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2016 Half year review

07 July 2016

Jonathan Marriot – Chief Investment Officer

Looking back over the first half of 2016, the FTSE 100 index increased by 6.7% when dividend payments are taken into account. However, this positive performance disguises the substantial equity market volatility seen in February, and again following the Brexit decision in June. There has been a very wide dispersion of returns within the UK equity market and this has been seen across global equity markets too. To illustrate just how varied sector performance has been, the FTSE All-Share Bank sector was down 20.4% in the first half of the year, while the FTSE All-Share Mining sector was up 44.8%. There has also been a large variation in the regional returns of equity markets. The Euro Stoxx 50 index was down 9.4% on a total return basis, while the US S&P 500 was up 3.8%. Government bonds have rallied and the UK’s ten-year-gilt yield is now below 1%, having been around 2% 12 months ago. This has resulted in individual holdings within balanced portfolios performing in very different ways. It has been more important than ever to diversify portfolios to mitigate this volatility.

The Brexit vote came as a surprise to markets and, on the evidence of comments shortly after the polls closed, to many of the leading leave campaigners. We now face a very uncertain future with new political leaders trying to deal with the aftermath. We do not know how it will pan out for the UK but the market moves around the vote give an indication of some of the fears in the market. The FTSE 100 and sterling fell sharply in the first couple of days after the vote but the FTSE 100 recovered as investors realized that many of the index member companies would benefit from the currency weakness.

However, the moves in the headline index are again misleading. The FTSE 250 index was down -6.3% from pre-referendum levels. Many Bank names remain severely depressed while companies with overseas earnings or exports have risen. While US equity markets fell in dollar terms they were up in Sterling terms due to the weaker pound.

European markets suffered a knee-jerk reaction and moved down as fears of a spread of any anti-European Union sentiment. The rise of populist anti-austerity political parties has been one of the characteristics of European politics. However, in the Spanish election the incumbent party gained ground allaying some of these fears. The referendum in Italy on important constitutional reforms in September will be the next test for the establishment and we will be watching opinion polls in France and Germany ahead of their elections next year.

As we have become accustomed to government bond markets responded to equity market volatility with yields sharply declining. The Bank of England has indicated that the base rate may fall during the summer. The UK’s ten-year-gilt yield fell below 1%. In the US, the markets moved to price out a rate rise this year and in Germany ten-year-bond yields moved negative. Despite yields being historically low, these moves show that government bonds can still have a role in smoothing returns at a time of economic and political troubles.

Sterling based clients who held well diversified portfolios, with US dollar denominated holdings and Gilts in particular, will find that their portfolios have been much less sensitive to market moves during the recent market volatility.

As far as the outlook from here is concerned, it is clouded in political maneuvering which is difficult to predict. In addition to Brexit and the impact of European votes, we will have a US presidential election to deal with. Markets do not like uncertainty so markets in the UK and Europe in particular are likely to remain volatile in the months to come. Investment decisions may be deferred and this is likely to slow economic growth. However, at times of volatility we need to remember the world is not coming to an end, day-to-day life continues and businesses continue to trade.

The weaker currency may make exporters more competitive in the global markets, helping counter the effects of delayed investment decisions. However, a weaker currency will increase prices for UK consumers. Global companies may continue to do well in sterling terms but domestically focused businesses may find things more difficult.

As portfolio managers we continue to follow developments and make appropriate changes when necessary. For those looking to mitigate the volatility in markets, a well diversified approach should continue to smooth returns.

Source: Bloomberg 30th June 2016