A month of markets in two minutes: Great rotation starting within equities?

Signs that a great rotation within UK equities is taking hold were seen in January as some of the defensive giants struggled to justify the sky-high valuations they now command, while the broad UK and US equity markets pulled back from peaks as a combination of Brexit fears at home and a slowdown of the Trump trade abroad weighed on indices.

Starting with the UK, corporate results season revealed all may not be well within UK plc, with some notable downturns coming through. Consumer staples giant Unilever reported a drop in profits and warned about the outlook this year, while BT found itself embroiled in an accounting scandal within its Italian division. Despite decisive action from the chief executive, shares finished the month sharply lower.

Diageo, another favourite among the defensives, fared better, its upbeat results bucking the trend and helping the stock climb ever higher, but even the drinks giant succumbed to some profit-taking at the close of the month which curtailed its overall gains. Weakness in the pound may yet ride to the rescue for such firms, but having already tumbled sharply, its impact is likely to be more muted from here.

These moves combined with an air of nervousness over Brexit and Donald Trump’s policies in the US to bring the FTSE 100 back down from peaks. Having hit the heady heights of 7,354 points in the middle of the month – around a 3% gain from 2016’s closing level – stocks have subsequently retreated to close at 7,099 at the end of January, down marginally.

In the US, the S&P 500’s mid-month peak of 2,300 points also proved unsustainable by month-end, with the index back down at 2,278 points, although it was marginally firmer than its starting point of 2,238 points.

Is this the peak for developed market equities? Peter Lowman, chief investment officer at Investment Quorum, said there was no denying markets both here and abroad were no longer cheap. “Come March 2017 we would have completed an eight-year bull market, the second longest in financial history. Therefore, many share prices for some individual stocks and sectors are now looking rather stretched, leaving very little room for corporate earnings disappointments.”

Further afield developed markets also showed signs of strain, with Japan’s Nikkei down from 19,298 to 19,041 by the close of the month, off around 1.5%. However, emerging markets outperformed, with the broad MSCI Emerging Markets index up some 6% in January as it rebounded sharply off lows.

Away from equity markets, the sell-off in government bonds continued, with gilt yields moving from 1.239% to 1.451% for 10-year bonds over the course of January, although US treasuries held firm at 2.45%, finishing the month where they started. Nonetheless, some parts of the bond market still offer value, according to Stephen Jones, Chief Investment Officer of Kames Capital.

“With cash rates at zero, or even negative interest rates in Europe, both investment grade and high yields bonds look attractive alternatives for income growth,” Jones said

Safe havens, the few that remain, could perhaps be the answer if the uncertainty continues. Gold has come off lows, gaining around 5% in the month to finish above $1,200, although even there the danger remains that further dollar strength could curtail its revival.

Looking across commodity markets, oil had a mixed month, finishing around 2% lower than it started after closing under $56 a barrel, having traded in a range between $53 and $57 a barrel throughout January. But oil and other commodities may yet come to the fore if inflationary pressures continue, according to Lowman.

“We are likely to see higher inflation and interest rates over the coming years which could lead to a retraction in consumer spending as the likes of fuel, food and utility prices rise”, he said.