The FTSE All-Share index has delivered a Brexit-busting, Project Fear-confounding 6 per cent capital return in the year to the beginning of December. Factor in the dividend returns – not to do so would rather miss the point – and you have a total return at time of writing of 10 per cent, according to Datastream figures.
As we know, the pound in your pocket is not always worth the same when retrieved, so we should consider the impact of inflation on those returns. Although there are some predictions that this will change, rising prices are not taking a huge bite out of stock market investor returns just yet. The latest data showed that consumer prices index inflation rose by 0.9 per cent in the year to October. Even adjusting for that, it’s been a bumper year for the UK stock market, compared with the two previous years: concerns about the domestic and global economy suppressed returns in 2014, while in 2015 a commodities slowdown and a strong pound meant measly performance among the bigger guns.
But a longer-term average is a more appropriate comparison. The annualised real total return on UK equities between 1900 and 2015 was 5.4 per cent, according to this year’s Credit Suisse Global Returns Yearbook. That compares with 6.4 per cent in the US over the same period. Barring any collapse before the new year, that suggests 2016 will go down as a bumper return.
But to temper any festive giddiness, we should acknowledge that Investors Chronicle readers do not own every stock in the index, unless they have a particularly severe case of what allocation experts call 'diworsification'. By cutting the data in a few different ways, we can detect a few trends that skew the top-level performance.
Mining the data
Going stock by stock through the FTSE All-Share demonstrates that just over a third (35 per cent) of stocks outperformed that average figure. It has been a year of uncommonly big winners, and some of those winners represent a bigger chunk of the overall market capitalisation, so they have dragged the overall real return higher.
The sector winners will come as no great surprise: oil and gas, industrials, mining. The biggest losers: general retailers, food producers, telecoms. There are two stories that we are being told here: the commodities revival and the UK’s vote to leave the European Union. And, broadly speaking, the winners from the former and dollar-earners boosted by the latter have outweighed the losses from those stocks that sold off following the referendum. These tales are being taken up in greater depth later in this Christmas issue, but they demand a quick note.
We wrote in this year's FTSE 350 review back in January that it was a tough time to be a contrarian, and those that had called the bottom on commodities last year found that beneath an apparent 'floor', there is often another one to be discovered. But for those with the fortitude to do so, the returns have been stellar. Seven listed miners have more than tripled in value year to date, including biggies Glencore (GLEN) and Anglo American (AAL), as restructuring plans dovetailed with rising commodity prices. Getting just about anything out of the ground has been better business this year, an effect compounded by cost-cutting programmes.
Oil is well
The oil majors are also sitting much more comfortably, as the Organisation of the Petroleum Exporting Countries (Opec) looks to have got the band back together. As we went to press, the price of Brent crude was up nearly a half this calendar year, pushing through the $50-per-barrel barrier: a major change, given that earlier this year the prospect of the black stuff hitting $20 was being openly discussed.
The path of BP (BP.) and Royal Dutch Shell (RDSB) was also boosted by their dollar revenues, following the big fall in the value of sterling after the Brexit vote. But even if we ignore the energy and materials sectors, we have seen the currency translation of revenue boost companies of all stripes. Aim-listed retailer Boohoo.com (BOO), internationally focused bank HSBC (HSBA) - also buoyed by the commodities revival - and electronics company Electrocomponents (ECM) are just three of the stocks that are up by more than a third since the day of the Brexit vote, according to Capital IQ data.
Looking at the post-Brexit losers, we can see why many UK stockpickers will not see 2016 as a particularly good vintage, if they have the wrong kind of domestic exposure. Considering for a moment those London-listed equities with a market capitalisation of £1bn or more at this moment, 35 have lost a fifth of their market value since the day of the vote. They include domestically focused banks Royal Bank of Scotland (RBS) and Lloyds Banking Group (LLOY) and all the housebuilders, with the exception of Bellway (BWY) and Redrow (RDW) and newly listed Countryside (CSP).
Planning for 2017
As the philosopher David Hume noticed back in the 18th century, human beings are rather inured to the idea of causation: we believe that things will continue to happen in the way that we have become accustomed to: “Being determined by custom to transfer the past to the future, in all our inferences; where the past has been entirely regular and uniform, we expect the event with the greatest assurance, and leave no room for any contrary supposition.”
This year we consider a few different scenarios about how 2017 will play out for UK equities. Only the first can be accused of transferring the past into the future. These are by no means the only variables, but it will be interesting to see in a year’s time which one was closest to the truth.
Scenario 1: Bleaker Brexit
The government has promised to trigger Article 50, the formal start of Brexit negotiations, before the end of March 2017. Let’s assume that happens, and that the imminent Supreme Court case on parliamentary approval does not get referred to the European Court of Justice. Further clarity on whether the UK government is open to compromises in order to secure single-market access, and whether European governments are amenable to a special case, could dent business confidence and growth forecasts.
Impact: The prospect of a ‘hard’ Brexit, without single-market access, could weigh further on the pound and dent consumer confidence. This could weigh on domestic consumer stocks, housebuilders and lenders.
Contrarian: A 'soft Brexit' compromise begins to emerge, reducing concerns about consumer fright and a business exodus from London. Property companies such as British Land (BLND) and Derwent London (DLN) start to close their discount to net assets, builders and banks make up ground.
Scenario 2: Rate rises speed up
The Federal Reserve could pull the rug from the emerging markets (EM) recovery by increasing interest rates quickly on the back of a strengthening US recovery and ‘Trumpflation’, as the new president cuts business taxes and increases spending. As a result, capital flows back from indebted emerging market corporates to developed markets.
Impact: further bad news for EM-focused stocks such as Aberdeen (ADN), Ashmore (ASHM), HSBC and Standard Chartered (STAN).
Contrarian: The rate rise turns out to be gradual; local currency-denominated emerging market debt absorbs the impact of any rise better. Rebalancing of global economic growth to newer markets continues, buoying EM operators.
Scenario 3: NOpec
Despite the agreement, Opec members fail to keep to their production targets, especially given the growing regional rivalry between Saudi Arabia and Iran, and the oil price loses ground. US shale operators beef up production, compounding the misery.
Impact: Another year of oil prices bumping along below $50 could make it difficult for the oil majors to hold on to their dividends – there are only so many projects that can be cut. Share prices could fall as investors anticipate income cuts, while those companies with exposure to the energy sector are forced to make further downward revisions to their growth forecasts.
Contrarian: As discussed in our recent feature on the oil price, many indicators pointed towards a recovery in the price of the black stuff irrespective of the Opec deal. BP and Shell making it out of the downturn with dividends intact supports their share price growth as investors mark the yield back to a stable level.
Or, Goldilocks cleans up
There is a fair chance that the trends that we have seen set in train at the end of this year simply continue for the course of 2017. On this reading, commodity prices would hold their gains now that the growth prospects of China and other emerging economies have been more realistically appraised. The oil price could maintain its upward trajectory and the Brexit debate may well muddle on without a definite movement for or against the interests of the domestic corporate sector.
If the reader sees such a ‘keep calm and carry on’ global economy in 2017, it is worth rereading my colleague Algy Hall’s recent article on the sectors to watch, looking through value and momentum screens.
Price momentum coupled with a longer-term increase in production after the discussed retrenchment could help the resources sector keep its rise, while the banking sector presents a good contrarian value call for those private investors who don’t believe we are going to hell in a handcart.
As ever, it is a bit much to expect the private investor to formulate an overarching macroeconomic view in a time that will make even the most hardened forecaster tear his or her hair out. In a stark briefing from RBS’s European rates team, widely shared when it was released in January 2016 (entitled 'The bears have killed Goldilocks') the researchers were clear from the start: “There is a difference between forecasting something and it actually crystallising.”
To be fair, many of the analysts’ concerns remain relevant: China, the level of debt in the global economy, quantitative easing programmes continuing. There is plenty of unwinding to do yet. What seems unarguable is that the big political decisions of this year have much further to play out. For the equity markets, the hangover from 2016 will be a big one.
