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Where next for market sentiment?

Sentiment

One of the many indicators of the health of the UK economy is the property market. It is an asset class that many of us can relate to. So when I recently put my family home up for sale, I was in for a shock. I expected our home to be paraded by dozens of people, resulting in bidding wars. Not in this case. It was clear that sentiment in the property market had fallen.

In fact, in 2018, annual house price growth slowed to its weakest pace in five years. Figure 1 below shows a snap shot of this trend. Unsurprisingly, the slowdown is attributed to the uncertain economic outlook despite the UK economy seeing solid employment growth, stronger wage growth and low borrowing costs.

Figure 1 – Annual percentage change in UK house prices

It has been a similar scenario for stock markets. Market sentiment is best demonstrated through price movements. If prices are on the rise then this is indicative of positive sentiment. If prices are falling then this points towards negative sentiment. Figure 2 below demonstrates that in 2018 the FTSE 100 Index finished the year down by nearly 9 per cent indicating that sentiment in the market had waned. Despite the rebound in early 2019, the optimism was short lived and market volatility resumed owing to continued uncertainty over Brexit.

Figure 2 – FTSE 100 Performance in 2018

FTSE Sentiment

Equities yielding more than bonds

What is more telling in the UK market is that the yield on the FTSE 100 Index has been creeping up in recent years and is significantly more than 10 year gilts. Morning Star has predicted the FTSE 100 will yield 5% over the coming year, which compared to the 30-year average yield of 3.5%, and the ten year gilt yields of around 1% suggests a period of unease in the UK economy and markets. The last time the FTSE 100 yield was this high was at the bottom of the financial crisis and before that during the 1991 recession.

Bleak global economic indicators

This weak sentiment has been further exacerbated by other global factors. Similar to the UK, the US housing market has seen a drop in sales over the last year, which together with the long running US-China trade war, has resulted in a fall in consumer confidence. Additionally, weaker economic data in the Eurozone is also pointing towards a period of slower economic growth.

Significance of an inverted yield curve

This downbeat mood in markets is also being reflected in the fall in bond yields in the US. In particular, the yield on ten year US Treasury bonds recently fell below the three month bonds which led to an inversion in the yield curve. Usually, the yield curve slopes upwards as investors demand a higher yield for bonds that are longer dated in nature as they price in the risk of inflation and other uncertainties.

When the yield curve inverts, it usually signals a period of worsening economic conditions. This is because investors have little confidence in the economy over the short term and therefore demand a higher yield on short dated bonds compared to longer dated bonds. Some economists believe that an inverted yield curve is the most reliable indicator for predicting a recession, and this was certainly the case in 1998 and 2008.

Change in interest rate outlook

In order to avoid a full blown recession, the Federal Reserve has recently changed its outlook on interest rates. In December 2018, there were projections for two hikes for the forthcoming year, but now policymakers expect rates to remain at current levels this year. This may go some way to lift consumer confidence, but crucially, a lot hinges on the US finding a resolution with China over its trade. In the UK, improved sentiment very much depends on the government reaching an agreement on Brexit.

Patience is the order of the day

So what does this mean for investors? Whether or not market sentiment is bullish or bearish, the important point for any long term investor is that it is still possible to add long term value through diversified portfolios. Portfolios that invest across a spectrum of different asset classes combined with a focus on volatility, such as those offered by Parmenion, could be sensible options. Markets will always ebb and flow over the short term, but patient investors with a long term approach in diversified portfolios should stand to benefit from attractive returns over the longer term.

Hear Meera speak on our upcoming investment webinar

On Tuesday 30th April, Meera along with Simon Brett and Abika Martin from the Parmenion investment team will be taking a deeper look at the volatility and returns experienced during the first three months of 2019 and expand on the context behind the figures. This bite-size webinar is a great opportunity for you to ask our investment team any questions about the the future market outlook.



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