James Klempster explains in this short video how a ghoulish tone over markets as the US earnings season progresses has reiterated why the Liontrust Multi-Asset team has taken a position in an equally weighted passive exposure to the S&P500 index. He also discusses the implications of the UK budget this week.
Hello, it's Friday the 1st of November. I thought we'd pause for a few moments and reflect on what's been going on in markets this week. Yesterday was Halloween and there was a bit of a ghoulish tone in markets. Not too bad, but the earnings season in the US has weighed on returns a bit. We had the worst day in the US for a couple of months. This was not that big in the grand scheme of things, but it did reflect the fact that earnings have not necessarily surprised on the upside universally, and that the mega cap behemoths that we talk a lot about in these videos had a mixed picture. The results weren't too bad in the grand scheme of things either, but perhaps they were weighed down by the scale of expectations. When reality doesn't live up to expectations you get a degree of price action and a smallish, but still notable, drag down. The NASDAQ was down around 3% over the course of yesterday.
The technology and mega cap dominance is one of the reasons that we've initiated a new position in our Dynamic Passive range. We have added an equally weighted passive exposure to the S&P 500 index. Most indices, and certainly the S&P 500, are market capitalization weighted, which means that the biggest stocks have the biggest weighting in the index, whereas an equally weighted index, as the name suggests, gives the same proportion, so one fifth of 1% to every stock in the index. The composition of the names in the index are the same but the proportions are clearly very different. The equally weighted S&P looks different in terms of the sectoral composition when compared to the market cap weighted S&P. You have more in utilities, more in consumers, more in industrials and less in telecommunications and communications services, which are very dominant in the S&P. Arguably, this looks a bit more like the actual US economy. Also, you have a smaller company bias because it downweighs the very large cap names that dominate the S&P. In the grand scheme of things – we're talking about the US here – these are not small companies by any means. In a global context they are still solid, but they are smaller in terms of market capitalization profile than you otherwise would get in the US.
So that's the new position we have put in our Dynamic Passive range. The reason being to try to emulate some of the exposure we already get in the solutions where we have active managers. This is because active managers are taking us down the cap scale deliberately as well to reduce the impact of those mega cap names. You might ask why now? And that's a great example of how one of the key criteria that we have when assessing passive managers is this combination of availability and suitability.
Interestingly, there wasn't a huge amount of availability in the equally weighted S&P index. There were a couple of different vehicles available, but they didn't match in terms of their suitability, their scale or their actual structure. We had to wait for this one to be launched, which was last week, and we started making investments in it this week. It is an allocation from part of our passive US exposure. It is a subcomponent of the overall US picture, so it is not going to be the dominant exposure within our Dynamic Passive exposure to the US, but it will be an allocation within the overall US sleeve.
The other information that we have to talk about this week is the UK's budget. A bit like the bucket of sweets that my kids came home with last night when it was first opened, the response wasn't too bad, but once digestion started to kick in it didn't necessarily land all that well. No massive surprises or shocks in the budget. It was more one of these 'devils in the detail' kind of scenarios. Looking at what's really happened, the UK stock market has sold off a bit and had a weak end to this week, although today it is looking a little better.
Sterling has weakened as well, but what is probably most important is what has been going on in the gilt market. We now have UK gilts flirting with 4.5% yield in the 10-year, or back to the same level that we saw yields peak at when Liz Truss had the disastrous mini budget. Clearly it is a bit different now because expectations around what is a normal yield for a 10-year have moved. We've seen the gilt move from around a 3.8% yield a month or so ago to 4.5% now. So a 70-ish basis point move, which is substantial but not as dramatic as what we saw around the Liz Truss mini budget, which was about 3.1% moving out to, again, 4.5%. So a more dramatic move and the other thing to bear in mind regarding the mini budget in 2022.
It was only a couple of months before that mini budget that we had yields on the 10-year of 1.8% because the overall inflationary picture, which was a global and not just a UK phenomenon, hadn't been factored into the picture either. Within the space of a few months, yields went from 1.8% to 4.5%, whereas this year the context is moving from high threes to 4.5%. You can see there's less of a dramatic move. Having said that though, because prices are inversely related to yields, gilts have had a capital loss in terms of mark to market. This is only something you realise if you sell it, of course. But again, it reflects the importance of yield and the importance in fixed income land of where we're going from here. We see active management as a key feature of fixed income markets when you get lots of interest rate differentials and different curve behaviour. A one size fits all and naive approach to fixed income probably isn't what you want to have in global fixed income markets today.
The final thing we've got to think about of course is the US election, which is next Tuesday. It's still finely balanced, it's fair to say. A couple of unfortunate pronouncements from candidates and comedians and all sorts of other people, the current president in fact, over the course of last week changed the odds a little bit here and there.
Again, it emphasizes why we don't try to predict political outcomes, and we certainly don't factor in a need to predict political outcomes in our process. We are much longer term, and we look through this kind of noise because it is very difficult to try to even assume you can predict the outcome correctly. Understanding what the impact on markets could be is even more difficult. We only need to look back to Brexit, or the original Trump presidency, to see that assuming you could predict the outcome correctly doesn't necessarily mean you can predict the market impact correctly, too. Rather than try and rely on that sort of foresight, we would rather diversify risks in portfolios, have lots of different return drivers and ways of experiencing price movements based on new news, and have a longer-term perspective that looks through short-term sentimental-driven factors to identify fundamentals that should be rewarded over the medium to long term.
That's it from me. Have a good weekend when you get there, and we'll see you next time.
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