After a torrid June, stock markets rallied strongly in July, with the FTSE World index up well over 4% in local currency terms. Pleasingly, the UK, which is a large overweight in most of our multi-asset portfolios, also had a stellar month, with the FTSE All-Share producing a sterling total return of 6.8%. Year-to-date total returns for the FTSE All-Share now stand at 15.9%, and within this the Mid 250 has been very strong, with sterling total returns in excess of 20%.
Looking further afield, US and European equity markets also performed strongly, while Japan struggled to make headway. However, Japan’s muted performance needs to be seen in the context of very strong performance year to date, and recent news flow from the likes of corporate bellwethers such as Toyota suggests that Japanese companies really are reaping significant benefits from the softer yen. Asian and emerging markets also rallied in July, although the latter in particular continue to disappoint in terms of their year-to-date performance.
Two key things helped to underpin the July equity rally. First, the US Federal Reserve has been at great pains to point out that the withdrawal of policy support will be gradual and data dependent. This helped to stabilize bond markets during the month, with benchmark 10-year US Treasury yields rising to only 2.6% from 2.5% at the beginning of July. From here, we anticipate a gradual rise in bond yields, not the rout that some market participants have feared. Nonetheless, despite further modest increases in yields in July, we still see better value in high yield and investment grade credit within fixed income, and are not inclined to close our large underweight in core sovereigns at current valuation levels. For investment grade credit markets, yield spreads continue to provide support but valuations will not be immune to the gradual rise in sovereign yields that we expect. It is for this reason that we have been reducing our large overweight in recent weeks. We remain constructive on high yield, and while market liquidity is thin, valuations are supported by the shorter duration of the asset class relative to investment grade.
The second thing supporting equity markets in July was the general improvement in global macroeconomic data – even in the most stressed areas, such as the peripheral Eurozone. While the better data is clearly positive in terms of sentiment, we are not inclined to reduce our European ex UK equity underweight, given the current political uncertainties and risks. However, this is likely to be something that we discuss in more detail in the months ahead, particularly if the better data starts to translate into meaningful earnings upgrades – although it remains to be seen how well European manufacturers will cope with the global competitive threat that is posed by a weaker yen.
In equity markets, we retain a large overweight in the UK, and are also overweight the Pacific ex Japan, emerging markets and Japan. Our overweight in emerging markets has worked against us this year, but the strength of our asset allocation decisions elsewhere has meant this has not mattered in terms of overall portfolio performance. Moreover, given where valuations are now, we do not think it makes sense to start unwinding this position. In the UK, we continue to regard equity valuations as attractive and further support comes from the UK’s high proportion of overseas earnings, which gives the UK leverage to the global recovery.
Turning to alternative assets, we remain overweight UK commercial property as the high real yield on property remains very attractive and anecdotal evidence suggests that forced sellers have now diminished significantly. Commodities also rallied in July, although perhaps counter intuitively they have been quite volatile when economic data releases have been strong, as market participants have viewed stronger data as hastening the likely demise of quantitative easing. For the year to date, however, returns from commodities remain poor.
Investment Strategy by Mark Burgess, Chief Investment Officer at Threadneedle Investments