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Our Investment Team Answer Your Questions!

Our latest quarterly client briefing presentation was extremely well attended, so much so we had to run two sessions!

Given the market turmoil the interest in finding out our views on markets, and how we’ve been positioning portfolios, was perhaps not unexpected.

At the event I presented our views that the current market turmoil is the result of a “perfect storm” of several concerns all arising at once. Slowing growth in China, a strong dollar and an oversupply of commodities, are all reasonably significant in their own right. When they all happen at the same time, the effect is magnified.

However, if the effect on markets is magnified because these things are all happening together, it only needs some small improvements in one or two areas to make quite a big difference. If the dollar weakens or the supply of commodities reduces slightly, then markets will worry less about China’s growth.

We therefore think that things will improve in the coming months and hopefully we’ll see some stability return to markets as we progress through the year, though in the short term they may remain volatile.

The client briefing also gives clients the opportunity to ask us questions. Below are a few of the questions we were asked along with our responses.

 

Are markets already factoring in the EU referendum?

In short, no. Markets are far too fixated with other issues right now.

A number of people think UK gilts could be negatively affected if Brexit looked likely. However, right now their prices are actually being pushed up as investors seek a safe haven. The pound is another asset which could weaken but of late it has actually strengthened.

 

Is the refugee crisis reflected in markets, especially as it starts to destabilise Europe?

This issue in itself has only a limited impact on markets. However, there are already stresses on the Union that markets have been worried about for some time. One risk is that if there is major disagreement between countries on how to deal with the refugee issue, this will add to the stresses that already worry markets.

 

Will my holiday to Europe this summer be more or less expensive if I wait to buy my currency?

We are reluctant to try to forecast currencies as it is extremely difficult and not our area of expertise.

Europe may well increase their quantitative easing programme which would probably push down the value of the Euro if it happened. However, as outlined above, as we get closer to the EU referendum and if a “leave” vote looks likely then Sterling could well fall.

Which of these factors will take precedent is anybody’s guess! I’m therefore going to plump for “about the same” but don’t quote me on it!

 

Do Equilibrium set aside more cash in volatile times?

Yes we do. In fact, what we try to do is set aside cash in anticipation of volatile times ahead!

We did this last year when markets were at their peak. We had less equity than usual and more cash than usual in portfolios, meaning we were able to invest this as markets dropped back.

More recently, last week we sold down some equity as markets recovered above 6,000, which means we now have cash available to take advantage of any further falls.

 

Explain the impact of the dollar on oil prices

Oil is priced in dollars, so the movement of the dollar makes a big difference to the price.

The dollar has strengthened significantly over the past few years. Against the pound, it has gone up from one dollar being worth 58p in mid-2014 to being worth about 70p at the start of February. That’s about a 20% increase against Sterling. Against other weaker currencies, the move has been much more dramatic, around 35% against the trade weighted basket of major currencies.

Let’s assume oil was $100 a barrel when the dollar was worth 58p. A barrel would therefore have cost £58 for someone in the UK to buy.

If oil was still $100 a barrel when a dollar is worth 70p then it would now cost £70 to buy oil; it would be much more expensive.

This means that when the dollar strengthens the oil price tends to fall to offset this effect, and vice versa. Whilst there are other factors affecting oil as well (both supply and demand), the dollar is an important reason for its falling price.

 

How do foreign exchange rates impact on my portfolio?

Exchange rates can impact investments in all sorts of ways, such as that outlined above.

Another example would be a UK based company whose sales are primarily in the USA. They would have benefited from the rising dollar. Its profits would have grown in sterling terms due to the exchange rate. Meanwhile, as the Euro has fallen a company that trades more with Europe would have seen profits fall, again due to currency movements.

When we invest overseas we do not hedge out currency risk. As mentioned earlier we think forecasting currency is very difficult to do. As a result, if we buy Japanese equities we are fully exposed to the Japanese Yen, if we buy US shares we are exposed to the dollar. However, because we diversify investments across a range of regions we also get a wide diversification of currency exposure. Diversification is the best way of managing currency risk in our view.

 

Why do the Chinese suspend trading if their stockmarket drops and what impact does this have globally?

The Chinese stockmarket until recently had a function designed to keep a lid on volatility. If stocks dropped by 5% there was a break in trading. Once trading re-opened, if stocks dropped by 7% on the day, trading was halted for the rest of that day.

This has backfired and actually increased volatility. As markets drop towards the break points then some investors would sell immediately fearing that if they waited they would not be able to sell. This exacerbates any fall. The Chinese have now removed this facility from their markets.

The direct global impact is limited since the Chinese stockmarket still remains relatively closed to outside investors. However, it gives the impression that the Chinese authorities do not know what they’re doing and are trying to hide what is really happening. This hits already fragile confidence.

 

Are any sectors oversold?

The recent market falls have certainly made markets look a lot better value. Generally, they are still not startlingly cheap but look reasonable value. We think Japan is an exception as it was cheaper than many other markets to start with and companies have carried on growing their profits, unlike in some other regions.

Chinese stocks listed in Hong Kong (as opposed to the mainland China indices discussed above) trade on very low multiples of earnings making them look pretty attractive, but of course this is a particularly risky area right now.

Investors may also be able to make a substantial amount of money by buying commodities at the right time. It seems likely that they will bounce sharply at some point. Unfortunately, there is also a reasonable chance they will drop much further before they do! Calling the bottom would be extremely difficult and it would take a braver investor than me to bet on commodities right now!

 

What impact do hedge funds have on markets?

Hedge funds generally don’t have any bigger impact on markets than any other class of investor.

However, computer driven, high frequency trading strategies can add to volatility. These tend to follow momentum strategies. This means that as markets start to fall, they can begin selling and this can make markets fall further.

This probably doesn’t impact much on long term returns but does make markets more volatile in the short term.

 

Our next client briefing will provisionally be held on 26 April 2016.

The content of this blog represents the opinions of Equilibrium investment management team and should not be construed as advice.