Weekly Market Report

29 August 2023

Global Report

UK Equity Market Outlook.

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Local Report

Life Cover/Personal Risk Policies – are they a waste of money or more important than ever for women in the modern era?

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Market Indicators

Global and Local Indicators.

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Global Report: UK Equity Market Outlook

By Nick Downing

The outlook for global equity markets in 2024 and 2025 is bullish. Lower inflation, falling interest rates and economic recoveries are expected to buoy equity markets higher. Artificial Intelligence (AI) should add to the strong performance via its benefits to higher productivity and lower inflation. Markets first need to navigate the dual perils of potential recession, however brief and mild, and continued anxiety over persistent inflation. Monetary policy tightening has a lagged impact on economic activity. A good portion of the interest rate tightening cycle has not yet filtered through the economy. Many analysts believe a recession is inevitable, although they also feel that it will be shallow and short-lived. Many analysts also believe that inflation will remain sticky, that the final push to 2% central bank targets will remain elusive. There is a good chance that global equity markets will consolidate before commencing their bull market in 2024. Rising bond yields may well be the catalyst for the consolidation. The US 10-year Treasury bond yield has surged over the past month from 3.95% to 4.18%, threatening to break above its October 2022 levels.

As well as placing downward pressure on the pricing of global assets, rising Treasury bond yields also sap global liquidity. Global liquidity is crucial to keeping financial markets buoyant. It may be wise to raise some cash in global portfolios as a precaution against potential short- to medium turbulence in global markets that would arise from further increases in bond yields.

The UK equity market is a likely candidate for raising precautionary cash in global portfolios. The UK market is admittedly cheap and enjoys high dividend yields, but over the near-term is riskier than most. UK households have not deleveraged or mended their balance sheets in the same way the US and Eurozone have done since the 2008/09 Global Financial Crisis. Moreover, its residential property market has risen to bubble proportions and in danger of protracted decline due to the sharp rise in mortgage interest rates. In the second quarter (Q2) Buy-to-Let mortgages in early arrears increased at an astonishing 41% quarter-on-quarter. The bulk of homeowners are still at fixed mortgages of below 3% but they will increasingly need to refinance at higher mortgage rates, so the number of arrears will likely accelerate and dampen home prices.

The UK economy is heading towards recession. The composite purchasing managers’ index (PMI) has dropped below the key 50 threshold into contractionary territory, from 50.8 in July to 47.9 in August its lowest since January 2021. According to independent research firm Capital Economics, this is consistent with a GDP contraction of 0.5% quarter-on-quarter in Q3. Companies cited “a reluctance to spend among clients in the wake of higher interest rates and stretched disposable household incomes.” The manufacturing sector PMI fell from an already depressed 45.3 to 42.5 its lowest since May 2020 at the outbreak of Covid. The previously resilient service sector PMI fell from 51.5 to 48.7.

Unlike the US, where inflation has decelerated sharply, cost pressures remain worryingly elevated. UK core CPI, excluding food and energy prices, remained unchanged in July at 6.9% year-on-year and rose 0.5% month-on-month. High wages are one of the main culprits and they unexpectedly increased in July to a year-on-year rate of 7.8%. Due largely to rising wage pressure, services inflation accelerated from 7.2% to 7.4% on the year. UK inflation is outpacing all other G7 economies. Meanwhile, UK wholesale gas prices have surged, adding to the Bank of England’s headache. The UK natural gas price is up by over 70% since mid-July.

Despite prospects of imminent recession, the Bank of England is not yet done with hiking interest rates. It hiked by an additional 25 basis points in early August from 5.0% to 5.25% but a further 25 basis points is expected in September. An additional hike may be required after that due to domestically driven inflationary pressures, and unlike the US and Eurozone which will be well on their way to cutting interest rates in 2024, the UK may be left stranded with higher rates for much of next year. As a result, household spending, which accounts for two-thirds of UK GDP, will remain subdued. As it is, retail sales fell in July by 1.2% month-on-month and were still 1.8% below their February 2020 pre-pandemic level.

Independent research firm MRB Partners cautions “The UK may be the most extreme case of wage gains and sticky core inflation in the DM (Developed Market) world. The danger is that a self-reinforcing inflation feedback loop develops. … The UK has the greatest risk in the DM of becoming mired in stagflation, with weak growth and elevated inflation.” Wages and core inflation are rising concurrently with growing unemployment. UK core inflation is double that of the US, due to its more extreme labour shortage and yet in Q2 UK GDP was still 0.2% smaller than pre-Covid levels while in the US, GDP was 6.2% above the pre-pandemic level.

Edinburgh Investment Trust Plc (EDIN), one of the largest and most liquid investment companies in the UK “growth and income” peer group, has performed well since being added in November 2020 to Overberg Asset Management’s client portfolios. The share benefited from the strong 2020/21 equity market rally and has outshone its peers. In the latest financial results for the year to end March 2023, EDIN increased its net asset value (NAV) per share by a solid 7.9% exceeding the FTSE All-Share Index return of 2.9%. Since the end of March 2020, when the current managers Liontrust took over, NAV has increased 68.1% compared with 46.7% from the FTSE All-Share Index. While EDIN has contributed to clients’ portfolios over the past 2-3 years, there are currently better prospects available in global markets and the share provides a good source of precautionary cash to help de-risk portfolios.

Local Report: Life Cover/Personal Risk Policies - Are they a waste of money or more important than ever for women in the modern era?

By Claire Moorhouse

For the most part, gone are the days of single-income households. Nowadays, women’s contributions to joint-income households are essential for achieving financial stability, shared decision-making, empowerment, and setting positive examples for future generations. And in many cases, women are the sole provider of income as well as financial stability.

I have sometimes found that clients can have a bit of an aversion when it comes to life cover/personal risk policies. The very idea that someone else is going to “benefit” from their death and that they have to “waste” their hard-earned money on something that will give them no benefit, can at times seem like a strange concept. This, therefore, prompted me to ask the question: “Are these policies a waste of money?”

Firstly, sound financial planning includes helping individuals and/or families by providing them with a roadmap to reach their financial goals. Following that, personal risk cover offers protection from unforeseen events and the potential loss of income, which could hinder the ability to create wealth over time and adequately provide protection for beneficiaries. There are three common benefits that should be considered when looking at personal risk policies:

1. Life insurance: This offers financial protection to your dependents in the event of your death.

  • It can provide a lump sum payout or regular income to your beneficiaries.
  • Life insurance is particularly significant if you are the primary breadwinner for your family or have significant financial obligations/debt.
  • The provision of liquidity in one’s estate. Estate duty is payable to SARS at a minimum of 20% of the value of an estate on death (other than between a husband and wife) and this could prevent a fire sale of prime assets.

2. Disability cover/Monthly income protection: Provides income replacement if you are unable to work due to a disability or injury. There are two options and depending on one’s circumstances there is a balance to be found in having a combination of each in a client’s personal risk portfolio.

  • Lump sum disability: This is a one-time payment if you become fully disabled/partially impaired. While this provides for the potential of a larger upfront payout, it does not provide a continuous income stream.
  • Monthly income protection: This benefit can cover your (net) monthly income on a temporary basis or permanent basis until selected retirement age. It can help cover your living expenses, medical bills, and other financial commitments during your period of disability. Essentially ensuring that you can maintain your standard of living without depleting your savings or investments.

3. Critical/severe illness cover: Critical illness insurance pays a lump sum if you are diagnosed with a serious illness covered by the policy. This benefit often covers well more than 100 medical conditions, with just a few examples being Cancer, Diabetes, Arthritis, and Hypertension. This can help cover medical expenses, treatment costs, and additional financial burdens that may arise due to your illness. Critical illness insurance provides financial security during a challenging time and allows you to focus on recovery without worrying about the financial impact. When considering this cover, it is especially important to ensure that the wording of the policy allows for 100% payout on less severe conditions and re-instate for unrelated conditions.

Following on from the above-mentioned points, further consideration for women to ensure they have this cover in place include:

  • Childcare costs: Women often take on the responsibility of childcare, and if they were to unexpectedly pass away, life cover/personal risk policies can help cover childcare costs, ensuring the financial well-being of their children and providing them with a stable environment.
  • Gender-specific medical conditions: Women may face specific health risks such as breast cancer, ovarian cancer, or maternity-related complications. Personal risk policies can be tailored to women’s needs and provide coverage for these conditions, offering financial support for treatment and recovery.

Unfortunately, risk cover, like sports and politics, can sometimes be one of those areas where reason often takes a back seat and emotions take control (for both men and women). However, it is important to make an accurate assessment of future obligations and then assess the most efficient way to meet these obligations. And more so than ever as we live in a time where women lead by example in the workplace and their communities, paving the way forward for their peers and protégés.

At Overberg Asset Management, we pride ourselves in customised support, and this month we would like to invite all women to reach out to our Wealth Managers and Personal Risk Specialists: Claire Moorhouse and Jade Kramer who are delighted to be part of your team and happy to help with an assessment of personal and financial needs analysis.

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Reference: Capital Economics – Historical bond and equity return data.

The Bottom Line: Innovation and the Magic of Compounding

By Carel La Cock

The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.

Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.

After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.

Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.

As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.

Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.

Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.

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