New polls, same uncertainty

Markets held their nerve in May amid a fresh terrorist atrocity in Manchester (soon followed by another in London in early June) and as polls published during the month pointed to growing uncertainty over the outcome of the fast-approaching general election.

In the event, the UK election delivered a surprising setback for Theresa May, and markets are braced for more uncertainty as the weakened Prime Minister forms a minority government and begins Brexit negotiations.

UK election polls weren’t alone in sending mixed signals in May. Bond markets had a positive month, with demand remaining firm for the perceived safety of major government bonds despite their paltry yields. But equity markets around the globe also continued their long march higher, suggesting appetite for these riskier assets remains healthy.

The Euro Stoxx index led the way with a 5.5% gain, while the FTSE 100 climbed an impressive 4.9% and S&P 500 notched a more modest 1.6% return. UK and US government bonds each rose about half a percent in May, but were outpaced by corporate bonds amid strength in earnings and expectations for continued global growth.

Sterling was little changed at around $1.29 over the month as a whole, erasing earlier gains towards the end of the month as several polls showed a dwindling lead for the Conservatives ahead of the June election. The UK currency briefly dipped below $1.28, but the move was short-lived with some polls still showing (erroneously as it turns out) a commanding lead for the Conservatives.

Rustbelt resurgence

Manufacturing activity remained robust in the developed world, according to purchasing managers indices (PMIs). On the last day of the month, the Chicago PMI confirmed America’s industrial heartland (known as the “Rustbelt”) is continuing to rise like a rusty phoenix from the ashes. The regional manufacturing index rose to 59.4, its highest since November 2014.

Not all US regions were exhibiting the same strong growth, with some flagging according to the Federal Reserve’s (Fed’s) latest “beige book” report on economic conditions. But overall, economic indicators were generally positive in the world’s largest economy, particularly jobs data, with weekly jobless claims reaching a near 30-year low during May.

Meanwhile, the all-important US earnings season came to a close with over three quarters of S&P 500 companies beating analysts’ estimates for revenue and earnings growth, and profits increased across almost all sectors.

Index

1 month

3 months

6 months

1 year

FTSE All-Share

4.4%

5.3%

13.6%

24.5%

FTSE 100

4.9%

4.7%

13.1%

25.5%

FTSE 250

2.2%

7.5%

15.5%

19.5%

FTSE SmallCap

2.6%

7.8%

16.4%

26.6%

S&P 500

1.6%

-1.3%

6.9%

31.6%

Euro Stoxx

5.5%

12.3%

23.0%

37.9%

Topix

3.4%

0.5%

7.6%

31.3%

Shanghai SE

0.1%

-6.7%

-6.3%

16.3%

FTSE Emerging

1.8%

1.8%

11.2%

41.5%

Source: FE Analytics, data sterling total return to 31 May

Danger: hidden exposures

Since the global financial crisis, both bonds and equities have been in a long-term rising trend (and indeed, both were up in May). Against this backdrop passive investments (which aim to match the performance of an index) have been growing in popularity. The danger is that many investors may have been piling into them during a period of generally rising asset prices, unaware of the risks they may be taking on.

In an environment like that – where a rising tide lifts all boats – it makes sense to cut out the middle man (in this case active managers who gets paid a fee for their services). But passive investors may have exposures they are unaware of, which could surface in unpleasant ways when the rising tide starts to ebb. The recent pullback in technology shares is a case in point. Investors in S&P 500 index-tracking funds may have been unpleasantly surprised to find out that how much technology exposure they have (it’s about a fifth of the index) when it took a beating.

Investors in index trackers are holding pure market risk – no more, no less.  Losing a significant portion of your capital in one or two stocks, even over a period of years, can have a tremendously negative impact on your returns, even if you do find one or two others that soar.

We prefer to carefully weigh up risk and potential returns to find the best value. Sticking to your strategy and expertise to achieve steady wins is much less glamorous, but then most hard work is.

Bond Yields

Sovereign 10-year

May 31

Apr 30

UK

1.05%

1.09%

US

2.21%

2.28%

Germany

0.31%

0.32%

Italy

2.20%

2.28%

Japan

0.05%

0.01%

Source: Bloomberg

 

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