Previous quarterly market updates

• Stock markets slipped in September as supply problems kicked in, but are up over the year so far   
• Higher prices and potential interest rate rises worried investors
• Bonds had a challenging time as rising inflation hit their performance

Three developments this quarter relevant to Shostra Bank Invest

1)    Prices rise but should peak this year

Inflation climbed to record highs on both sides of the Atlantic. In the it shot up by 5.1% in the year to November, and rose by 6.8% in the US – its highest hike since 1982. The rises were driven by higher fuel and food costs and supply chain bottlenecks brought on by the coronavirus.

Our view: We expect inflation to eventually ease later this year as supply chain issues are resolved, but it may still end up higher than the levels we saw before the pandemic.

2)   Surprise surprise

To tackle rising inflation, the Bank (BoE) raised interest rates to 0.25% from 0.1% in December. While the rise itself was widely expected, the timing surprised markets as it came amidst the emergence of Omicron. Across the pond, the US Federal Reserve also suggested it might raise rates sooner than expected.

Our view: While it’s likely that we’ll see several rate rises this year, overall, the ultra-low interest rate regime in place since 2008 isn’t going to change any time soon.

3)    Omicron can't dent investor optimism

Covid-19 cases rose rapidly across the world towards the end of 2021 as the more contagious, although seemingly less harmful, Omicron variant emerged. Many countries introduced restrictions, but markets remained reasonably unphased, with the S&P 500 going on to hit a record high in December.

Our view: The vaccination rollout, better treatments and new medicines in development should make coronavirus even less of a market concern in time.

“While higher inflation remains something to keep an eye on, we expect it to settle this year. And even if it should persist, interest rates are likely to go up by only a fraction of a per cent to help deal with it.”

Alan Higgins, Chief Investment Officer at Coutts, which runs the Shostra Bank Invest funds.

Changes the experts at Coutts have made so far this year include:

Sell European stocks

At the end of November we sold some of our European stocks. We have kept the cash for now so that we’re poised to buy into any new opportunities as they arise. Slowing economic growth and less central bank support make this a good time to reduce our exposure to stocks slightly. Europe has been particularly vulnerable because of its Covid-related restrictions and trading relationship with China, which saw a big economic slowdown.  

Reduce government bonds

We reduced our exposure to government bonds In July. The economy is solid and we believe it will remain so this year. This can be good for share prices, but makes bonds less attractive as they’re generally more popular in challenging markets. 

• Stock markets slipped in September as supply problems kicked in, but are up over the year so far   
• Higher prices and potential interest rate rises worried investors
• Bonds had a challenging time as rising inflation hit their performance

Three developments this quarter relevant to Shostra Bank Invest

1)    Growth slows but stays solid

The world economy is still growing, but more slowly than initially expected. Supply chain problems, rising energy prices and inflation concerns took their toll.

Our view: The economy should continue to grow into the first half of next year. It may have slowed, but it’s basically returning to more normal levels after a post-lockdown surge – when people rushed out to spend their money.

2)    Price rises interest investors

Inflation continues to rise on both sides of the Atlantic, which often leads to higher interest rates. This has worried investors as rising prices and bigger borrowing costs can dent company performance.  

Our view: Higher inflation has caused central banks – which set interest rates – to take another look at their plans, but they’ve said any changes would be well signposted and gradual. If we see even higher inflation, however, that could put more pressure on them to act sooner.

3)    China crisis

Chinese stock markets suffered during the quarter. A government crackdown on companies appearing to create monopolies, and a major debt crisis at property giant Evergrande, took their toll on an already-slowing economy.

Our view: We reduced our allocation to the emerging markets earlier this year because of the country’s slowing economic growth. This helped shield the RBS Invest funds from what’s happening in China. 

“While supply and labour shortages are feeding into higher inflation, their impact is not expected to be permanent. It takes time for businesses and their supply chains to adjust. And when they do adjust, this year’s shortages could become next year’s glut, bringing prices back down again.”

Monique Wong, Executive Director, Asset Management at Coutts, which runs the Shostra Bank Invest funds.

Changes the experts at Coutts have made so far this year include:

Reduce government bonds

We reduced our exposure to government bonds in July. The economy is solid and we believe it will remain so into next year. This can be good for share prices, but makes bonds less attractive as they’re generally more popular in challenging markets.

Sold emerging market shares, bought European stocks

In May, we sold some of our emerging market investments and bought more European stocks instead. Emerging market shares rose in late 2020 and early 2021, but then became more subdued. This was partly due to slowing economic growth in China and a strong dollar, which can be bad for emerging market returns.

Europe, meanwhile, performed well after its vaccination program gathered momentum and the European Commission agreed an economic support package.

• Stock markets ended the quarter on a positive note as vaccinations continued and the world opened up
• Bonds also delivered positive returns
• Inflation shot up but central banks said it was temporary

Three developments this quarter relevant to Shostra Bank Invest

1)    Europe – better late than never

European stocks performed well after a slow start to the year. Vaccinations and economic support took a while to get going on the continent, but have since picked up.

Our view: We believe improving economic conditions worldwide will continue to benefit stock markets in Europe. We increased the amount we invest in the region earlier this year.  

2)    Don’t worry, the price is still right

We saw relatively large rises in inflation in the US over the quarter. This worried markets as higher prices can lead to higher interest rates, which can dampen company profits.

Our view: Central banks on both sides of the Atlantic calmed market nerves by calling the jumps in inflation temporary and keeping interest rates low. We don’t expect any imminent changes as policymakers don’t want to derail the strong economic recovery.

3)    Best of British

Stock markets in the performed well for most of the quarter thanks to a speedy vaccination program and large number of companies that do well in a growing economy, such as energy firms.

Our view: The Bank said it expects the country’s economy to recover from the coronavirus pandemic faster than expected. This, along with a fall in unemployment and increase in consumer spending, points to solid progress since the pandemic.

“Stock markets have risen all year as economies around the world increasingly open up again. Successful vaccine roll-outs, particularly in the UK, US and Europe, are proving to be the perfect remedy for investors right now.”

Monique Wong, Executive Director, Asset Management at Coutts, which runs the Shostra Bank Invest funds.

Changes the experts at Coutts made this quarter

Sold emerging market shares, bought European stocks

We sold some of our emerging market investments and bought more European stocks instead. Emerging market shares rose in late 2020 and early 2021, but have become more subdued. This is partly due to slowing economic growth in China and a strong dollar, which can be bad for emerging market returns.

Europe, meanwhile, has performed well after its vaccination program gathered momentum and the European Commission agreed an economic support package.

• Stocks rise as government and central bank support does its job
• Vaccine roll-out boosts investor confidence
• Bonds have challenging time as prospect of higher inflation cuts prices

Three developments this quarter relevant to Shostra Bank Invest

1)    American dream

US stocks were boosted by President Biden’s $1.9 trillion economic support package passing through both houses of Congress.

Our view: The package is widely expected to turbocharge the world’s biggest economy, which should in turn benefit the rest of the world.

2)    Rule Britannia

stocks are doing well. Britain is home to a number of companies that tend to prosper when the economy grows – as it is now – such as energy companies and banks.

Our view: The has been unloved by investors for a while and looks fairly cheap as a result, providing good opportunities. The country’s successful vaccine roll-out should also be good for its stock markets.

3)    The price of bonds

Bond prices dropped as investors saw the possibility of higher inflation on the horizon. Economic growth can lead to a higher cost of living but a bond’s interest payments stay the same, so they lose value.

Our view: Bonds, particularly government bonds, are likely to remain less popular than shares as an improving economy supports company profits. But today’s extremely low interest rates, which are likely to remain for some time, should support bond returns.

“Governments have shown continued willingness to support their economies, and central banks have re-iterated their intention to keep interest rates low. When combined with the progress on the virus, it’s not surprising that record economic growth is widely expected in developed markets in 2021.”

Sven Balzer, Head of Investment Strategy at Coutts, which runs the Shostra Bank Invest funds.

Changes the experts at Coutts made this quarter

Sold Chinese shares, bought stocks

We banked profits from our position in Chinese companies after a period of good returns. We’ve used some of that money to buy more stocks as we see the economy there continuing to improve.

Added to government bonds, reduced US Treasuries, emerging market and investment grade bonds, and gold

We bought more government bonds, which should benefit from the Bank keeping interest rates on hold – something Coutts believes they will do for quite a while.

We also took profit on US government bonds (US Treasuries), which have done well over the last year. And we sold out of some other investments with limited prospects currently – namely emerging market bonds, investment grade bonds and gold.

Performance in the last quarter of 2020 was defined by news of successful anti-coronavirus vaccine trials in November and their gradual deployment at the end of the year. During the summer and autumn of 2020, the manager positioned the Shostra Bank Invest funds to benefit from an economic recovery – which then came largely because of the vaccines’ positive impact.

In particular, reducing the allocation to US equity in favour of emerging markets was very positive to performance. Emerging markets benefited from a double hit of a weaker US dollar – which makes emerging market exports more attractive – and the prospects of a post-COVID global economic recovery. The latter could see consumer demand increase and boost demand for commodities and manufactured goods, areas where the emerging markets excel.

The manager has also been working to reduce the environmental impact of the Shostra Bank Invest funds by switching to funds that concentrate on companies with lower carbon footprints. Data released in October showed that they reduced carbon emissions by 33% on average for each fund in the first half of 2020.

Equity markets made strong gains over the last few months of 2020 following positive news about vaccines and ongoing stimulus measures by central banks and governments. While rapid development of the vaccines boosted investor confidence, a resurgence in coronavirus cases at the end of December led to further widespread lockdowns across the Europe.

Emerging markets were the outstanding performers of the period as the global economy began to recover and the US dollar weakened. Notably, many emerging market countries have managed the coronavirus pandemic more effectively than developed markets. For example, China seems to have the virus largely under control, reporting that its economy grew by 4.9% between July and September.

In the US, a change in president was generally seen as positive by markets. After a close election, Joe Biden became the 46th US president. While the predicted ‘blue wave’ didn’t appear on the night, a re-run in Georgia saw Democrats take control of the Senate, giving them a majority in both houses of Congress and the Presidency for the first time since 2009.

Markets remained sanguine as the result brought greater certainty after a few months of political uncertainty. With Democrats controlling both houses of Congress, the potential for more fiscal stimulus could be beneficial for equities.

equities had a positive quarter, doing particularly well in November and December, thanks to heavy weighting in the economically sensitive sectors such as financials and energy that benefited from renewed economic optimism.

The UK’s departure from the EU has been the defining factor for the pound since the June 2016 referendum, and its value has been jolted higher and lower by the vagaries of trade talks. After negotiators reached a historic pact on Christmas Eve, sterling rallied to just below its 2020 peak against the US dollar and advanced against the euro. 

The manager remains positive on the prospects for long-term economic growth. The latest lockdown has come with renewed fiscal support from the government and, in their view, has merely delayed the recovery, not stopped it completely. They are therefore keeping a bias to equity over defensive assets like bonds and focusing on sectors and regions that typically do well in times of economic growth.

Emerging markets should continue to benefit from a weaker dollar, which has been pushed down by the magnitude of monetary and fiscal stimulus deployed by US authorities, and investors’ confidence in an economic recovery.

In the UK, a sustained revival for sterling will be positive for assets, and could provide a further boost for shares. Investors now simply have no excuse not to consider equities.

One concern is the highly optimistic market sentiment, which has priced in a lot of positive news. Market corrections are not unusual in situations like this if the news flow turns negative, even if the underlying picture is still supportive.

After the very positive months of November and December, some retrenchment is possible. However, the manager is more likely to see this as a buying opportunity and could look to add to favoured themes during any periods of market stress.

The Shostra Bank Invest funds made a positive return over the last quarter, despite the spectre of a coronavirus second wave towards the end of the period. This took its toll on market confidence, but only after global economic activity had picked up throughout the summer.

The Lower and Lower/Medium Risk funds have preserved their value over the year to date, in line with their goal of reducing the impact of market ups and downs. Having more invested in shares has seen the three Medium and Higher Risk funds down over the year so far, but performance is strongly positive over the last three years. All funds have returned double figures for that period, except the Lower Risk fund which is just shy of it at 9.7%.

This demonstrates the importance and benefit of long-term investing. Major events in the world can make a big difference to markets but those markets tend to recover over time.

The manager believes that economic conditions are likely to be more challenging over the rest of the year, but the longer-term outlook remains positive, largely thanks to continued support from governments and central banks.

The manager’s view is that the world economy will pick up speed next spring, as medical solutions to the COVID-19 pandemic become available.

World economic activity picked up over the summer as lockdown restrictions relaxed. Consumer spending increased and businesses became cautiously optimistic, with key economic indicators turning positive.

Then many regions, including the UK, reintroduced measures to slow an increasing coronavirus infection rate towards the end of the quarter, and there were noticeable falls in some markets.

Despite this, stock markets around the world still rose over the quarter, with the MSCI All Countries World Index returning 6.9% in local currency terms.

Meanwhile, measures taken to support economies through the pandemic, such as low interest rates, and the popularity of perceived ‘safe-haven’ investment types such as gold, drew investors away from government bonds. government bonds returned -1.3% over the quarter, and their American equivalent returned just 0.2%.

Tech stocks fell sharply early in September, dragging the tech-heavy US indices with them – the S&P 500 recorded its worst trading period since March. But before the deep drop, share prices in the tech sector had soared ahead of the rest of the market, pushing leading US indices to record highs.

The manager does not see the falls at the end of summer as signalling a deeper market retreat. Stock markets were overdue a correction after rallying strongly since the spring. The falls were a healthy mix of profit taking and some rotation in positioning.

Geopolitical risk continues to loom over markets. The quarter came to an end with arguably the most chaotic US Presidential debate in the country’s history, as President Trump and Joe Biden took verbal pot shots at one another. Just a few days later, it was announced that President Trump had contracted coronavirus. Closer to home, the government’s controversial Brexit bill raised the stakes in its negotiations with the European Union, and sterling fell because of the ensuing uncertainty.

After reducing their holdings earlier in the year following market falls, the manager has been adding to shares and corporate bonds over recent months, reflecting their confidence in the long-term prospects of the economy and markets.

The manager increased the amount invested in shares in July, having added to Japanese stocks and investment grade bonds in May, and bought more US shares in June. The manager believes these investment types should do particularly well as the economy recovers from the effects of the coronavirus lockdown.

Although the final quarter of 2020 is likely to present challenges for investors as the coronavirus pandemic further unfolds, the manager doesn’t see a long period of economic stagnation ahead. Government and central bank support for the global economy is doing its job, the longer-term outlook remains positive, and a medical solution for coronavirus, when it comes, should keep economies in recovery mode.

Buoyant markets in June helped cause positive performance across all the Shostra Bank Invest funds over the quarter. This built on the rebound in April and May and has gone some way to mitigate the negative returns earlier in the year.

While most funds are showing a negative return over the year to date, performance remains strongly positive over the longer term. Big market events such as we’ve seen in recent months can have a major impact on the short term, but markets tend to bounce back.

The manager believes that, while Investing can be unnerving when markets fall, the last three months have shown how staying invested could be a better option than cashing in and crystallising a loss.

Lower-risk strategies have, of course, been less affected by recent market moves. Over the longer-term, however, their returns are well below other strategies that have more invested in shares and other risk assets.

Investor confidence grew steadily in the second quarter as the trend in coronavirus infections reversed and governments and central banks kept supportive economic policies.

Accordingly, stock markets around the world bounced back from the sharp falls in Q1 as the initial panic subsided and investors started considering the opportunities ahead.

Most markets recorded big rises between April and the end of June – the S&P 500 had its best quarter since 1998, and the FTSE 100 its best since 2010. This shows how quickly markets can bounce back after big falls, and adds context to the manager’s view that long-term investing requires riding out bumps along the way.

The stock market rally was first led by the health care and tech sectors, which proved relatively resilient during the sell-off. In May, some sectors that struggled earlier in the year saw positive returns, including banks, energy and oil, transport and homebuilders.

Despite improving investor sentiment, stock markets are yet to fully recover from the earlier losses. stocks in particular have fallen behind other markets – the FTSE 100 includes a high proportion of energy and oil companies which have suffered due to falling demand, and a lower proportion of the tech and health care stocks that benefited from the outbreak.

But the manager does not believe the current downturn will extend to a depression. The economy was in good shape before coronavirus, and the recovery is building on a sound financial foundation. Markets are largely ignoring the bad news and focusing on central bank and government stimulus measures. Those measures help navigate the short-term economic tempest and create opportunities for economies to invest in the future, providing further comfort for investors.

After reducing our holdings in riskier assets earlier in the year, we’ve been adding to shares and corporate bonds to take advantage of the increase in investor confidence. We added to Japanese shares and investment grade bonds in May and US shares in June. We think these will do well as the economy recovers from the effects of the coronavirus lockdown.

The manager believes we’re unlikely to see a long economic stagnation. Once the medical crisis is brought under control, we believe the world economy will steadily get better.

Of course, there is still some way to go before the crisis is over and many people are still suffering severe hardship. Localised outbreaks of COVID-19 continue and lockdown measures are being imposed in response.

But the data shows that people are returning to work and contemplating spending again. This can only be good news, and investors are positioning themselves to benefit from the economic recovery.

All the Shostra Bank Invest funds fell over the quarter as the coronavirus outbreak swept the world, keeping people inside and hitting businesses hard. Efforts to slow down the spread of the virus meant many households couldn’t spend or earn money as they normally would do, affecting economies and investment markets everywhere.

Investor sentiment quickly faltered as the true scale of the pandemic became clearer. Market volatility reached record levels, with some investors turning to the perceived safety of cash which reduced the demand for bonds and shares.

The shocking impact of the virus has led to many markets pricing in a deep but short recession. The manager believes that a sustained recovery will only happen once the spread of the virus has peaked, and when investors can see a clearer path back to normality.

Against this backdrop, the manager intends to stay invested in shares as far as is prudent, to help avoid crystallising losses and to be in a good place for the recovery when it comes. As always, keeping a long-term view and staying calm during short-term setbacks are priorities.

Financial markets had a dramatic start to the year as coronavirus spread quickly from country to country and tough measures to slow it down were put in place.

Fears about COVID-19 initially focused on the economic impact on China, where the problem started. But as the disease began to cross continents, it became clear the consequences would be far wider than first thought. Stock markets were very volatile after the worst fall for more than 10 years in March.

Central banks around the world acted decisively to boost the money supply with rate cuts and unprecedented levels of quantitative easing. Historic levels of fiscal stimulus were also introduced – £330 billion from the government, billions of yuan in loans for businesses affected by the virus from the People’s Bank of China and over $2 trillion from the US government. This is all aimed at making sure businesses have access to money to get them through lockdown.

At the start of March, government bonds went up in value as investors tried to shelter from stock market falls. However, as uncertainty over the economic impact of the coronavirus outbreak rose, safe-haven assets – notably the US dollar and gold – began to rise in value at the expense of bonds.

The pandemic has eclipsed some of the other big events that affected the market mood. For example, stock markets were volatile in January after the US stoked tensions by assassinating Iranian general Qassem Suleimani. Also, Saudi Arabia sparked an oil price war in early March when Russia refused to agree to OPEC oil production limits, sending oil prices down a lot.

Normally these could be expected to dominate headlines on financial pages. But their impact has been overshadowed by COVID-19, showing how quickly investor views can change during a non-financial crisis.

The manager reduced the amount invested in shares in March to lower the overall risk profile and create a reserve of cash to take investment opportunities that come following the market falls. For now, the manager is still wary of making big changes while the long-term outcomes aren’t clear.

The demand shock is likely to last throughout the second quarter. But by the end of June the manager believes we could start thinking about what the economy looks like after the pandemic.

It’s worth remembering that economic indicators suggested a period of recovery at the start of 2020 after a slowdown at the end of 2018. While the pandemic has knocked markets off kilter, it’s not a shock caused by economic or financial factors. The manager believes that, when coronavirus recedes, the seeds of economic growth that now lie dormant could spring back to life. It will take time before we see levels of activity get back to what they were, but the case for long-term investing is still strong.

Most of the Shostra Bank Invest funds delivered a positive return over the quarter, with the more defensive strategies dragged down by falling government bond prices as investors favoured risk assets. For less defensive funds, positive news on US/China trade talks and a decisive election result drove share markets forwards and boosted returns.

The biggest news in the for the quarter was the decisive victory of the Conservative party in the general election in December. This had three key impacts that could influence performance.

Firstly, the pound surged in value, reaching $1.35 before falling back to what looks like its current default level of around $1.30. This creates a headwind for sterling-based investors, reducing returns from assets denominated in foreign currencies and putting pressure on profits for large, export-driven companies in the FTSE 100.

Secondly, we believe that share prices could benefit from the return of global investors after a period of under-investment. The political uncertainty that came in the wake of the EU referendum result led many investors across the world to reduce their holdings in the UK. As a consequence, shares offer good value, based on attractive internal share valuation characteristics and a cheap pound, recent rises notwithstanding, which makes them cheaper for overseas investors.

While Boris Johnson’s large majority in the House of Commons has increased the possibility of a harder Brexit – which would reignite concerns around shares – we see a reasonably accommodative deal being made in 2020 which should support share prices.

The third impact of the election result has been on government bonds. Yields have risen (and prices fallen) as investors regained their appetite for risk assets, and bonds sold off world-wide in reaction to the news of a US/China trade deal. With inflation still well below the Bank ’s 2% target, however, interest rates are likely to stay low, which could put a ceiling on yields (and therefore a floor on bond prices) for the time being, but we don’t see any clear catalyst that is likely to lead to a change in fortunes.

Stock markets entered 2020 on a high after the election outcome relieved Brexit uncertainty and the US and China sealed a ‘phase one’ trade deal.

The end of 2019 saw markets around the world in decisively positive territory, with the MSCI AC World Index returning 26.2% over the year. Local market returns varied, but particularly strong returns came from the S&P 500 at 31.5%, MSCI Europe ex at 27.1% and MSCI Japan at 21.8% (all in local currency terms). shares struggled at times under the twin pressures of political turmoil and volatile sterling, but the MSCI Index ended 2019 with a return of 16.4%.

As the year begins, our analysis suggests the world economy is heading into an expansionist phase, which could be positive for markets in the months ahead. Important considerations, in our view, are improving global manufacturing forecasts and the continued strength of the world economy. We see a good chance of a recovery in economic growth in the coming months, largely supported by global monetary policy stimulus. This could be positive for assets that are sensitive to the global economic cycle, such as shares.

But there are still risks to consider. We’ll be keeping a close eye on the US presidential election and policy decisions by central banks, which will be important to fledgling signs of growth. But the 2020s have started in a broadly positive place that suggests risk could be rewarded in the coming months.

In the days after the election, we used cash reserves to add to our holdings in shares. They look attractive based on our analysis, particularly on valuation measures. Greater clarity on Brexit, albeit with some potential uncertainty further down the line, could act as a trigger for gains.

We increased our investment in European shares. Companies in the region get a large share of revenues from emerging markets and other sectors sensitive to global economic activity. As the broader global economy improves, we’re seeing encouraging signs from those markets. This positive trend has not yet been widely recognised by investors so European shares are good value in our view.

It was a summer of ups and downs as a sharp fall in August was sandwiched between positive returns in July and September. Taken as a whole, the quarter provided a demonstration of how holding your nerve can be a better bet than selling out as all of the Personal Portfolio Funds ultimately delivered a positive return over the three months.

With economic growth slowing, central banks have enacted policies intended to stimulate economic activity. The US Federal Reserve cut interest rates twice – by 25 basis points in July and the same amount in September – while the European Central Bank also unveiled new stimulus measures to bolster the eurozone economy. The Bank kept interest rates on hold at 0.75%, and policymakers indicated that prolonged Brexit uncertainty would keep rates lower for longer.

These measures are intended to counteract the effect on companies of a slower economy by making it easier for them to raise cash as money becomes tight, meaning they can develop and expand. This means that they should continue to be able to grow their profit, which has supported share prices this quarter and contributed positively to the performance of our funds.

Falling interest rates are also good for government bonds. Positive returns in this sector supported our funds, particularly at the more defensive end of the spectrum where they have a higher bond allocation.

Despite political shocks in August, markets turned in a broadly positive performance in the third quarter, with the MSCI AC World Index of global shares returning 1.1% in local currency terms. This translated to 3.3% for sterling investors as a falling pound boosted the value of non-sterling assets. Over the year-to-date, market performance remains very strong, with global shares returning 17.2% in local currency terms.

Events that unnerved markets in August included political unrest in Hong Kong, an increasingly fractious debate about Brexit in the UK, and rising temperatures in the US and China trade dispute. But while political news flow can lead to increased volatility, the global economy has a more powerful impact on long-term investment performance than geopolitics.

Economic growth remains in good shape, with reasonably resilient growth, supported by central banks, continuing for the time being. Our funds are more defensively positioned than this time last year with more of the amount in shares invested in developed markets – principally the US – and a greater allocation to US Treasuries which we see as less risky than government bonds.

Further political noise came at the end of September. In the US, Democrats moved to start impeachment proceedings against President Trump, while in the there were remarkable scenes in Westminster as the Prime Minister tried to assert his Brexit agenda.

We think market reaction to potential impeachment proceedings are overdone – the process could cause some administrative delays in the US, but in our view it’s unlikely to result in the removal of the President from office. Brexit uncertainty continues to put the pound under pressure, but we have reduced the amount invested in sterling-based assets in recent months. However, given sterling’s attractive valuation, we are watching the situation closely for opportunities should the political climate improve.

Despite a sharp drawdown in August, funds benefitted from strong performance by shares in July and a solid recovery in September. This demonstrates the value in staying invested during volatility as the quarter ended with positive returns from all strategies.

We’ve added to US shares, bringing our allocation up to a more or less neutral weight. US shares typically display higher quality characteristics and tend to be better placed to perform over different economic conditions.

While we’ve reduced the amount invested in sterling-based assets recently in recognition of short-term volatility, we retain a modest preference on the basis of our contrarian principles.

All strategies rose in the second quarter as markets continued to recover from December’s sharp falls. Gains over the first half of the year have more than made up for 2018’s losses, and on a 12-month view to the end of June 2019 all strategies delivered above-inflation returns, protecting the real value of customers’ money.

The driving forces behind market performance remained the same in the second quarter of the year as the first – central bank policies and trade tensions against a background of slowing global growth. A low interest rate environment tends to be positive for the economy and financial markets because companies can borrow money relatively cheaply to develop and expand, and it costs them less to service existing debts. The US Federal Reserve has been clear that it will continue to support growth by keeping rates low and other central banks are likely to follow its lead. However, the trade dispute between the US and China continues to weigh on investor confidence and a resolution failed to materialise at the end of the quarter, despite initial hopes.

While the world economy continues to expand, the pace of growth is slowing as we reach the latter stages of the business cycle. The manager anticipated this slowdown and, while remaining cautiously positive, has tilted funds away from riskier markets and towards more defensive areas. This has left the funds less exposed to areas that are underperforming, such as Japan, and with more focus on regions that are likely to provide more stable returns, such as the US. The manager increased investments in European stocks in the second quarter as the outlook for the region improved.

The second quarter was broadly positive for markets. Trade tensions remain a matter of concern for investors, but markets recovered from a sell-off following an escalation in rhetoric in May, and most regions ended the quarter in positive territory.

While the pace of global growth continued to slow, central banks have maintained their commitment to supporting economic growth. Interest rates on both sides of the Atlantic are widely expected to remain low, with the possibility of a cut by the US Federal Reserve before the end of the year. The Bank has kept interest rates on hold at 0.75% and suggested a long-term average of just 1% – lower than previous estimates.

Trade negotiations between the US and China seemed to be progressing well in April until President Trump raised duties on $200 billion of Chinese exports in May. China fought back with higher tariffs on American goods and stock markets around the world wobbled. While the immediate impact on markets of these flare-ups is negative, investors have typically returned to risk assets as valuations become more attractive, as happened on this occasion. Trade tariffs remain a risk, but the world’s two largest economies look likely to settle their trade-related differences eventually.

equity returns remained subdued in June relative to global markets. Investors remained cautious owing to Brexit uncertainty along with the added distraction of the Conservative Party leadership election. Theresa May’s announcement that she would stand down as Prime Minister didn’t trigger much of a response from markets because it was widely expected. Despite faring reasonably well during the first quarter of the year, the economy showed signs of strain in the second quarter and the economy contracted by 0.4% in April.

Against the current economic and political backdrop, we are considering a number of factors such as valuations, business cycle sensitivity and technical measures to guide our investment decisions. These continue to suggest a balanced approach to investing in risk assets and government bonds.

Over the second quarter, the manager trimmed equity exposure in favour of cash. In the highly volatile markets seen over recent months, a higher cash allocation provides flexibility to take advantage of any opportunities that arise.

The manager increased investments in European stocks slightly over the period. The Eurozone economy grew in the first three months of the year, benefitting from supportive central bank policies – particularly the European Central Bank, which announced that it would postpone further rate rises – and economic stimulus measures in China, a key export market for Europe. While challenges remain, this has improved the outlook for the region.

All funds have benefitted from increasing exposure to longer duration gilts, except for Personal Portfolio Fund 5, which doesn’t hold bonds.

All strategies rose in the first quarter of the year as markets recovered robustly from December’s sharp falls. As prices fell at the end of the year, it became apparent that the sell-off was overdone and valuations became more attractive – leading investors back to the market.

The gains of this quarter have made back the losses of 2018, and on a 12-month view to the end of March 2019 all strategies have delivered above-inflation returns, protecting the real value of clients’ money.

A key factor behind the shift in market mood was the US Federal Reserve adopting a more patient approach to raising interest rates in January. The central bank signalled it would ease off monetary tightening for now, and this more accommodative stance was echoed by many of its peers across the globe. Less pressure on monetary policy is positive for markets as it reduces the cost of borrowing, making it easier for companies to develop and expand, and to service existing debts.  Increasingly positive signs that a US-China trade deal could be reached also bolstered markets.

Global economic growth has continued to slow. The manager saw this slowdown coming and, while remaining cautiously positive, tilted funds away from riskier markets and towards more defensive areas. This move has benefitted performance as the funds have had less exposure to areas that are underperforming, particularly Europe and Japan.

After a rough end to 2018, markets have staged an equally dramatic rebound. Changes in sentiment were driven by three factors that we believe still have the capacity to influence markets.

The major catalyst for the rally was the change in the US Federal Reserve’s (Fed’s) monetary policy outlook. While this more dovish approach is good news for markets, the Fed has been clear that it will continue to be driven by data, and interest rates could start rising again should the economic backdrop change.

Positive news on trade negotiations between China and the US also provided relief to investors. Further moves towards an agreement would be positive for investor sentiment not only in Asia, but also in Europe’s export countries, like Germany.

The perceived instability of the US government at the end of 2018 – exacerbated by the US government shutdown – made investors cautious. While concern over the political mood in Washington still has the potential to knock investor confidence, the risk has receded somewhat since the end of the investigation into the 2016 presidential election.

Markets have reacted calmly to Brexit uncertainty, with equities recovering substantially, although perhaps with less confidence than elsewhere, and sterling remaining steady within a relatively narrow range. A longer extension has been priced-in and there is potential for UK-focussed midcaps to benefit from the eventual resolution.

Overall, the environment for risk assets now looks fairly balanced. The economic slowdown that our in-house indicators identified last year is still ongoing, but growth remains positive for the time being. 

Over this quarter the manager has trimmed equity exposure in favour of cash. In the highly mobile markets seen over the last six months, a higher cash allocation provides flexibility to take advantage of any opportunities that arise.

The manager reduced exposure to Japanese and European equity last year. Europe and Japan are key exporters so their markets have been hit by the trade tensions of previous months and a slowing Chinese economy – both of which dented demand for their goods. Resolution of trade tensions is likely to benefit these markets, however, and so the funds retain a neutral allocation.

All funds increased exposure to longer duration gilts – except for PPF5 which doesn’t hold bonds – and subsequently benefitted from recent gains. The manager also added some exposure to dollar-denominated emerging market government bonds based on attractive yields, while turning negative on corporate debt and adding the proceeds to cash.

These moves have left the funds with a slightly higher overall allocation to bonds than at the start of the year, although still marginally below benchmark and neutral on equities.