer and healthcare, compared to the more financial and commodity dominated large cap indices. Yet they trade at much lower valuations than their Western counterparts due to concerns about market structure and the short term trading bias of domestic retail investors. However, the market, like the country, is vast and specialist professional managers can identify many fast growing companies at compelling valuations.

Vietnam is another Asian stock market that has been de rated on headline trade related fears, despite delivering EPS growth far superior to developed markets.

The UK also has many opportunities for further re rating. The chart below from Unicorn highlights how far the re valuation of Small stocks has to go. Both JO Hambro UK Equity Income and GAM UK Equity Income continue to offer 5% yields which are growing and yet the funds only trail at around ten times earnings. An uplift to twelve times would not be a stretch.

Chart 5. Relative value in UK Small Caps

Relative value in UK Small Caps

Source; Unicorn Asset Management and Peel Hunt as at 16 December 2019

Chart 6 below shows how much ground UK domestics have to make up to regain the losses since the referendum.

Chart 6. Divergence in performance of FTSE 100 stocks versus stocks in the FTSE local UK index

Divergence in performance of FTSE 100 stocks versus stocks in the FTSE local UK index

Source; GAM, Bloomberg

Here is a quote from the GAM management team whose fund we own; “Despite the jump in performance following the General Election the fund remains attractively valued on a forward PE of Ten Times and offers a forward dividend yield of 5.1%. Furthermore we are on track to deliver in excess of 5% dividend growth in 2019, which we also aim to deliver in 2020. The free cash flow yield on the fund is over 8% which implies that dividends are amply covered by free cash flow.” This to me bears all the hallmarks of a decent long term investment in most macro environments.

The above are just some examples of funds that offer opportunity due to investor fear rather than fundamental reasons. So we are comfortable that, as a group, we progressively added through 2019 and therefore look set to reap the benefits in going forward. The specific funds we have not purchased yet remain on our watch list and will be bought as soon as opportunities arise.

In terms of actual activity in Q4 we followed our desired strategy of adding incrementally to UK domestically focussed funds offering attractive yields. We did so in three tranches, two before the election and one after. Then in December we added large cap Energy exposure via an ETF. The Chart below augments the yield case for Energy shares by demonstrating how the long term relationship between the oil price and oil related shares has broken down. We did not buy this in anticipation of the recent increase in tensions in the Middle East.

Chart 7. Divergence in performance of BP versus Brent Oil price

Divergence in performance of BP versus Brent Oil price

Source; GAM

Very late in the year we took a little profit in both Japan and the US as an insurance policy against short term turbulence. We consider this prudent and in line with our long held policy of taking the top off after significant upside moves. We are likely to reinvest in Asia for reasons provided elsewhere in the commentary.

Figure 3.  Portfolio changes during Q4 – RJIS

Portfolio changes during Q4 – RJIS


So to conclude, 2019 saw financial assets deliver robust returns but such levels of returns are not sustainable over the long term. In most regions of the world large cap equities outperformed small cap yet in bond markets more lowly rated credits outperformed quality (High Yield sector outperformed Corporate Bonds Sector which outperformed Governments) in an environment ultimately flush with liquidity.

The overwhelming consensus going forward is for a modest uptick in global economic activity without any accompanying acceleration in inflation.

Investors belatedly embraced equities, mostly via passive investments, without giving up on fixed interest.

We are in agreement that many parts of the world will see some improvement by the middle of the year. However, politics at least as much as economic policy will determine the extent of the pickup. With all of semiconductors, autos and energy sectors having put the worst behind them and with unemployment still low and fiscal easing ahead, I find it tough to believe inflationary expectations will survive the year without at least one shock to the upside.

So I am hoping we can eke out positive gains in the year ahead by concentrating on areas with above inflation yields and which can continue to grow these already significant dividends.

Although we already have some Asian representation, the region is not close to being represented in indices to the extent it contributes to current global GDP and it’s even less representative of the impetus Asia provides towards global growth.

We will therefore use any bouts of weakness to add in the above areas, just as we did in the UK last year.

There has been, understandably, much in the press about liquidity this past year in light of the Woodford Equity funds and M&G UK Property Funds. However, in my opinion, a much bigger potential liquidity crisis has faded into obscurity because recent returns have been robust in the asset class. I am referring to High Yield and indeed overall Corporate Bonds. It is well known that the size of the asset class has ballooned since the financial crises whilst inventory and liquidity levels provided by brokers and investment banks have collapsed. This is not a good combination, especially as levels of corporate indebtedness are at or are approaching all time highs. The ratio of debt to underlying profits does not look too encouraging either.

Given, at the best of times, liquidity in these markets is worse than equities I dread to think what will happen if a genuine threat to liquidity occurs. December 2018 gave a little insight into what could happen but the return of easy money has caused investors to put reward, not risk, at the forefront of their thoughts. We have missed out on significant gains this year by being underweight such assets but retain the belief we will be vindicated about concentrating on risk in the times ahead.

So we enter the new decade cautiously optimistic in the expectations the macro environment and drivers of return are likely to be different to the decade just gone.

Best Regards,


Ian Brady

Chief Investment Officer

6th January 2020

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Current Asset Allocation

Harpsden Wealth Management Current Asset Allocation Jan 2020

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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