The major US benchmarks reached new highs in January 2017, whilst an extraordinary situation arose in the UK whereby a new high was reached on each one of the first 12 trading days of the New Year, although the momentum faded at the mid-point of the month and the FTSE 100 ended January at the level of 7,099 compared to 7,142 at the beginning of the year. At the sector level mining and tobacco companies both performed well. We continue to have little exposure to cyclical resources companies but our Equity Income fund choices have substantial exposure to tobacco. Sterling strengthened a little over the month compared to the US Dollar and the positive influence of currency for our global fund choices weakened somewhat.
We have met with a number of equity managers this month including Mark Barnett of Invesco Perpetual Income/High Income, Nick Clay of Newton Global Income, Jacob de Tusch-Lec of Artemis Global Income and Derek Stuart of Artemis UK Special Situations. This has been very useful in refreshing and refining our views with regard to market valuations and rotation between sectors in addition to updating us on fund positioning.
Despite the FTSE 100 having a total return of -0.57% in January we retain our concern with regard to equity market valuations. Broad based stock market valuations such as Price/Earnings and Price/Cash Flow ratios are high in the context of historic levels, although they do remain below the extremes of past market bubbles. Recent fund manager meetings have emphasised the fact the market is not being driven by substantial factors like earnings growth but rather by sheer momentum. We remain concerned that there is little substance backing high equity market valuations and the risk of volatility remains present. On the other hand a market pullback might present an opportunity to deploy tactical cash balances.
There is so much confusion, that in an effort to understand, and explain, commentators fall back on labels, and try to fit market movements into them. We hear a great deal therefore about cyclical resource companies, such as oil and mining stocks, about value stocks, which may have been mispriced by markets and about momentum buying which means stocks are being bought because others are, and there is no fundamental reason for it. Quality stocks which generate good, and secure levels of income, are being labelled as “bond proxies”, often inaccurately.
You will be aware that the funds we recommend tend to ignore labels, and instead search out companies, in almost any area, which have a good market position, which have strong positive cash flows which they use wisely and which generally pay dividends.
Such funds have typically outperformed their relevant index over reasonable periods of time, but, as now, can underperform when markets are momentum driven. This can mean that even when markets are high, or have been high, but are falling a little, such funds when chosen with care, can provide a good home for future solid growth.
At the aggregate level both UK and US corporates have significantly increased their debt levels since the financial crisis due to the cheap cost of funding. Highly leveraged companies are vulnerable to a rising cost of capital as interest rates increase and this is another reason to retain a focus on quality companies with low debt levels and strong balance sheets.