Quarterly update: Politics casts clouds on sunny markets

Health care wounded (for now)

A prominent example of the role politics can play in investments can be seen in the evolving fortunes of the health care sector.

As Sven explains, “US politicians on both sides have already voiced concerns over drug pricing as part of their pre-presidential campaigns. If turned into policy, this could hurt the profitability of health care companies.

“This political headwind is likely to increase in the next 12 months and is one important reason that we sold out of our dedicated health care position in May.”

But he adds, “We still believe in the long-term positive story for the sector, and we may re-enter at some point in the future.”

Coutts retains some exposure to the sector through our general holdings in equities – health care stocks make up about 15% of the S&P 500, and 9% of the FTSE 100, for example.

Trade war flares up

It had appeared that the trade war negotiations were going really, really well – until they weren’t.

President Trump raised duties on $200 billion of Chinese exports. China fought back with higher tariffs on American goods. Stock markets around the world wobbled in May.

But while the immediate impact of all this on markets was clear, there are powerful forces at play that could soften any blows.

Sven says, “Central bank policies and economic stimulus by the Chinese government remain the main mitigating response to any adverse developments. China has already put a significant amount of monetary and fiscal stimulus in place, and looks ready to deploy more if needed, as economic stability remains the main Chinese objective.

“The US Federal Reserve (Fed) also appears determined to remain supportive and markets are already anticipating interest rate cuts this year. Other central banks will likely follow the Fed’s lead.”

In the meantime, we maintain our long-held view that the world’s two biggest economies will settle their trade-related differences eventually.

Brexit still TBC

You can’t talk about the effect of politics on markets without mentioning Brexit. And UK equity returns remained subdued in June relative to global markets as Brexit uncertainty – with the added distraction of the Conservative Party leadership election – made investors cautious.

Theresa May’s announcement in May that she would stand down as Prime Minister didn’t actually move markets much, largely because it was widely expected. But the UK economy, despite weathering Brexit-fuelled uncertainty reasonably well during the first quarter of the year, did show signs of strain in Q2 with GDP falling -0.4% in April.

Sven says Coutts is staying nimble when it comes to its UK exposure in portfolios.

“Back in February, we tilted our investment in UK equities slightly towards mid-cap companies, which largely focus on meeting domestic demand and stand to benefit from a Brexit resolution,” he says. “But if we see prolonged uncertainty, we might consider some alternative options further down the line."

Our plan

Against this complex economic and political backdrop, we are concentrating on the essentials. We consider on a daily basis a number of factors such as valuations, business cycle sensitivity and technical measures to guide our investment decisions.

At the moment, these continue to point towards a broadly balanced approach to risk assets like equities or credit on the one side, and government bonds – which tend to perform well when the business cycle slows – on the other.

In line with our contrarian approach, we see negative investor sentiment as an opportunity, while equally viewing any investor exuberance as a risk. For example, we hold a low exposure to emerging market equity and selective positions in emerging market debt, in part because both have rapidly become popular this year.

“There are imminent risks on both the upside and the downside,” says Sven. “Resolution of trade tensions and further economic expansion would be positive for markets, while a further slowdown in economic activity under the impact of renewed uncertainty would see some asset classes struggle.   

“As the year unfolds, we will continue to monitor markets with an eye to the longer term and make adjustments as necessary."

Important information

When investing, past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.