UK Equity Markets are down this morning. Communication is key and below are two emails from one of our fund managers which will keep you informed of experts’ views through this difficult time! Please contact us if you have any queries.
“We are seeing new lows this morning in equity markets with the FTSE 100 down 2.5% at 5527 as I write. We held an investment committee meeting on Tuesday and did not reduce our total equity position. The US Federal Reserve’s Janet Yellen speaking yesterday spoke of the risks to the economy from recent market moves but while the tone was softer she was still talking of rate rises later this year, effectively saying let’s not jump to conclusions too soon. She has a difficult path to tread because the market is no longer expecting rate rises but The Federal Reserve at its last meeting was still talking three to four rate rises this year. So while taking a softer tone, she was unlikely to move further than the market. She will be speaking again today and while the text of the formal presentation will be the same, the question and answer section may be different.
Overnight the oil market has dipped with West Texas Intermediate oil down to $26.6 per barrel (Brent is still slightly above $30). Government bond yields have been falling but credit spreads are wider so borrowers are not seeing the benefit of lower rates. 10 year gilt yields are down to 1.3% this morning. This means the 10 year gilt has now rallied 10% this year. The Sterling futures are pricing a near 50% chance of a rate cut rather than a rise.
At times like this we need to remember that markets are more volatile than the underlying businesses, When equity prices fall we should look to see if anything has changed in the underlying business and when markets fall this gives us mare opportunity to make money in future than when they were higher.
At present the FTSE All Share index is on a price earnings ratio of 14.4x and the S&P 500 US equity index is on 15.4x this corresponds to an earnings yield of around 7%. If company earnings halve then we they would still yield more than double UK government bonds at 1.3% for ten years. 3.5% compounded for ten years is over 40%. 1.3% compounded for ten years is only 14%. Long term this very much favours equity investments. The volatility indices were last this high in 2011 during the Euro crisis which is also usually a sign that the market is over shooting on the downside.
However sentiment in risk assets is against this view and it may take time to correct. Yet again it feels like catching a falling knife and in the short run markets may fall further but we do not believe that we should be selling into the falling market at these levels.”
“Over the past few days, markets have taken another leg downwards. This move is once more off the back of nervous sentiment stemming from the usual suspects; the oil price, China, and UK/US interest rates. However over the past couple of days, a new player has walked onto the field, adding an additional trigger to this mix. Since the start of the year, banking stocks have lost 25% in Europe, 19% in the US and 15% in Asia. Negative sentiment has overshadowed earning releases; this negative sentiment having been caused by concerns over the health of European banks.
The recent fear has been sparked by a bond known as a ‘coco’, a tier one contingent convertible bond. Coco bonds are designed to allow banks to rebuild their capital ratios when they are close to breaching the minimum capital requirements from regulators. The cocos may transform automatically from debt to equity, halt their coupon payments or alternatively can be written off when losses force a bank’s capital below a certain threshold. To compensate investors for the risks, coco bonds often paid coupons of 6-7% which was attractive given the yielding environment. The bonds have their roots in the financial crisis when governments were forced to bail out banks, a situation going forward they are clearly keen to avoid. There have been questions over whether Deutsche Bank is able to pay the coupon on their cocos, not for this year or next but for the few years after that. This has sparked general nervousness over the strength of the European banking sector.
Within the MPS portfolios, the sell-off of financials has primarily affected the Invesco Perpetual Global Financial Capital fund; it is down 10% YTD. It has been discounted by markets, firstly because of the Fed and BofE are now unlikely to now raise interest rates this year and secondly this sell-off has become compounded by the fresh concern over European banks which to my mind is sentiment led and an overcorrection of a market searching for a direction other than that of moves in the oil price. The Financials fund was added to MPS portfolios during the summer in a favourable environment for the sector, and positively contributed to performance. The position was gradually wound down over the next few months and now sits at 2% of the balanced model. We are comfortable continuing to hold this position, it represents the more risky element of portfolios and is balanced in portfolios with exposure to less volatile government debt.”