Market Review

In the third quarter of 2017 North Korean geopolitical risk took main stage after test missiles were fired together with constant aggressive rhetoric from both North Korea and the US. While the North Korean nuclear war threat had the effect of increasing volatility and affecting short-term risk sentiment, the risk of an ensuing war is extremely low considering North Korea’s military capabilities versus the global superpowers that oppose them. An interesting notion is that geopolitical risk has not had a lasting impact on markets since WWII; that was what has also been seen thus far in the third quarter of 2017. Over the period the anti-Trump media momentum at last seems to have levelled off while Trump’s policy implementation remains in question. In Europe the German elections passed with no material surprise, while the Catalan uprising in Spain has gained momentum. While the situation has been a source of some volatility, the Catalan’s has been a populist revolt for two or three centuries in Europe; whether it will come to something this time around remains to be seen. In the UK the surprise of higher core inflation versus expectations put the Bank of England (BOE) in a much more hawkish stance, which in turn strengthened the pound notably. The market is currently pricing in an 83% chance of a hike in November by the BOE. Over the quarter the UK’s position with regards to Brexit negotiations has, if anything, only weakened with the Conservative Party dwindling towards disarray. As noted in previous commentaries, we do not expect an end to Brexit negotiations any time soon and a transition period also now seems likely. It is general consensus that valuations in the US are at least fairly valued or much rather at elevated or expensive levels while volatility remains at historical lows - the hunt for yield has forced huge flows into illiquid assets and this has been underestimated by market participants; complacency is a growing concern. Over the quarter the Fed has made it clear that an interest rate hike is due in December and possible further hikes in 2018, albeit at a very gradual pace.

Returns around the world were good over the period; defensives struggled this time followed by financials, while cyclicals and resources were the strongest. A positive for active managers have been the drop in stock correlation and dispersion rising - a favourable change for stock pickers. Corporate earnings are doing better and in general global economic data continued to gain momentum while the equity market remained firm on solid fundamentals. A tailwind to global growth has been China leaving its currency to strengthen and this should remain supportive to the global backdrop. A short-term correction, however, is very possible - again it does not point to a problem with corporate profits or the economy. Unless we see a sell-off or systemic event as was seen in 2000 or 2008, and subsequent significant dislocations between earnings and prices, i.e. something extreme, a correction should be shortlived.

During the quarter global equity markets, as measured by the MSCI World Index, rose 4.84%. For the calendar months over the quarter the MSCI World returned 2.39%, 0.14% and 2.24% in chronological order respectively. All major regions produced positive returns; Emerging Markets produced the strongest result by rising 7.89%, followed by Europe with another strong quarter of 6.45%. Asia followed with strong returns of 5.93% and 5.17% for the ex-Japan and Asia Pacific indices respectively. MSCI North America rose 4.50% while Japan returned 3.97%.

From a sector perspective the big outliers in performance were the Energy and Material sectors, which posted positive returns of 8.94% and 8.93% respectively. Information Technology followed closely with a return 8.93% respectively. Information Technology followed closely with a return of 8.41%. Financials continued its strong recovery, returning 5.35%, and is now the strongest performer over the past 12 months with a return of 14.89%, well ahead of the runner-up, Information Technology, which has risen 9.71% over the same period. Industrials rose a respectable 5.50% over the quarter while Consumer Discretionary, Health Care, Telecommunication Services and Utilities produced more muted returns. The only negative sector over the period was Consumer Staples, which declined a marginal -0.46%.

All performance numbers are in US dollars unless stated otherwise