Scottish Field’s new market report column

John Henderson, the managing director of Edinburgh-based asset managers Close Brothers, kicks off his first quarterly market report for Scottish Field with an assessment of how Trump’s trade wars and the ECB’s change of boss are affecting global markets


The last three months make me feel like I have just gone the full twelve rounds in a boxing match and come out with a draw. The market hasn’t really gone anywhere over the last quarter but there has been a lot of noise. In one corner we have Trump (Boo! Hiss!); in the other central bankers (hurrah!).

Trump is still waging a trade war against the Chinese and this is definitely having an effect and causing a slowdown in global economic growth. It takes a brave or foolish man to take on the Chinese and President Xi has called for the nation to embark on a ‘new Long March’, a sign it is preparing for a prolonged trade war.

However, figures from the US are slightly better but a lot of this has come from his significant tax cuts and a financial package worth $15 billion to farmers hurt by trade tensions with China. So, puffed up by success, Mr Trump threatened a trade war against Mexico, although this is now off the table thanks to the ‘great job’ the Mexican Government has done in stemming migrant flows from Central America.

Trump’s latest salvo is to impose $4 billion of tariffs on European goods – specifically cheese, milk, coffee, copper, pork products, and Irish and Scottish whisky – in retaliation for subsidies paid to Airbus (or perhaps this latest protectionist stance is simply a ruse to help US darlings Boeing, who are suffering after the suspension of the 737 Max).

Historically, trade wars and tariffs do not work – they slow growth and lower productivity or, as Mark Carney said, trade wars ‘shipwreck the global economy’. They can also create misleading production figures as companies and countries alike stockpile affected items.


In the UK there is also seeing evidence of stockpiling ahead of Brexit, in the same way that there was a significant forward order momentum ahead of a possible no-deal on March 29. We now have a new deadline of October 31, but this time stockpiling will be more difficult as warehouse space is normally at a premium at this time of year to prepare for Black Friday, Christmas shopping season and potential weather disruption. There is therefore no space left to stockpile – it is estimated that the vacancy rate for warehouses over 100,000 square feet nationwide is just 6.8%. In the ‘inner M25’ this figure falls to 2.2%. By contrast in 2009 the national vacancy rate was 23%. Top tip: don’t leave Christmas shopping to the last minute!


Another unexpected feature of stockpiling at the moment is cash savings in Europe, which are estimated to be over £10 trillion. The countries with the highest percentage held in cash (as a proportion to financial assets) are Portugal (41%), Spain (40%), Ireland (37%) and Italy (33%), which compares to the UK (24%), Denmark (15%) and Sweden (14%).

One reason for large cash holdings in Europe is the fact that the return on European bonds is dire, with €12 trillion of bonds yielding zero to negatives interest rates as the threat of a global slowdown makes central bankers more ‘dovish’ and prone to lower interest rates. This has led to 10-year Government bond yields falling to 1.91% in the US (its lowest for 10 years) and 0.74% in the UK, with 30-year UK Government bonds yielding just 1.37% pa.

In Europe the ECB sees Mario Draghi retire and be replaced by its first non-economist head, Christine Lagarde, who is known for her dovish sentiment, a combination which has helped to push 10 years Bunds to -0.3%. It is interesting to note that not a single respondent in January’s Wall Street Journal survey of economists predicted the yield on 10-year US territory note would fall below 2.5% this year. So perhaps we should be encouraged by Lagarde’s appointment!


As interest rates are predicted to fall, investors have to find alternative homes for their money. Government bonds were the ‘safe home’ of choice but with these now yielding less than inflation investors have to cast their net wider to include corporate bonds (and therefore increase their risk levels). This market has also gone a little bonkers; by way of example Prudential came to the market last week with a new £300 million 30-year bond. At 9am they indicated a yield of 4.55%, but by 11.30am this had been cut to 3.95% due to a surge of interest from institutional investors.

This is the largest price compression for a new bond that our fixed interest team have ever seen. Even after this it was 18 times oversubscribed (there were £5.3 billion orders for this bond). This is the most oversubscribed bond that the team has ever seen. By 9.30am the next day the yield on the bond was 3.35%, which is the strongest overnight compression we have ever witnessed. We believe that bonds now have an asymmetric risk/return, and that if rates rise by 0.5% then the bond market has a problem.


Given the asymmetric risk/return in the bond markets, we have therefore been focusing on that other safe haven investment – gold.

We first bought gold around three years ago based on the fact that we felt that the surge of Quantative Easing and the start of negative interest rates would lead to a rise in inflation and that there may be some concern about central banks and their stretched balance sheets. Whilst our reasons might not have been right, the gold price has moved up back to levels last seen during the financial crisis.

The beauty of gold is that it moves on many different factors, ranging from our reasons to disinflation and global conflicts. The tensions with Iran have given gold a fillip but I am cognisant of Mark Twain’s quote: ‘The value of gold is what the next fool will pay for it.’ On this basis I decided to look back in history to see if today’s price of around $1400 per ounce was fair value.

In Roman times a centurion was paid 150 Aureus coins pa, which weighed around 38.5oz. In today’s terms would equal £43,428, which is almost identical to the annual salary paid to a captain in the British Army, which today stands at £43,000. On that basis gold is not overpriced.


Comparative valuations in today’s markets seem, on the face of it, less understandable. For instance, if you look at the valuations of European markets you see France’s stock market with a total valuation of $1551 billion, Germany on $1188 billion and Spain on $503 billion. The market capitalisations of just five US tech giants – Apple, Amazon, Google, Facebook and Walt Disney – have a combined value of $3,371 billion, more than the three countries combined. Nor is it just technology companies which dwarf whole economies – Starbucks has a greater value than the Irish stock market, Hershey is bigger than Portugal, and for $13 billion you could buy Tiffany or the whole of the Greek market (a more difficult choice perhaps).

If we look at the S+P 500 since January 2012, the tech stocks have annualised 10% pa whilst the rest of the market is only up 1% pa. In the UK over the last five years it has been a three-tiered market with domestic earners giving you a negative return, international earners (excluding resource stocks) around 25%, whilst a narrow group of large commodity stocks have led the market up nearer 70%.

This has created a market place with very differing valuations on companies. The Growth stocks (technology and resource) look expensive and Value stocks cheap. The latter do better in ‘inflationary growth’ conditions whilst the former fare best in ‘disinflationary growth’. We feel that the current environment will be one where inflation remains low, interest rates remain low and whilst we see global growth falling, we still see some growth. Therefore, whilst valuations of companies such as Amazon, MasterCard, Diageo and Unilever may be high by historic levels, we see no reason why this will not continue. Never though has it been more necessary to ‘kick the tyres’ of our stocks.

There are more than 170,000 words in the Oxford English Dictionary but 90% of communication is done using just 500 words. In the same way 90 firms (0.4% of all US stocks) created half the wealth between 1926 and 2016.

To go back to my opening paragraph, we had Trump in the ‘badies’ corner and central bankers in the ‘goodies’ corner. Globally, we have witnessed central bankers’ desire to keep stoking their economies by either fiscal stimulus or interest rate cuts, which is why when we have seen bad news such as GDP and PMI downgrades or news on a hard Brexit, the market rises on the hope of another shot of central bank largesse. Bad news can sometimes bring good times.

At Close we have an investment funnel where we start with 12,000 global stocks. After applying quantative screens this number is reduced to a 1,400 stock universe, we reduce this further to 550 stocks (our core list) by using proprietary screens (valuation and quality) and investment manager/research analyst selection. We then review 80-100 of these in detail to provide a focus list. As an investment manager I can take the best, most suitable 30-40 stocks to form the core of a portfolio. This discipline helps to give me comfort in a difficult, complex and confusing investment world.