September 2013

A forward view of the global economy

and financial markets

July 2017

GHC Capital Markets Limited

22–30 Horsefair Street

Leicester

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T: 0116 204 5500

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Market 2 Market

July 2017

Going Green

“I feel more confident than ever that the power to save the planet rests

with the individual consumer.”

Denis Hayes

Towards the end of the recent G20 Conference President Macron of France announced that

the sale of petrol and diesel cars will end in France in 2040. His new ecology minister, Nicolas

Hulot, said that this was a “veritable revolution”. I am not so sure that this is really the case

but I shouldn’t disparage Monsieur Hulot for ‘bigging up’ up the new policy. I suspect that by

2040 only a very few specialist manufactures of diesel and petrol cars will be left and we will

all be sitting in driverless electric cars. Jeremy Clarkson will not be happy.

At the other end of the green energy debate sits President Donald Trump who has pulled the

US out of the Paris Agreement, which was signed by 195 countries. The good news is the

momentum to develop renewable energy rather than burn fossil fuels is unstoppable.

Between July and September 2016 50% of the UK’s electricity supply came from wind

turbines, solar panels, wood burning and nuclear reactors. In Scotland the figure is even

better with 77% of electricity being generated by low carbon power sources. The Scottish

Parliament has said that it aims to have a ‘carbon free’ electricity sector by 2032, which is

rather more ambitious than banning the sale of petrol cars by 2040.

Tesla has announced that in 2018 it hopes to manufacture 500,000 units of its new Model 3

salon car that can be bought new for $35,000. With 400,000 advanced orders already, it is

clear that the demand for environmentally friendly cars exists. Volvo has announced that it

will only be manufacturing electric or hybrid cars from 2019 onwards. Nissan and Renault are

already making small electric cars and all the other big car manufacturers are investing huge

sums of money into this sector.

I did come across an encouraging story by the BBC which showed that Argent Energy has

built a second plant in Ellesmere Port that converts solidified fat and grease (Fatbergs) from

the sewers into biodiesel, which is 80% cleaner than ordinary diesel. Argent has been

collecting 30 tonnes per week from one sewage treatment plant in Birmingham and they

plan to make 90 million litres of biodiesel this year. There are another 8,999 sewage

treatment works in the UK. The numbers are startling and the bonus of making the sewers

more efficient as well as saving the water companies millions in maintenance work bodes

well for this enterprise. Who knows this may prolong the life of diesel powered cars.

I have not mentioned power generation from wave or tidal power, deemed as uneconomic

20 years ago. Advances in technology have meant that we now have a number of projects

that are trialling this power source and it is clear that good progress is being made.

While it is important for governments to take the lead in reducing carbon emissions the

momentum is now with industry to produce low carbon power and the public want to buy

goods that use little or no carbon. Technology is continually advancing and companies are

now investing seriously in green technology to produce environmentally friendly products

because people are making purchasing decisions based on environmental considerations.

Most large corporations now have environmental policies in their ‘Stewardship Codes’ and it

is a brave CEO who flies in the face of environmental considerations. Politicians can, and

have helped but social responsibility and helping protect the planet will happen in spite of

Donald Trump because it is what the majority of people want.

Richard Harper

GHC Capital Markets Limited

Image source: Wikipedia

A Fatberg

July 2017

Richard Dziewulski GHC Capital Markets Limited Reproduced from Capital Economics

A Global Economic Update

The price/earnings ratio of the MSCI Emerging Markets Index has now increased to a level that is well above its long-run

average. However, the valuation of the index is not especially high in either absolute of relative terms. On average valuations

of emerging market equities have risen due to material declines in real interest rates and risk premiums (partly reflecting

improved management of emerging economies). As a result, it is wise to be sceptical that the valuation of the index will revert

to its long-run average.

The index also looks low when compared with the MSCI World Index of developed market equities. Some of the disparity in the

two indices’ valuations can be explained by the different sectoral compositions with the MSCI Emerging Markets Index

containing a slightly high proportion of firms in sectors such as materials, where valuations are typically below the index

average. However, only about a fifth of the gap in valuations can be explained in sectoral weights.

The majority of the difference is actually down to firms in the same sectors trading at lower price/earnings multiples in

emerging markets than in developed markets. One example of this is the technology sector, the recent rise of which, especially

in the US, has been the main source of investors’ worries. Technology firms in advanced economies trade at a price/earnings

ratio which is about 20% higher on average than that of their emerging market counterparts. This is not just a technology story

either. Price/earnings ratios are higher in developed markets than in emerging markets in the majority of GICS sectors (Global

Industry Classification Standard) and in some cases this is significant.

Emerging Market equities have nearly always traded at a discount to their developed market peers which reflects the greater

level of risk investors are taking on. The difference in their risk premiums however should have shrunk over the last five to ten

years due to fundamentally positive changes in emerging economies. The size of the price/earnings ratio gap has however

grown considerably over the last five years. This seems to be a clear indication that emerging market equities are now

undervalued in relative terms. Whilst this does not mean that emerging market equities are bound to perform well, it is one

reason why they should fare a little better than their developed market peers over the next few years.

In the UK, recent hard data for the industrial and construction sectors was far from encouraging and recent Markit/CIPS PMI

surveys for June showed a dip. However, they still provided some reassurance that growth will pick-up in Q2. As a result of this

it is likely that the economy will still gain some momentum in Q2 though the forecast of 0.4% now looks as though it should

now be revised slightly to the downside.

Across the pond the 222,000 gain in non-farm payrolls in June is another illustration that the US economy is in good health.

Admittedly, the unemployment rate did edge back up to 4.4% from 4.3%, but only because of a massive 361,000 increase in

the labour force. Looking ahead, it seems likely that the Fed will push ahead with hiking interest rates and the unemployment

rate which is already unusually low will fall further over the coming months.

In Europe discussions about Greece are over for now and the Eurogroup has turned its attention to the issues of non-

performing loans and euro-zone banks. Euro-zone data for May look set to show that industrial production increased strongly

and it is expected that the euro-zone’s trade surplus will rise. Industrial data for Germany, France and Spain showed that

output rose sharply across the board and a weighted output of the national data implies that euro-zone industrial production

rose by about 1.5% in May. This would push the annual growth rate up by about 4% (the best since August 2011), and the

manufacturing surveys are now consistent with a similarly strong pace of growth in the months ahead.

Over in Japan, a rebound in machinery orders is expected for May as well as an improvement in the Economy Watchers Survey

which supports the view that consumer spending accelerated in Q2. Growth in labour cash earnings picked up from 0.5% y/y in

April to 0.7% y/y in May, with the 0.9% y/y increase in regular earnings being the strongest in two decades. Large gains in

hourly wages of part time employees point to higher growth in full-time earnings ahead and show Arrow Three of Abenomics

now coming to fruition. Much stronger growth still needs to be achieved if the Bank of Japan’s 2% inflation target is to be hit.

Chinese CPI has rebounded over the past few months and it is likely it will rise further in June. However, falls in global

commodity prices will have weighed on producer price inflation. Trade growth has been strong recently and China’s foreign

exchange reserves recently increased by £3bn in June to $3,056.8bn. This suggests that having eased markedly since the start

of the year, capital outflow pressures have remained muted over the last month.

July 2017

Tim Harris Chair of Asset Allocation Committee GHC Capital Markets Limited

Asset Allocation

UK Markets overshadowed by the general election result

European equities strong first half, but concerns below the surface

US second quarter earnings season is underway

Overall a mixed picture across Emerging Markets

We remain concerned about the direction of oil prices

We shall not add to the mountain of post-result analysis on the UK general election, save to say

that the UK equity and bond markets are reflecting heightened uncertainty as to the future

direction of the incumbent government. With headline inflation flirting with the 3% level, rising

gilt yields and a fall back in equity levels from all-time highs seem likely to be a theme of the

summer.

A weaker sterling helps UK exporters. It also highlights the translated returns of our portfolios’

unhedged overseas assets, which we believe retain better attractions than domestic counterparts.

Since the beginning of the year, the EURO STOXX 50 index is up 7%, despite the 9% appreciation of

the EUR/USD, as growth has been stronger and yields relatively anchored. Both valuation

expansion and earnings have contributed to this good performance: 2017 earnings estimates are

up 2% in the first half, an improvement compared with constant earnings downgrades since 2010.

The strong economic backdrop has contributed to deflate the European equity risk premium, the

sharpest decline across regions, and has boosted the number of buybacks made by European

companies, one of the most cyclical uses of cash.

However, the second derivative of growth (rate of change), to which equities are particularly

sensitive, has slowed down. The expansion of equity valuations has been driven by the rerating of

defensive sectors, such as Food & Beverage, Personal & Household Goods and Healthcare. Within

cyclicals, Banks stand out as the fourth best performing sector. While the appreciation of the

EUR/USD has not weighed on the market at the aggregate level, it has significantly affected

European companies with US sales exposure. Going through the end of the year we are mindful of

elevated equity valuations and risks of a growth deceleration or monetary policy shocks.

89% of S&P 500 market capitalisation will report earnings by August 4. Consensus expects second

quarter adjusted EPS will grow by a respectable 7% year-on-year, driven primarily by a rebound in

Energy EPS. Relative to Q2 2016, average Brent oil prices were 8% higher in Q2 2017. S&P 500

EPS growth is expected to slow from 14% in Q1, the fastest pace of growth since 2011. Although

the Q2 earnings surprise will likely be smaller than in Q1, reported earnings typically beat

consensus forecasts, and the macro environment suggests this will also be the case this earnings

season. Fading USD strength and higher interest rates should also support Q2 EPS growth.

The 10-year US Treasury yield averaged 2.3% in Q2 2017 versus 1.8% in Q2 2016, which reflects

widespread expectations of Federal Reserve interest rate increases over the next 18 months. The

US economy added 222,000 jobs during the month of June and average hourly earnings grew 2.5%

year/year. Any wage measures have shown signs of deceleration in recent months. However,

given that the US economy is at full employment, we expect wages will continue to rise. Hence

expectations of rising interest rates and upward pressure on treasury yields.

Economically, we foresee a China economic slowdown into 2018 after the 19th National Congress

resets medium-term policy, Central & Eastern Europe doing well, Russia struggling out of

recession, Mexico performing above expectations, and Brazil and Argentina showing signs of

recovery from their respective domestic challenges. Last year saw a rebound in overall EM growth

back to 4% from 3% in 2015/16. Asia was strongest region, but Latin America growth was near

zero.

Many EM countries are at different stages of their respective macro cycles. Overall we expect

modestly positive total returns from this heterogeneous equities asset class. One attraction is EM

dollar debt, which is yielding an average of 6.5% at present.

Crude oil prices fell in the second quarter and the balance of risk still weighs to the downside. The

rapid return of both Libyan and Nigerian production has contributed to record-high global oil

inventories, highlighting that the market’s supply problem is yet to be solved. The demand-side

picture is less clear, though it may disappoint in the next 6-12 months as a result of weakening US

and Chinese aggregate demand.

We continue to manage portfolios in a conservative fashion, relative to their defined risk ranges.

We are generating positive returns across the board, but keep a weather eye on increased

developed markets’ risks, following UK and US political developments.

July 2017

Markets at a glance

Source: Lipper

The UK general election result is raising the risk premium of UK equities, given uncertainty over the sustainability of the next government at a critical time for Brexit negotiations. The FTSE 100 index has given up 200 points from peak and there has been an increase in market volatility. However, the lower levels of sterling against world currencies help the UK’s terms of trade at a time of softer consumer behaviour. With 2% pa GDP growth penned in for the next 18 months, earnings growth should be able to support UK equity levels. That said, inflation pressures may persist for longer than previously anticipated, which will keep markets aware of changes in monetary policy. This in turn will keep the lid on equity advances.

Source: Lipper

The major global equity markets have made solid single digit gains in the first half of the year. US equities are no longer cheaply valued and the economic expansion, which started in 2009, is now mature by historic standards. Tax and spending plans remain unclear in the US, although we believe that growing inflation pressure means that it is likely that the Federal Reserve will be raising interest rates over the next 18 months. Correlations among the returns of regional equity markets remain high, although the relative cheapness of Europe and the ECB’s monetary policy that is supportive to growth suggest that there may be better opportunity in this region. We believe that improving growth prospects in Japan offer relative advantage to equities here, despite continuing deflation trends

Source: Lipper

UK 10-year gilt yields continue to rise to a current 1.32%. The combination of a weak pound and easier monetary policy is underpinning growth across the UK economy. However, with headline inflation a little below 3% the monetary policy committee of the Bank of England will be keeping a close eye on further upside risks. At its last meeting, three of the eight voting members argued for an increase in the repo interest rate. This may be signalling that the post-Brexit rate cut is no longer needed. However, the Bank of England will be careful how it communicates changes in interest rate policy, lest the markets determine it is changing medium term policy. Meanwhile the term premium in markets suggest that longer dated gilts are tracking modestly higher.

Source: FactSet

Markets are pricing two more interest rate hikes by the Federal Reserve in 2017. The current monetary tightening cycle could see rates hit 3% by early 2019. The White House is focused upon a more fiscally expansive policy, which gives an upside tilt to growth and inflation forecasts. Higher short term growth at a time when US economic activity is close to potential and employment rates are high raises inflation risks. We expect US yields to move higher. German bunds appear to be responding to external rather than domestic forces. 10-year yields have fallen back to near zero. We assume an extension of ECB quantitative easing to end 2018. Any rise in other Euro Area yields reflects low risk appetite and a focus on quality bonds, rather than growth or inflation developments.

July 2017

Source: Lipper

After the Brexit referendum vote, the Bank cut UK repo rates to a record low of 0.25% and announced a further £70 billion of quantitative easing. We doubt that official policy will lead to tighter monetary conditions any time soon, despite headline inflation rising to 2.7% - somewhat above the 2% target and in excess of earnings growth rates. However, we note that three members of the Bank’s monetary policy committee registered votes in favour of an interest rate hike at the last meeting. The balance of future votes may not be so tight, given imminent changes in membership of the committee. The Bank of England is likely to purchase fixed income securities through the year, which may limit the sell-off in short and longer-term interest rates and flatten the yield curve.

Source: Lipper

Crude oil prices fell in the second quarter, despite the announcement of an extension to the 'OPEC-NOPEC' supply agreement, and the balance of risk still weighs to the downside. The rapid return of both Libyan and Nigerian production has contributed to the persistence of record-high global oil inventories, highlighting that the market’s supply problem is yet to be solved. The demand-side picture is less clear, though it may disappoint in the next 6-12 months as a result of weakening US and Chinese aggregate demand. Looking ahead, the oil market needs a supply disruption. While the risks of such an event being caused by an interruption to supplies in the Middle East are clearly growing, we see it as a greater chance currently that the disruption is triggered by another oil price swoon, the effect of which would be to more enduringly reduce the ambitions of US oil producers.

Source: Lipper for Investment Management

Commodities have proved good portfolio diversifiers in high inflation periods such as the 1970s but returns have been positively correlated with equities since the Global Financial Crisis. Gold can provide a hedge, but only in currencies with low real yields such as the euro and yen – it might be more difficult in US dollar, as real yields rise. We remain positive on gold, though recent US policy rhetoric does suggest as plausible a scenario whereby the Fed continues to raise rates despite weak US inflation and mixed growth indicators. Such a scenario would push up real rates, damaging gold sentiment and possibly prices in the near term, but sharper than justified tightening would increase mid-term threats to both economic growth and highly elevated equity market valuations – therefore ultimately positive for gold.

Note that where an MSCI Index has been used for illustration. This has been sourced with permission from MSCI Inc.

July 2017

Quick facts

ISA Allowance 2017/2018

Stocks & Shares ISA Cash ISA Junior ISA

£20,000 £20,000

£4,080

Pension Allowance 2017/2018 The limit is the greater of £3,600 and 100% of

salary, subject to the annual allowance of

£40,000 (unless money has been accessed

through flexi drawdown in which case the

annual allowance is limited to £10,000.

Tax facts

Income Tax Capital Gains Tax Inheritance Tax Corporation Tax

Personal Allowance 2017/2018 Basic Rate @ 20% Higher Rate @ 40% Additional Rate @ 45% Married couple’s allowance: Older spouse born before 6 April 1935 Annual Exemption - Individuals Basic Rate tax band (residential property) Basic Rate tax band (other assets) Higher Rate tax band (residential property) Higher Rate tax band (other assets) Entrepreneurs’ relief rate Entrepreneurs’ relief lifetime limit of gains Threshold up to £325,000 Over £325,000 Full Rate Small Companies Rate (SCR)

Up to £11,500 £11,500 to £45,000

£45,001 to £150,000 Over £150,000

£8,445

£11,300

18% 10% 28% 20% 10%

£10,000,000

Nil 40%

19% 19%

GHC Capital Markets Limited · Investment Managers & Stockbrokers · 22-30 Horsefair Street, Leicester LE1 5BD Telephone 0116 204 5500 · Facsimile 0116 254 3621 · www.ghcl.co.uk The information given is of the opinion of GHC Capital Markets Limited, the opinions constitute our judgment which are subject to change. This document is for the information of clients and prospective clients and is not intended as an offer or solicitation to buy or sell securities. The information given is believed to be correct but cannot be guaranteed and opinions constitute our judgment, which is subject to change. Certain investments carry a higher degree of risk than others, are less marketable and therefore may not be suitable for all clients who should always consult their investment adviser before dealing. The value of stocks, shares and units and the income from them may fall as well as rise and this also applies to interest rates and the Sterling value of overseas investments. Past performance is not necessarily a guide to future returns and investors may not get back the amount they invested. Any anticipated tax benefits depend upon an individual’s circumstances and are subject to changes in legislation and regulation, which cannot be foreseen. Directors, employees and other clients of GHC Capital Markets Limited may have an interest in securities mentioned by the firm but all officers operate a policy of independence which requires them to disregard any such interest when making recommendations. Note that telephone calls may be recorded. COPYRIGHT: © GHC Capital Markets Limited, 2011. All rights reserved. No part of this publication may be reproduced, transmitted, transcribed, stored in a retrieval system, or translated into any language in any form by any means without the written permission of GHC Capital Markets Limited. A Member of The London Stock Exchange · Authorised and regulated by the Financial Conduct Authority · A Member of WMA GHC Capital Markets Limited · Registered office: 22-30 Horsefair Street, Leicester LE1 5BD · Registered in England number 3113332 VAT

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