Investor insight: in search of market value

Brad Holland

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With global stock markets buoyant, Brad Holland, Nutmeg’s senior investment manager, answers Nutmeg customer questions on finding continued value across the investment landscape.

Hot air balloons over canyon landscapes

Q) With most asset markets now historically high, how can you find sustainable value and growth for portfolios?

Historical valuation comparisons are not that reliable as indicators of value in my opinion. Too many things are different from one cycle to the next. We do look at valuations, but we take our main view about portfolio structure from economic and policy cycles.

With that in mind we think that the US still has more economic gas in its tank, and the rest of the world is also beginning to accelerate. While central banks will start to tighten policy more this year, I don’t think they will tighten that much, and fiscal policy is being eased which will be pro-growth.

Q) What are your predictions for the sterling/euro exchange rate and how will this affect investments?

There are several cyclical and structural factors to consider here. First, we think the dollar will remain strong until at least the second half of 2017. That means that the euro will fall against the dollar. When this happens, it usually means the euro falls against sterling as well.

Secondly, sterling has already fallen heavily against the euro in the last 18 months due to fears over Brexit. As the reality of the UK’s situation outside the EU becomes less of a concern, there is every reason to expect that this discount may at least partially reverse.

In addition to this, the Eurozone itself is entering a turbulent 12-18-month political calendar. So it’s possible that new risks could emerge on the continent.

For these reasons, we’re underweight on continental equity markets in managed portfolios and, consequently, underweight on the euro versus sterling.

Q) How would a weakening US dollar affect my portfolio?

Nutmeg’s managed portfolios are currently positioned for a stronger dollar. This decision is based on there being a more advanced economic and monetary policy normalisation since the financial crisis, a reduction in the US trade deficit, a repatriation of overseas corporate cash-piles to the US, and a view on the potential geopolitical risks, e.g. Russia and the Middle East.

That said, it’s true that as the global economy picks up more steam later in the year, the dollar may come under threat from rising commodity prices and stronger emerging market exchange rates.

So what does this mean for our managed portfolios? We will be watching the dollar very closely in the second half of 2017 – when we expect it to come under threat – and adjust portfolios as necessary. However, we have already moved the portfolios to a normal level of exposure to emerging market currencies. This will help us if the speed of events is quicker than expected. Our gold holdings will also provide some hedge if the dollar weakens against our expectations.

Q) Could value in emerging markets be wiped due to a dollar that keeps getting stronger?

We don’t see emerging markets being exposed to as much risk as they were in the past when US monetary policy was tightened. There are two primary reasons for this.

Firstly, emerging markets have recently financed themselves using local currency debt. In the past it was mainly US dollar-denominated debt. Clearly, in the latter case, a strong dollar makes it difficult for other countries to service their loans. But, given the trend towards local currency debt, this is far less a threat than in previous US tightening episodes.

Secondly, the emerging market economic cycles have been out of sync with the US – another break from the past. At the moment, a maturing US recovery is occurring at the same time as early stage recovery elsewhere in the world. This re-synchronisation is a key reason for our confidence in the current equity market cycle.

Q) A significant proportion of my Nutmeg pot is GBP-hedged ETFs. What is the impact of GBP hedging on real value in a world where Brexit could push sterling still lower?

You’re right to expect that if sterling weakened further that a hedge would not be a good strategy. However, at Nutmeg we are not as pessimistic about the UK’s prospects as some media, hence our overweight UK equity and currency position.

We have hedged some US dollar exposures in our managed portfolios, but remain more exposed to US dollars there than in our fixed allocation portfolios.

We have also hedged our Japan exposures. This is because Japan has an ongoing quantitative easing program, which would tend to weaken its currency. Plus, we have a strong US dollar view, which would mean a weak yen, and we expect a positive risk environment, which would normally favour sterling versus yen.

This article is taken from a live Q&A session that Brad hosted for Nutmeg customers on 21st February 2017, where there was a lot of interest in the global political landscape. You can also read about Brad’s opinions on two other big themes that emerged during the live Q&A – the impact of Brexit and Trump on the markets and managing investment risk in 2017.    

Risk warning: Your capital is at risk. The value of your investment, and the income you get from it, can go down as well as up. As with any investment, there is a chance you will get back less than you originally invested.

Brad Holland
Brad is Nutmeg’s director of investment strategy. A veteran – 28 years at last count – in financial markets, he started his career as a professional economist at the Australian Reserve Bank. He now specialises in economic and financial market strategy within investment management. Brad studied post-graduate quantitative economics at the University of Queensland, Australia. Despite living in London for 20 years now as a naturalised British citizen, he’s still not quite ready to support England-v-Wallabies.

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