This edition of the investment portfolios has been one of the most demanding with so many factors at play at one time. We have taken into consideration global inflation, interest rate rises, US tax incentives and government spending, Brexit, trade wars between the US and China, corporate earnings, oil prices and late cycle nerves. Our overall view is that equity assets have the ability to continue to offer growth to investors but the levels of growth are likely to decline as global growth slows.
The rate of slowing will be impacted by the tightening of UD$ liquidity, US interest rate rises, US treasury yields and the Federal Reserve’s quantitative tightening. US inflation is standing at 2.5% with most institutions expecting US inflation to stay at around that rate but HSBC is predicting US inflation will hit 3% by the end of the year. Inflation should be impacted by wage growth, but recent levels of wage inflation have been declining.
An optimistic outlook can be held particularly if inflation in the US is well behaved and US interest rates rise along the gradual path the Federal Reserve has signalled. However, with 10-year US treasury stock yields now rising to 3% there is a feeling that inflationary pressure is growing. Any policy error with respect to the curbing of future inflation could be a catalyst for market falls.
There is some concern that at this late stage in the economic cycle, stock markets are heading for another significant correction. Opinions differ considerably between those that see the economic fundamentals such as raising corporate earnings, low interest rates and lacklustre inflation still supporting global growth to those commentators that fear overvalued stock will be hit by the threat of higher borrowing costs. We continue to take a cautious stance, one that has held up well during recent volatility but without losing out on growth opportunities that do exist around the world.
We made the correct call in January to increase our cash holdings to offer capital protection against significant market volatility in February and March. Our portfolios performed very well against the national averages benchmarks over this period.
We are more confident, post correction, that we can now reduce our cash holdings. Cash is an inefficient asset but useful in times of overvalue and uncertainty. We have continued to avoid any directly held government gilts funds due to poor yields and the potential price impact of raising US treasuries. We have replaced our UK index linked gilts with global inflation linked bonds as there is little inflationary pressure in the UK but raising inflation in the US. US inflation will have a major bearing on US interest rates and if inflation takes off this will have a negative impact on bond and equity values. If inflation rises as expected so that the Federal Reserve increases interest rates in line with their own forward guidance, we can expect bond and equities to respond favourably.
We have increased our overall weightings in UK bricks and mortar property funds as they have performed well and offer diversification from equity and bonds. Property yields look favourable from the funds selected.
The UK FTSE 100 has seen significant volatility in the first few months of 2018. This was due to a recovery in sterling values, Brexit uncertainty and underinvestment. However the UK main stock market has fully regained its lost value and more as investors see the UK as an undervalued asset. We have therefore increased our holdings in UK equity funds particularly those funds with a value investment style.
We have been positive about the US for many years and remain so. Stock valuation have been trading at 18.4 times forecasted earnings which is the highest rate for many years and one with little room for upward movement. Thanks mostly to the Trump tax cuts and spending, the corporate earnings of S&P500 companies is expected to increase by as much as 18% this year over last, meaning that stock valuations will come in at around 16 times forecast earnings and are therefore not so stretched. The US may be still overpriced and under threat of correction but look as if there is still some more to come so long as the Fed keeps to its plan.
We were proved right to come out of US mid cap and small cap funds and move to mega cap companies. Our tech giant holdings surpassed expectations while the US smaller companies did not benefit as well from the Trump tax reforms and capital repatriation incentives.
We are reducing our weighting in Europe as there is evidence of some slowing in economic growth. We have enjoyed some very good returns from our European funds in last year but are now taking some profits. The managed slowdown in China will have an impact on Europe. We expect that the European Central Bank (ECB) to continue to buy bond assets beyond September as part of an on-going Quantitative Easing (QE) programme to encourage inflation and growth. For this reason we think that European corporate bonds will retain their prices. Japan has proved to be firmly on the path of reform. Corporate earnings are strong and stock values attractive. We have therefore increased our support for Japanese businesses over European.
We are feeling more comfortable about China now that the Beijing government is pursuing a more sustainable form of growth. Credit restrictions and banking reform and recapitalisation have reduced concerns over a property collapse and banking problems. We expect the US and China to agree over tariffs and that there will be greater open market access in order to avoid a damaging trade war.
With sustained global growth and commodity prices rising, particularly oil, the emerging markets have had an economic boost. We remain attracted to emerging market investment and in particular to South East Asia. However, any US interest rate rises will consequently strengthen the US$ and will impact dollar denominated debt and encourage currency repatriation which will hurt weaker emerging economies the most.
In order to broaden the diversification within the portfolios we have allocated assets not just on a geographical basis but also on a sector level. We have invested into sectors that have scope for long term returns. We continue to hold specialist healthcare funds, infrastructure funds, global insurance funds and technology funds. These funds have with the exception of our infrastructure holding, performed very well so far this year and provide diversification to the portfolios.
As far as our fixed interest securities are concerned we have supported leading strategic bond funds, short dated high-yield stock, and also have a small holding in European Bonds. Our global inflation linked bond fund is mainly invested in US indexed linked treasuries.
We will remain overweight in cash but we know cash is costly to performance and is only used at times of volatility to protect capital from any potential correction that may or may not occur. An overweight poisiton in cash allows us a higher equity allocation and remain within agreed risk tolerances.
At this rebalance we will redirect some cash holdings to other areas that provide protection but offer the potential for higher returns such as global inflation linked bonds, short duration high yield bonds, property funds and target return equity funds.
Our asset allocation remains broadly in line with that of Editions 27 and 28. We are still holding significant levels of cash and are underweight in fixed interest, primarily as markets are high and US inflation is a threat to interest rate rises. We have increased our Japanese, US and UK exposure across the portfolios. We have increased our specialist holdings to give additional sector diversification and have retained across all of our portfolios some Absolute Return Funds that invest in short and long equity positions that can provide both growth and protection. Our general strategy is to remain very well diversified across all portfolios.
We are pleased to report that the gross performance of our nine portfolios up until 21st May 2018, as measured against the associated national Investment Association (IA) benchmark, has been very satisfying. The relative performance is measured over six time periods from 6 months, 1 year, 2 years, 3 years, 4 years and 5 years. Two of our portfolios showed up very well producing some significant gains ahead of their benchmarks over all time periods. Collectively the eight portfolios outperformed their respective benchmarks on 47 out of 50 occasions which is 94% competency, our highest ever.