Market Commentary - February 2015
First an oil shock in December and then the Swiss National Bank (SNB) pulls the plug on the euro in January; what price February being an interesting month too? The oil price has “stabilised” at around $50 for Brent and the SNB are allegedly now targeting a “soft” peg for the Swiss Franc at around €1.05; will they never learn? The trend line on the chart below shows that their intervention which has cost them untold billions was a complete and utter waste of time as the exchange rate has got where it was going anyway!
The other news in the shock/horror camp is that sovereign debt yields continue to fall. The Swiss 10-year yield curve is negative all the way up to 10 years; in other words you are paying for the privilege of getting your money back in 10 years’ time. It is not much different in Germany and France and even in the UK in an election year! Added to that there have been a spate of central bank interest rate cuts in countries as diverse as India, Denmark, China and Australia. The Danish rate, like the Swiss and ECB, is negative.
There are more opinions regarding oil, interest rates and currencies than solutions and they all seem to be treated as one-off standalone events. This is likely to be a big mistake. When we see price moves of such magnitude the reverberations are going to be significant. When the oil shock wave meets negative interest rates and massive currency volatility, (and we haven’t mentioned Greece yet) something has got to give and equity markets look to be the favourite regardless of the continuing support from central banks. The SNB has swooned, who will be next?
Although burdened with oil and commodity stocks, the FTSE 100 has had a better January than the S&P, mainly on the basis that the aforementioned stocks were getting rather oversold and in some eyes were beginning to represent good value. Brent crude has rallied off the lows, but quite where the next move will take it is as uncertain as ever. Sterling looks like it will have a breather at around $1.50, given the relatively rapid fall from $1.70, but with an election in May, and the US likely to raise rates later this year, we can’t discount further sterling weakness. UK gilt yields look priced for perfection, but then we were saying this a year ago…
Economic data out of the US still appears encouraging, but there is definitely a feeling that there is a two tier economy in operation. The unemployment rate is flattered by the number of folk falling out of the workforce and the continuing rise in part-time occupation, at the same time as the average hourly earnings rate is falling not rising. Lower oil prices are allegedly helping consumers, but the shale oil operations in Texas and North Dakota are definitely feeling the pinch.
The rise and rise of the S&P 500 has been relentless, but is approaching levels where valuations are getting expensive and are predicated on corporate profit margins remaining at current high levels ad infinitum. The market is showing some signs of slowing momentum, but we have been here before as recently as last December and a further rally cannot be ruled out.
It’s all about Greece! The new Greek government has locked horns with the ECB and so far it is 1-0 in favour of the bank. Draghi has rescinded a waiver that allowed Greek government debt to be used as collateral for loans. This means that the Greek central bank has to supply liquidity to its own banks, whose customers are withdrawing cash as fast as they can. If there is no agreement on a restructuring of Greek debt by February 25th the Greeks will be on their own, with the implication that they will have to leave the eurozone and revert to issuing drachma. This would not be good news for Greece, but quite possibly it would be even worse news for Germany. As with the oil price there are more opinions than solutions, but until this “drama” plays out we will remain underweight European stocks.
The BoJ has been rather overshadowed recently by its counterparts at the ECB and the SNB. They haven’t helped themselves either by being too cautious with their QE programme. This has led to a doubling of the interest rate on the 10-year JGB from 0.2% to 0.4%. Hardly a penal rate, but a worrying trend. We expect the BoJ to move to a more aggressive stance soon, otherwise the latest “great Japanese recovery” will go the way of its predecessors. We are still targeting 21,000 for the Nikkei, but a fall below support around 16,000 would be a concern.
Asia Pacific and Emerging Markets
The Asia Pacific region has started to make some progress since the December lows, having been left behind by the US market in particular. In Emerging Markets the two main commodity countries, Brazil and Russia, are looking very much oversold and they too may try to play catch up, but it will, as ever, be a volatile ride. The Chinese government introduced a ban on opening new margin accounts (that enable speculators to borrow money to trade the market), which resulted in a sharp drop in the Shanghai Composite. However the ban is only in place for three months and the index has already started to recover.
Commodities and Gold
Oil is trying to make a bottom, but until we see production cuts from OPEC (the Saudis) or the US shale operations we can’t see a sustained rise in the near future. The gold price did initially benefit from the SNB decision to abandon the peg. Ironic in that the reason the SNB gave for being against the December referendum to force them to increase their gold reserves was that it would become too expensive to defend the euro peg. Will we ever trust central bankers again? Assuming that we ever did…
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European bond yields, having fallen on the rumour of QE for some time, have started to rise, albeit modestly, on the news. The logic being that if sellers of bonds then receive a negative interest rate from the ECB on their disposals will there be sufficient sellers to meet Draghi’s target? We suspect most of the proceeds will end up in equity markets, as has been the case with QE notably in the US, rather than being lent into the economy. QE never seems to work the way it was intended to does it?
The central banks, as ever, hold the key to market movements. The ECB has gone all in with a €1 trillion QE programme stretching out until September 2016, but beware Greeks offering up spanners (click here to read more)!
• Government bonds still look expensive; sovereign yields surprised on the downside in 2014. Low interest rate sensitivity is the strategy to follow for “fear” assets.
• Spreads on corporate bonds are still tight. They are not cheap either and default risk can only rise from here, making high yield in particular less attractive.
• Western equity markets are still expensive and the December correction was just that; a correction. Some froth does need removing, notably in the US, but short term 2,250 on the S&P looks possible.
• Property remains attractive as a real asset offering a higher spread against most fixed interest markets, but not without risk.
• The German and French markets, potentially the main beneficiaries of QE are showing some signs of renaissance, but will Greece throw a spanner in the works? Japan has stalled, but we expect action from the BoJ soon. Emerging and Asia Pacific markets are not overly expensive, but will continue to be volatile.
• Central banks are committed to negative real yields; the ECB, the SNB and the Danish central bank have all gone for negative nominal rates! Ultra loose monetary policy will create inflation eventually, but currently deflation is back on the agenda and it is getting harder to see where anything other than tepid growth is going to come from.
• Gold and gold mining shares are still in a bottoming out phase as long as support at $1,200 holds
Clive Hale, Director - February 2015
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