We are now nearly a decade on from the financial crisis and the major world economies remain characterised by comparatively low growth and low inflation.
Equity markets have seen good absolute returns in the year to date. By the end of the second quarter (in Sterling terms) the FTSE 100 had gained 5%, the S&P 500 4%, the FTSE World Europe index 13%, the FTSE Japan index 5% and the FTSE World Asia Pacific ex Japan index 12%. Asset prices have responded positively to economic data that has in general been better than expected, especially in Europe. Inflation remains fairly benign and fiscal and monetary policies are still supportive of risk assets, although recent comments from the governors of the major world central banks have indicated this cannot continue indefinitely. There are political risks in the UK, US and Europe but they have so far not materially impaired markets.
Energy and commodity prices have moderated in the year to date, for instance the Sterling Brent crude price has dropped by 20%. Energy and mining companies have not performed well as a result and our portfolios have benefitted from their limited exposure to these sectors. They have also been advantaged by good performance from the following sectors: consumer goods (especially tobacco), healthcare/pharmaceuticals and their exposure to more mature technology stocks which are cash generative.
It is important not to be complacent and assume the 8-year bull run in equity markets can continue indefinitely. Equities are generally at historically high valuations. Conversely, volatility remains low, with the VIX index currently 11, compared to a long term average since 1993 of 19. This index only covers the US equity market and has other limitations. It is a reasonable guide to market sentiment in the largest global equity market though. The 46% spike in the index on 17 May is an indication of how quickly more turbulent market conditions could emerge with little warning.
Despite the need for vigilance, we still favour equities above other asset classes. We also expect active management and careful stock selection on the part of the fund managers who make up our panel to add substantially to returns. We retain our perennial preference for funds which invest in companies with resilient, global business models and which generate ample cash. Such companies should prove defensive relative to those with weaker balance sheets in the event of a market downturn.
We have met with most of the managers of core fund choices in the first half of the year and have discussed portfolio positioning in detail for each fund. It is clear that even companies operating in traditionally stable and defensive industries such as consumer goods and healthcare must continue to evolve their business models and adopt changing technology and adapt to (or acquire) new entrants.