MONTHLY MARKET COMMENTARY JUNE 2016 UNITED KINGDOM

Our theme this month is coins. A penny for your thoughts? This idiom suggests one’s thoughts are a) worth paying for, but b) not much! However, since a rare 1933 penny (George V “pattern version”) sold at a London auction for £72,000 last month, perhaps we should give a little more respect to the change in our pockets. Around the world, despite “advances” in technology that now brings us plastic credit cards and contactless payments, we still have coins. Some readers may be concerned about the prospect of the penny becoming a euro cent – the EU Referendum gets plenty of coverage this month (to reiterate, at present we believe the Bremain campaign (i.e. not Brexit) will prevail). A penny for your thoughts is usually said when we want to know what another is thinking, typically when they have been quiet for a while. Are they thinking about the price of butter, food mountains, the Common Agricultural Policy and/or jobs, for example? All were issues the last time we had an EU Referendum, in 1975 … and for many reasons, some nothing whatsoever to do with Europe, others squarely down to the continent, they all turned up as big topics of conversation in the few years that followed. The arguments this time around can be summed up (broadly) in two words, namely sovereignty (Brexit) and the economy (Bremain). We remain apolitical, and endeavour across several of this month’s articles to show neutral information in as interesting a light as possible. Ultimately, in this Commentary we are interested in the outcome for invested assets (and related elements such as sterling). According to ft.com, the last 20 polls (16th May to 5th June inclusive) across various polling organisations have a wide spread of outcomes, ranging from between 58% and 41% in favour of staying, between 48% and 35% in favour of leaving and a massive 21% to 4% “undecided”. The latest average is 45% to stay, 43% to leave and the remainder undecided. Clearly, if many more of the latter decide to vote to leave, a Brexit becomes a reality. If slightly less than half do, we Bremain. Based on the polls in the run up to the general election last year, the undecideds, if that is indeed what they are, will hold sway on the day. The weather on 23rd June may also have an impact … oh yes, and the percentage turnout. Probably not what colour socks we decide to wear. The point is, at time of publication, there remains uncertainty.

MONTHLY MARKET COMMENTARY JUNE 2016 UNITED KINGDOM (cont’d)

The UK economy, whilst perhaps not as strong at this stage as might have been anticipated, is still growing. With interest rates low and inflation within range (2%, set for the Bank of England MPC by the Chancellor), small numbers should be anticipated as the status quo for a while yet. However, in the event of a “shock”, we expect increased volatility and bigger numbers to prevail, and there are more than two sides to that coin. Brexit will be seen as a shock in these terms; we have the anticipation of a US rate rise, but when and by how much could easily shock; and still in the US we have Trump/Clinton pretty much confirmed for November. Add to that the ongoing OPEC discussions on oil, a Eurozone economy struggling to its feet and the permanent possibility of a “black swan”, and caution seems to be the right approach. Despite a relatively calm month, we remain cautious in our outlook for 2016 across all risk strategies. The UK equity market remains of interest to us, but tactically we prefer to hold less in UK equities and their European cousins, for now. Term or word to watch: penalties … for leaving the EU, for staying in the EU, and the anticipated penalties to remain in or be knocked out of the European Football Championship. Many zombie companies have avoided the penalties of bad management/too much debt thanks to the policies of the likes of the Bank of England, Fed and ECB and a global zero interest rate policy … but for how much longer? Perhaps owning some element 79, for the chemists among our readers, is good insurance (except against missing from 12 yards in Paris next month – only practice and some luck can help with that one …).

NORTH AMERICA

Markets seem to have been genuinely surprised by the emergence of a more hawkish tone from the Federal Reserve. Some had begun to doubt whether we would see any further rate rises this year, but the suggestion from Janet Yellen and her colleagues that that was some way off the mark caused reflection. The Fed does not want to give the impression that it is unable to raise rates as that might suggest that they are dictated to by global events and they then risk a loss of credibility. At the same time, the US economy is not hermetically sealed and immune from a global downturn, which could ensue from a premature rate rise. If the market re-prices a more hawkish Fed, then equity markets will weaken, and if the tone is seen as too dovish, bond markets will fret over inflation expectations. Though uncertain to materialise, the very remote possibility of Brexit means that a June hike is far from likely, but July looks a genuine possibility … or did until pretty poor employment numbers last week.

MONTHLY MARKET COMMENTARY JUNE 2016 NORTH AMERICA (cont’d)

Markets responded calmly to these developments, perhaps reassured by the impression of a strong central bank in a world where faith in them is quickly evaporating. It has provided some support for banking stocks, which have been severely hampered by the threat to margins and a flattened yield curve. Before any final decision is taken, the supposedly “data dependent” Federal Reserve will have the opportunity to digest a slew of economic figures relating to consumer spending, housing, industrial production and retail sales. The Fed must have a degree of confidence to contemplate this course of action, but for us the outlook is rather uncertain. Manufacturing looks very weak and the wider data appears to be hit and miss. Even if one is convinced of the robustness of the economy, it is difficult to construct an aggressively bullish model for US equities. Valuations remain very elevated, margins (which tend to mean revert) are under pressure and earnings are in a downward trend. The first US penny, known as the “Birch Cent” was sold in 2015 for almost $1.2million. The coin was made in 1792, months after the one cent denomination was first authorised by Congress. The US has been resilient in comparison with other major indices, but increasing exposure here would seem a move unsupported by the balance of probabilities regarding the economic outlook. Yes, the dollar could provide some protection for sterling investors – this does not seem an adequate reason given the valuation headwinds.

EUROPE

It is a busy month for Europe with three potentially significant events to watch out for, hence a slightly longer section than normal. Starting with France, where the end of May saw disruption for many travellers (a blockade on many of the country’s oil refineries saw many petrol stations run dry), proposed labour reforms have been the catalyst for a dispute between the government and unions. The reforms remain deeply unpopular with unions, who have been taking action for the last few months to protest this. In the face of this action, embattled President Francois Hollande has refused to back down and the Labour Reform Bill was pushed through the National Assembly (lower house of parliament) without a vote. This led to an escalation of protests from unions, including the refineries protest, and to add to that, unions recently announced an open-ended rail strike. The main reforms include fewer regulations around special leave such as maternity leave; around laying off workers (and reducing pay); and changing the 35-hour week to an average so firms can negotiate fewer or more hours depending on demand.

MONTHLY MARKET COMMENTARY JUNE 2016 EUROPE (cont’d)

The government hopes this improved labour flexibility will stimulate the economy through giving companies the confidence to take on more employees in good times without having to worry about having to retain them if conditions turn. The bill will go in front of the Senate on 14th June, with unions calling for a further day of action on this date; this promises to be a real test for Hollande, exactly one month before Bastille Day. The unions argue that he did not have these reforms in his manifesto; indeed, when first elected, Hollande was seen as a popularist nonmainstream choice, a socialist. The need to introduce these hardnosed economic reforms by the popularist candidate once again illustrates the tough compromises which will be faced not just in France but across the continent. Whilst still a relatively new currency, there are some very rare and potentially valuable euro coins out there. Readers who have just returned from a trip to Italy may want to check their 1 cent coins as it may be able to pay for their next trip! There was a limited run of Italian 1 cent coins which mistakenly show the Mole Antonelliana in Turin instead of Castel del Monte in Apulia, the former usually reserved for the 2 cent coin. If you are fortunate enough to find one of these coins, some have recently gone to auction with a reserve of €2,500 (c.£1,950). Which leads us to Spain, where 26th June will see a fresh round of elections after those held last October failed to see a government emerge. The rise of popularist parties fragmented the vote, and a working coalition could not be formed. Recent polling suggests a repeat of this outcome seems likely, with 80% of those questioned commenting they would not be changing their original vote. The caretaker government will be encouraged by recent economic data, including stronger services data and evidence of the economy adding jobs. The challenge of building on this improving data and tackling the still significantly high youth unemployment will be a pressing priority at the same time as keeping any new coalition together. Last, and by no means least, a few words on the UK’s EU Membership Referendum. Whilst unsurprisingly most of the news coverage here in the UK has centred on the implications at home, the impact on Europe is also potentially significant. In their biannual economic report, the OECD suggest that in the event of a Brexit vote the countries which will be most highly impacted are the Netherlands, Republic of Ireland and Luxembourg. This is based on a model which includes share of exports and investment in Britain.

MONTHLY MARKET COMMENTARY JUNE 2016 EUROPE (cont’d)

Longer term, there will also be questions on the future of the EU and the single market itself. As the generally held market wisdom goes, markets hate uncertainty, so this development could add a headwind to European equities. A recent survey suggested Italians, given a referendum now, would vote to leave the EU … Of course, there are a few cities which may benefit from Brexit such as Dublin, Frankfurt and Paris (all/any of which may gain if London were to become less “attractive”). Indeed, there is already evidence that some financial services companies are exploring moving their headquarters. We remain relatively positive on the case for European equities in the medium term. Europe remains home to world leading companies in their fields, plus some highly innovative smaller companies. Given the potential speed bumps, not least the impact of the Referendum, we are holding less in European equities, as we see more short-term downside than upside.

JAPAN

After widespread concern over the potentially negative impact of the slated consumption tax rise, Abe looks to have decided that a delay is justifiable. The original plan – to see the tax rate rise from 8% to 10% and scheduled for April next year – will be delayed until October 2019. This prevents a substantial fiscal squeeze on a faltering economy and comes ahead of upper house elections in July. A fiscal stimulus is also planned and Kuroda recently voiced concerns about a possible global downturn and crisis at a G7 meeting. The last time a hike in consumption tax occurred was in 2014, and it induced a recession in an already fragile economy. Japan finds herself in the unenviable position of not wanting to throw an (arguably) nascent recovery off balance, but at the same time having to address a fiscal problem which may already be beyond help. Quite how the market can be reassured about this conundrum is difficult to see. Is Abenomics failing to the extent that we could see credit ratings for government bonds adversely affected? This would be a big deal and lead to a reassessment of the investment case for the country. A more positive take is that the authorities are showing signs of willingness to respond to circumstances as they need to, which could reassure investors. Certainly it is difficult to plough on with a tax rise when the country continues to flirt with recession and produce contractionary manufacturing PMI figures.

MONTHLY MARKET COMMENTARY JUNE 2016 JAPAN (cont’d)

Chinese coinage became used as the standard currency of Japan from the 12th to the 17th century. These were obtained from China either through trade or through acts of piracy, where pirates would raid the coastlines of China and Korea administering medieval punishments.

Japan remains an overweight allocation as a relatively short-term trade. This means we are monitoring the situation especially closely as doubts over Abenomics seem to be growing with each passing week. We are happy, relatively, to be contrarian here … not least as we do see record pay outs to shareholders and increased M&A activity drawing investors back. ASIA

We have written extensively about the links between the fortunes of China and the rest of the Asian region, which in the current market climate justifies caution. However, one genuine positive for the region were the recently released last quarter GDP figures for India. The country’s GDP rose by 7.9% in the final quarter of the last fiscal year and by 7.6% for the 12-month period. This gets reported relatively “late” due to complications involved in compiling the data. The figures point to a strong economic recovery led by consumption, and the indications that the economy is building up momentum are consistent with other data points on car sales, corporate profits and industrial production. The headline number is one of the highest rates of quarterly growth in recent years (one has to go back to second quarter fiscal 2015 for a better reading) and there really is the feeling that India can now take over from China as the consistent generator of high growth rates year on year. Prime Minister Modi has continued to try and push economic reforms through Parliament and to market the country on the international stage as a manufacturing base and, although he faces obstacles, there are reasons to be hopeful. In Raghuram Rajan they also have one of the most respected central bank governors, and if the country can continue to make progress on policy implementation, the prospects are very exciting and the “hype” may be justified. There is work to do … Old British India coins were still in use as a “frozen” currency until 1950, despite India gaining Independence in August 1947. We continue to hold Indian equity exposure for more growth and adventurously oriented investors and will consider broadening the exposure both there and in lower risk portfolios if we become further convinced of the story.

MONTHLY MARKET COMMENTARY JUNE 2016 EMERGING MARKETS

After benefiting from more favourable conditions over the last six months, May saw a distinct change of sentiment towards emerging markets. Turkey has been especially hard hit after President Erdogan moved to consolidate his power, isolating key reformist figures and announcing a new Prime Minister. The shift in tone from the Federal Reserve (discussed elsewhere in this Commentary) has been damaging to performance, with countries running substantial current account deficits such as South Africa and Turkey (again!) vulnerable to capital outflows in the face of rising US rates. Renewed concern over a faltering China and a return of yuan depreciation fears has hit emerging market currencies and made the various stock markets less attractive. On a more positive note, Chinese stocks have put in a creditable performance, supported by hopes that the index provider MSCI would be announcing that mainland Chinese shares would be added to its index at its June review. China remains a key determinant of the fortunes of many emerging markets (as indeed it does those of the developed world) and the persistent concerns over the state of China remain a major obstacle for further progress in equity indices. It is interesting to note that the credit multiplier (measured by the percentage increase in bank loans required to provide a 1% increase in nominal GDP) has risen from 1 in 2007 to 16 at the present time. Growth is undeniably becoming more difficult to generate through credit expansion alone! Surely Bitcoin is a classic candidate for the role of “emerging currency”. The digital asset and payment system is a form of cryptocurrency and is the largest decentralised digital currency in terms of total market value. Speculation has very recently raged as to the true inventor of Bitcoin, with Craig Steven Wright claiming he could prove to be the founder, but then retracting this statement – to coin a phrase, he performed a 180! We continue to prefer a “nuanced” approach to emerging markets, trying to identify the likely winners on a long-term perspective (still China and India) rather than adopting a generic approach, which is more likely to work in environments unlike those we currently face. Making a “blanket” case for emerging economies over their developed peers seems a very tall order – at least in the shorter term.

ETHICAL/ SUSTAINABLE INVESTING

May saw AXA announce that it would be ditching its tobacco investment (equities and bonds) as ownership of them “conflicted with its position as a health insurer”. This only applies to the group’s direct holdings and not those held on behalf of third parties in funds sold by AXA.

MONTHLY MARKET COMMENTARY JUNE 2016 ETHICAL/ SUSTAINABLE INVESTING (cont’d)

The equity holdings will be divested immediately (amounting to around €184m), but the tobacco industry bonds, worth €1.6bn, will be held until maturity – which is 2027 in some instances! Hardly swift action on a sum that is certainly not “mere shrapnel”. Ethical investors have had a favourable time over the past year, avoiding those areas of the market which have been most adversely affected by pricing weakness – oil, energy and commodities. Purely from a performance perspective, avoiding tobacco has not been a historically advantageous position; the sector has defied the odds and overcome obstacle after obstacle. Large public pension funds have often found themselves in the difficult position of trying to balance ethical and social responsibilities with their fiduciary and “purely” investment duties. A stark example of this was the decision of Calpers – the Californian public pension fund – to divest itself of tobacco holdings as far back as 2000, which has led to the “sacrifice” of significant returns for its members. Coins were of course made from lead for centuries. Probably not something we will see in the future given the litany of medical problems it is now known are caused by exposure to the element. A cynic would claim that exiting tobacco holdings after they have enjoyed such a strong run is a very “convenient” time to make a decision; others reasonably argue there is never a wrong time to do the right thing.

FIXED INCOME

A numismatist is not only a student of or collector of coins. The discipline of numismatics includes the broader study of money and “other payment media used to resolve debts and the exchange of goods”. When it comes to bond funds, we are assured by students of the craft that there are options for all seasons, like a range of coins, if you will – carry some for the trip to the penny arcade (Ed: we think someone is showing their age here), carry others for a long stay car park ticket machine. In a rising rate environment, one wants something quite different from an environment of economic slowdown. One of the current conundrums is that we may be about to get both conditions at the same time … so what should we carry? Like an expensive commemorative coin, the face value of gilts is not attractive based on the price we are being asked to pay. Emerging market debt is very exposed to movements in the US dollar, where the analogy might be with a gold coin, worth more or less not on the coin itself but the value of the substance from which it was crafted.

MONTHLY MARKET COMMENTARY JUNE 2016 FIXED INCOME (cont’d)

Investment grade credit – our preferred play in the space – seems to offer the best compromise between the credit quality of the cash flows and the vulnerability of capital values to interest rate increases (gilts generally having the highest interest rate sensitivity, or duration). Fixed income does what it says on the tin … sort of. If we buy a bond (corporate or government backed), we can expect a fixed coupon or interest payment, but rising interest rates can make these less attractive and the cash flows, like some coinage, can be debased.

COMMODITIES & SPECIALIST

One of the consequences of the massive over-investment in China has been the blowing and subsequent bursting of the commodity bubble. This has long lasting consequences which are not only economic but also political in nature. There is perhaps no better example of this than the Chinese “dumping” of steel into the markets of competitors and the response this has seen. The US has already moved to impose tariffs on steel imports and the EU has warned China that it faces new measures amid growing pressure for the West to block Beijing’s bid for “market economy status” and greater access to world markets. Japanese authorities are trying to frame the ongoing discussions on this matter in terms of commodities in general – well beyond the steel issue which has been felt here in the UK in the form of Tata Steel. If China does get “market economy status” under WTO rules later this year, it will make it much more difficult for third parties to impose anti-dumping sanctions. All this serves as a reminder that beggar thy neighbour policies, whether in the form of “dumping” or competitive currency devaluations, can generate severe political tensions which are a threat to economic well-being. In the current global economy, this risk is very real indeed. Elsewhere, oil continues to be a fixation for market watchers, and its rapid rise over the last three months has provided some reassurance to equity markets. Prices have been steadily rising since they dropped to a 13-year low in February, with better than expected demand from China and India and miscellaneous supply outages both contributing. Plenty of commentators seem to be peddling the narrative that some kind of deal is going to come out of OPEC, but this still seems quite elusive.

MONTHLY MARKET COMMENTARY JUNE 2016 COMMODITIES & SPECIALIST (cont’d)

That said, the tenor of the recent OPEC meeting suggested there might be a higher degree of cooperation and “shared” interests, and it is likely oil will stay around the $50 level in the short term. At the same time, it is difficult to see a significant further upward movement when one considers that a lot of US producers will return to production at this level and that the rig count has a lag time of three to four months before responding to price signals. We still hold oil in balanced and higher risk portfolios, having exited in lower risk ones following the recent rally.

PROPERTY

Fears over Brexit weigh on commercial property, with some funds experiencing large outflows in the past few months. Indeed, data provided by the Investment Association showed property fund outflows during February at their highest levels since 2008. Due to the inherent illiquidity of property, open-ended funds can experience difficulties when large numbers of investors attempt to redeem. In order to deter investors heading for the exit, several large property funds moved to a “bid pricing” basis, which effectively “charges” those wishing to sell. This move is not purely a function of liquidity concerns, more an act to protect long-term investors in the fund from the costs associated with selling property, such as stamp duty. Whilst we believe the move to “bid pricing” is material, we do not have any urgent concerns over open-ended property funds. Indeed, the Bank of England has held discussions with a number of high profile property fund managers in order to address issues surrounding the Referendum. Thankfully, fund managers have had a number of months to prepare since David Cameron announced a formal date for the Referendum back in February. Most funds have made defensive moves, with many holding cash allocations of around 20%. However, with open-ended funds priced according to the Net Asset Value of the properties, a decision to leave the EU could create “valuation gaps” if prices fall as anticipated. The Royal Mint is based in Llantrisant, South Wales and was officially opened by the Queen in 1968 as Britain prepared for decimalisation in February 1971. The 35-acre site is closely guarded by the Ministry of Defence Police, who are tasked with the protection of the 5 billion coins produced each year. We hold a mix of open-ended and closed-ended property across portfolios. Whilst the former has come under pressure recently, its ability to avoid equity-like volatility during periods of market stress makes it an important part of our property allocation. This said, we are reviewing the regional and sectoral breakdown of the holdings in our funds, in light of recent developments.

MONTHLY MARKET COMMENTARY JUNE 2016 CURRENCY

How about a non-EU Referendum related currency comment or two? No, oh well, we did try … “Pound falls as polls suggest Brexit lead” – BBC Business News, 10am, 6th June 2016. As we approach the summer rush for changing sterling for [insert your currency of choice here], some readers may be a little closer to the exchange rates than they normally are. We know others have to look at rates daily for their business, and some will be blissfully uninterested. Whichever camp you fall into, rest assured we expect sterling and its relationship with the euro, US dollar, yen et al. to be in the news as we approach (and perhaps as we go past) 23rd June.

UK INTEREST RATES

When two headlines (on the same day) are “Skipton relaunches 5year ISA at 2.01%” and “N&P unveils lowest 90% LTV 5-year deal” (where the rate is 2.93%), one senses that interest rates are not going up anytime soon. Aside from the possibility of a snap rate rise to protect sterling (you can guess why this might happen, though we still feel it less than likely), what is there to suggest the Bank of England MPC needs to raise the rate from the 0.5% that we have had since March 2009? The 2.01% ISA rate may well look too low in five years from now. However, many struggled to see why they should buy into a rate of 4.15% for three years as recently as 2011, believing they would be the wrong side of a rising interest rate. We would prefer not to assume anything, except that rates look as if they will remain low for longer yet …

MONTHLY MARKET COMMENTARY JUNE 2016 NUMBERS OF THE MONTH Our monthly look at numbers which may or may not have grabbed the headlines.

6%

7.6%

84%

Germany’s unemployment rate during May, a record low.

India’s annual GDP growth for 2015–16.

The proportion of Ladbrokes customers betting on Brexit (though they are still only offering odds of 3/10 on Bremain).

MARKET DATA Index IPD UK All Property* FTSE British Gilt All Stocks M-DAX (Germany) S&P 500 Dow Jones Industrials FTSE Small Cap BSE (India) FTSE 250 RTS (Russia) Bovespa (Brazil) FTSE All Share CAC 40 (France) FTSE 100 Nikkei 225 Hang Seng Shanghai A (China) *Figures delayed by one month

31.05.16 177.04 20,762.38 2,096.96 17,787.20 4,596.01 26,667.96 17,184.73 904.33 48,471.71 3,429.77 4,505.62 6,230.79 17,234.98 20,815.09 3,052.78

1 month 0.54% 1.13% 3.29% 1.53% 0.08% 0.15% 4.14% 2.28% −4.92% −10.09% 0.24% 1.73% −0.18% 3.41% −1.20% −0.72%

1 Year 12.29% 2.48% 1.53% −0.49% −1.24% −4.06% −4.17% −5.34% −6.66% −8.13% −9.67% −10.03% −10.79% −16.19% −24.10% −36.78%

3 Years 51.43% 5.58% 47.32% 28.59% 17.67% 16.03% 34.96% 19.75% −32.08% −9.41% −1.27% 14.11% −5.35% 25.12% −7.04% 26.76%

The Monthly Market Commentary (MMC) is written and researched by Simon Gibson, Richard Smith and Scott Bradshaw for clients and professional connections of Mattioli Woods plc, and is for information purposes only. It is not intended to be an invitation to buy, or to act upon the comments made, and all investment decisions should be taken with advice, given appropriate knowledge of the investor’s circumstances. Mattioli Woods plc is authorised and regulated by the Financial Conduct Authority. The MMC will always be sent to you by the seventh working day of each month, usually sooner, is normally delivered via email, and is free of charge as the MMC is generally made available to clients who have assets under our management in excess of £200,000, and to all clients under our Portfolio Management Service (PMS). Normally, the MMC costs £397 + VAT per annum. Professional advisers and their clients should contact us if they are interested in receiving a monthly copy. Sources: www.bbc.co.uk, www.bloomberg.com, Morningstar, www.royalmint.org.uk, www.sportskeeda.com, www.bbc.co.uk, www.vishwagujarat, www.stou.eu. All other sources quoted if used directly; except fund managers who will be left anonymous; otherwise, this is the work of Mattioli Woods plc.