Search for direction after the recovery

6 May 2016

As warmer temperatures finally arrived with the beginning of May, capital market action confirmed that the upward momentum of the recovery rally had cooled. This immediately triggered various '˜Sell in May and go away' articles and we are therefore dedicating the second article of this week's edition to the evidence (or not) behind this alleged seasonal market return pattern.

First a review of April's market returns.

In the middle of the month, the vehemence of the recovery rally that started in the second half of February fizzled out, as central banks balked at enticing markets even further with enhancing prospects of monetary easing beyond their March announcements. At the same time corporate results for the 1st quarter of 2016 brought sobering confirmation that the Global economy had indeed suffered another winter slowdown, resulting in overall flat to negative company earnings updates.

What prevented markets from turning straight back to their beginning of year depression, was the fact that commodities held on to their stabilised levels and the US$ continued to weaken, thereby breaking its previous multi-year strengthening trend. While a stabilisation of commodity prices helps to de-stress energy and exploration related shrinkage and default fears, the weakening of the US$ should take the headwind out for overseas US corporate earnings and help Developing World debt servicing concerns as far as they relate to US$ denominated liabilities.

This helped commodity heavy markets like the UK's large cap stocks, but in the short term put downward pressure on US$ denominated investments. The month closed well of its mid-month stock market highs, while bonds were unable to recover all of their earlier losses and still closed down for the month. Japan's stock market experienced a short term '˜sugar high' in the false anticipation of further central bank stimuli there and has fallen back rapidly since the month end.

Our mid-month portfolio rebalancing, which took off the temporary equity overweight we had drifted to as a result of our fortuitous bottom of market rebalance timing back in mid-February and closing of the government bond underweight position we had in the Overlay funds proved well timed. While these actions have added relative value for the longer term, monthly portfolio returns in absolute terms were fairly flat for the month in the end, which is also the case for the 2016 year to date picture.

After the stormy first quarter, it appears that markets may be entering a consolidation phase, while they search for new (better?) direction after what turned out to be a clear overreaction in January. There is plenty to fret about on the political front, as the UK's EU referendum draws nearer and Donald Trump is all but certain to become the US Republican party's presidential candidate, after the other two remaining candidates suspended their campaigns.

The relative uncertainty created by the Brexit referendum has started to filter through into UK economic activity figures, where construction, industrial output and now even the mighty service sector are all being reported to have hit stagnation over the recent months. Together with an increasing number of forecasts by various national and international bodies of the relative economic cost a Brexit would be likely to inflict on the UK economy it is becoming increasingly clear that there is unlikely to be economic benefit in leaving the EU. If the Scottish referendum of 2014 is anything to go by - and I believe it is - then the likelihood of a '˜Leave' majority in the 23 June vote is decreasing by the day. London's preference of a '˜Remain' supporting mayoral candidate over a '˜Leave' advocating candidate may also be seen as a first test of the electorate's June voting intentions.

Too bad then that this will have still cost the UK the economic growth momentum it carried through from 2015 and could render the first half of 2016 a bit of a lost 6 months. Not all lost though for the 2nd half of 2016, because the weakness in £-Sterling, which the uncertainty also brought with it, should have allowed British businesses to reposition themselves with more competitive prices in the Global markets and temporarily halted investment projects should be kicked-off fairly quickly in the second half as well. Historically this would have resulted in a not insignificant economic stimulus and so in the coming month it will be advisable to look ahead, rather than behind for any clues as to where the rest of the year will go.