Three months ago, online trading firm IG joined the digital wealth management industry with the launch of IG Smart Portfolios, a range of risk managed investment portfolios in partnership with BlackRock built exclusively with iShares ETFs. The five actively managed risk-rated portfolios (from cautious to aggressive) provide global investment reach, spreading risk across asset classes, geographies and sectors.

Oliver Smith, portfolio manager at IG.

By Oliver Smith, portfolio manager at IG Group.

The second quarter of 2017 proved to be relatively muted from an investment perspective. The MSCI All Country World Index, which includes emerging markets, was up just 0.5% in GBP terms.

In May, Emmanuel Macron was sensationally elected as the French President and the June Parliamentary elections cemented his power.  Macron’s election has changed the narrative in the EU, and this perceived reduction in EU political risk saw markets rally. Europe ex UK was up 4.5%, and the euro strengthened 3.4% against the pound.

Across the Atlantic, US President Donald Trump continues to tweet at a prodigious pace, amusing his supporters and enraging his opponents. Having hung on his every word, markets appear to have adjusted to the new normal. The S&P 500 was down just 0.6% in sterling terms, and equity market volatility hovers near all-time lows.

In the UK, Theresa May was humiliated at the ballot box. Having had a twenty-point lead in the polls, she ended up with a DUP backed minority government. Markets have been sanguine in their approach to political uncertainty. The overseas earnings-dominated FTSE 100 ended the quarter up by 1%, but perhaps the biggest surprise was the domestic FTSE 250, which gained 3%.

Fixed income

Perhaps the most noteworthy event in this quarter was the spike in UK gilt yields in the last few days of June after Mark Carney, the governor of the Bank of England (BoE), surprised the market by saying some removal of monetary stimulus may be necessary. The ten-year gilt yield moved from 1.01% to 1.26% in short order with the market now factoring in a 55% chance of a rate hike by the end of the year, as opposed to a 20% chance just ten days earlier on 20 June.

Outlook

Over the past five years market commentators have done their best to alarm readers, with warnings of a collapse in Chinese growth, over indebtedness in developed market economies, the spectre of deflation, the spectre of inflation, the collapse in commodity prices, or the fact that this economic cycle has been longer than nearly any in the past 100 years. Anyone paying heed to these messages would have missed a near doubling of the MSCI All Country World Index.

This economic cycle must, and will eventually, come to an end. However, with the cause and the extent of the next economic decline unknown, the downside that equity markets could face is similarly uncertain. It could be that the next recession disappoints those with cash on the side-lines in both its depth and length.

While asset classes are expensive, we continue to believe that long-term ownership of equities is the best way to grow your wealth over time and to avoid the corrosive effects of inflation on cash savings. IG Smart Portfolios are currently positioned with a modest underweight to equities, sterling hedged positions (protecting against a rally in sterling) and short dated bonds (which will add value if interest rates rise).

One more thing: ETF ownership

There has been a lot of focus on the increasing ETF ownership of the equity markets, and what would happen if that was to reverse. Goldman Sachs produced a report in June showing that ETFs own 6% of the US equity market. However, a lot of this growth is at the expense of mutual funds, which in aggregate own the market in similar proportions but with a higher annual management charge.

Over the first quarter ETFs bought $98 billion of stock, however this was exceeded by corporate buybacks of $136 billion. Who is really the marginal buyer of the market?  We believe corporate buybacks get less attention than they deserve; over the past five years, 10% of US market cap has been bought back and cancelled by companies.

With company shareholders still happy enough to see corporates issue very cheap debt to finance buybacks, and US economic conditions looking healthy, it will take softening economic data or interest rate rises from the Federal Reserve to end this trend.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)