Realm Investment Management Monthly Update – September 2018
Welcome to the first Realm IM monthly update and review of investment markets. We plan to make this a regular post each month. We start with a summary for September.
September wasn’t a positive month for most Sectors. All Bond Sectors were lower apart from High Yield which was up 0.33%. In the UK, the All Companies Sector was off -0.58% and Small Caps -0.77%. Overseas equities also struggled with Asia Pacific down the most at -1.68%. Europe was off -1.56% and N. America down -0.19%. China -1.11%, Emerging Markets -0.92%. Only Japan managed a gain at 2.48% (overseas performance figures are shown for sterling investors).
A feature of equity markets over recent months has been the growing disconnect between the US and other global regions. The graphic below illustrates the point showing the performance of six major indices year-to-date. We have rebased the data so all start at a level of 100 at the beginning of the year. Please note that clicking on any image will open it in a new tab and enlarge it.
In the US economic data remains strong. Consumer confidence reached its highest level since 2000, unemployment claims just reached a 49 year low and retail sales growth hit a new high in July. So maybe it’s not surprising that the US stock market has put in such a relatively strong performance this year (see SPX & R2000 on the chart).
Japan (Nikkei) rallied strongly through September and is now in positive territory for the year so far.
UK FTSE 100 and German Dax have under-performed for the year.
China (Shanghai) has fallen more than 20% from its high in January so is officially in a bear market.
So the US is clearly the leading region and we always need to monitor the leader closely for signs of weakening.
It is interesting to note that throughout this period of US out-performance, investment managers were underweight the region – but we now see in the latest survey of global fund managers from the Bank of America Merrill Lynch (BAML) that this is no longer the case. Investment managers are now overweight US equities for the first time in many months. As counter-intuitive as it may seem this contrarian indicator has us thinking the US may now start to relatively lag other regions going forward. We will be monitoring our relative strength indicators closely for evidence and if we see this developing we would look to cut back our position in favour of other regions. Of course, as sterling investors, the Pound/Dollar relationship will have a major bearing here as well, see below for more on this.
Over the same time period, managers have rated Europe as the most attractive region (Europe as you can see has badly under-performed) but the latest survey tells us this region has now fallen out of favour. A purely contrarian investor may assume that Europe will now begin to out-perform but we need to see some confirming evidence in our research and currently we do not. We have had a low exposure to Europe this year apart from European small-caps which have performed well.
A final observation from the September BoAML Manager Survey: the biggest risk for the market cited by respondents in the survey is the trade tensions between the US and China. At a time when the Fed is continuing to reduce its balance sheet and US interest rates have been rising, it is President Trump’s recent aggressive escalation in trade tariffs, with the possibility of tit-for-tat retaliations, that is the biggest concern for most managers.
Every Monday in our Market View we publish our Market Timing indicators as weekly charts, see Market View Archive. Below we present the same indicators on a monthly timeframe to show more data and give a longer term perspective.
Firstly, the UK Market Timing Chart
Over recent months there has been some deterioration in both the Breadth Indicator, shown as colours on the price bars, and the Momentum Indicator at the bottom of the chart. Although the red colour on the latest price bar indicates weakening breadth, and Momentum has been heading lower (although not yet negative), price itself has held up reasonably well since the last positive green bar.
The US Market Chart, below, looks much more positive.
Here, Breadth remains positive and Momentum on a monthly basis has picked up. As stated above, we need to monitor the technical picture of this leading chart for signs of weakening.
Next, we look at our Risk Barometers, again on the monthly timeframe.
Risk Barometers explained here
Firstly, the US
Note that at the beginning of the last two Bear Markets our US Risk Barometer broke down before price did. Nothing is guaranteed but this indicator has given reliable warning signals in the past. Currently it is positive.
Our European Risk Barometer:
Our European Risk Barometer has historically been more volatile and less reliable than the US but remains positive for now.
Small Cap vs Large Cap
UK equities have been hampered by fears of a no-deal Brexit. With that uncertainty most would expect the Pound to come under pressure and logically this should see UK Large Caps out-performing Small Caps. Actually, this hasn’t been the case – both sectors are down year-to-date, but Large Caps more so. We have favoured Small Caps for quite a while and our fund of choice is the AXA Framlington UK Smaller Companies which has done well this year, up nearly 2.5%. We also own the Marlborough UK Micro Cap Growth Fund, up nearly 7% this year. We believe our proprietary relative strength indicators will keep us on the right side of this relationship and if/when we see Large Caps relatively improving, we will adjust our allocation to these sectors accordingly. The two charts below serve to illustrate the current situation for both the UK and Europe.
We favoured Small Caps from late 2016. The indicator at the bottom of the chart crossed up through zero at this time and the middle line of the chart (the relative relationship) started to pick up. As long as this line is heading higher we would expect UK Small Caps to continue out-performing Large Caps. An amber warning is flashed if the indicator falls below zero.
See similar chart for Europe below.
In Europe we see the same thing – with Small Caps (for a sterling investor) up nearly 2% year-to-date and Large Caps up nearly 1%. We have held the JPM European Smaller Companies fund which is up just under 4% this year.
Clearly the Pound will remain volatile but it is important to have a view. The Chart below, showing the Pound relative to the US Dollar, is one of the most important at the moment – see comments below.
You can see that the trend has been generally down for GBPUSD since early in the year. There has been a rally back over the last two months and this tested a level that we see as critical on this chart, at 1.3200. Although tested, that level has not yet been convincingly exceeded. If the chart manages to spend time above that point it would imply further strength in our view and we would look to reduce our exposure either by cutting back on relevant funds or hedging. It would also prompt us to review that UK Small Cap/Large Cap relationship
Currently Global Bonds is our highest ranking Bond Sector with a current Relative Strength % Number (%Rank) of just 47. This means that, according to our criteria, the Global Bonds Sector is out-performing 47% of all other Sectors. No Bond Sector ranks above 50. The Weekly Chart below shows Global Bonds with the %Rank as an indicator.
Finally, we take a look at Market Sentiment. You can see our current weekly Sentiment report here. At the moment we’d say the overall Sentiment reading is neutral with one exception – our Bull Bear Ratio (US market) recently reached its highest level as indicated by the red arrow on the chart below. Extreme readings in this indicator are often a warning. However, with most other Sentiment readings not currently at elevated levels we stick with our overall neutral interpretation. You can read a description of the Bull Bear Ratio in our Weekly Sentiment report, link above.
Sentiment indicators are often useful, see our July article Some Numbers to Bear in Mind where we interpreted extreme bearish readings as bullish for the US market.
We hope you have found this latest update of interest. Thank you for reading. Monthly updates will be a regular feature.
Disclaimer: ‘Where the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. The information contained within this communication is believed to be reliable but Realm Investment Management Limited does not warrant its completeness or accuracy.
This communication is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell investments.’