Market Commentary - June 2015
After April’s bond “massacre” things have quietened down a bit in May (June may be another thing), but there is still the threat of another storm; rather like the weather in Old Blighty! The UK election has come and gone with the “oppositions various” making an appalling fist of it. Nothing of any import was debated and UKIP must feel mightily aggrieved to register one seat after receiving nearly 4 million votes - more than the Lib Dems and the SNP combined with 64 seats. The American author, Walter Lippmann, opined that, “In a democracy, the opposition is not only tolerated as constitutional, but must be maintained because it is indispensable.” It is a pity we don’t have one worthy of the name…
But the “resounding” Tory victory was well received by the City and sterling and the stock market had a one day vote of confidence; short lived in both cases, but the nightmare of a Labour/SNP government had passed in the night. The UK recovery, like so many others around the world, is still a fragile thing despite the chancellor’s spin; which many, the press in particular, take at face value. Yes there is growth, but at this stage in the cycle it should be much stronger. Why isn’t it? Well all the “munnee” has gone into the banking system where it has been “recycled” into financial assets of one description or another and that is supposed to make us all feel better off, isn't it? What it most certainly has done is to force otherwise cautious and conservative investors into parts of the market where they should fear to tread, in search of income. And in corporate world, particularly in the US, it has been far too easy to massage the figures, by borrowing at very cheap rates courtesy of central bank munificence, and buying back their own shares at overvalued prices.
There has been a seismic warning from the bond market, and after the traditional “quiet” summer, it would be no surprise to see equities have a similar reaction to the unintended consequences of central bank experimentation. Draghi’s QE bonanza had the predictable effect, initially, of goosing both the bond and equity markets. European sovereign debt led the bond rout which, so far, has cost an estimated $500 billion (half a trillion) globally and this has slowed the equity markets for the time being. There is still a lot more ECB QE to come so the support is theoretically there. In the US, Janet Yellen continues to tease the markets about the timing of the Fed’s rate rise, which keeps getting pushed back. Any move before the end of the year probably won’t go down too well. They are still printing in Japan, with little practical effect on the economy, but don’t tell the stock market - the Nikkei is at a 15 year high!
And finally, in the list of storm catalysts, as ever, we have Greece. The general perception, aided and abetted by – in no particular order – the press, the German and Dutch finance ministers, the IMF and the investment banks holding Greek debt, is that Syriza is in no position to dictate terms to the very creditors who have bailed out their country in the past. That they have a mandate from the Greek people to do just that and that much of the “aid” did not go whence it was intended, apparently counts for nothing. If there is an agreement soon, then it will be another band aid affair for sure.
Bond markets have generally had a quiet, but positive month, and much the same for equities. The stand-outs have been UK mid and small caps which continue to defy gravity - a Tory victory is a plus for the domestic economy allegedly - and Japan. On the downside China is having a well-earned breather along with Brazil, Russia and emerging markets generally. We still believe that valuations in both equities and bonds are, in the most part, very rich.
Along with pretty much everyone else, ex the BBC exit poll, we expected a hung parliament. The concern of the electorate over the unimpressive showing of Labour in opposition, and in the election campaign, was underestimated. The Tories are undoubtedly “big business” friendly, but they will need a change of policy direction if they are to get the UK economy moving at the rate it should be at this stage of the recovery. 7,000 on the main index is proving challenging, although mid and small caps are enjoying the post-election sunshine.
Technically, momentum in US equity markets is beginning to struggle in a way we haven’t seen since the bull market started in 2009. Volume is drying up and all the action is at the opening and closing bells, when the high frequency traders vie for whatever deals are on offer. It is not a market as we used to know it, and being underweight seems a sensible strategy.
Meanwhile in the land of the free, as well as in the UK and Europe, there is little debate over the Transatlantic Trade and Investment Partnership (TTIP). This wholly undemocratic agreement, if enacted, will allow international corporations to sue governments if they believe legislation, properly enacted, hurts their way of doing business. The negotiations on this treaty are held in secret and are symptomatic of the way our freedoms are being subverted, but it will be good for big corporates…
The chickens still can’t lay an egg on the Greek debacle. Rumour follows rumour, and trial by press is the order of the day for both Greece and the markets. A fudge may be the best solution, and already this month the Greeks will roll up their repayment obligations to the IMF to the end of the June - which they are entitled to do - to gain more breathing space. Tsipras has gone on record in Le Monde to say that the whole negotiating position of the “troika” has completely ignored the mandate he has from the Greek people. In reality Greece is irrelevant and her exit from the eurozone, even if such a thing were possible (there is no mechanism built into the treaty), would on its own barely cause a ripple. But the markets remain very concerned about contagion. If there is a fudge, expect the markets to rally hard until the first cracks start to appear in Spain, Italy and/or France.
Last month we said this: "On a relative basis Japan still has one of the lowliest rated stock markets despite an impressive start to the year, with the broad equity market up 16%. It is finding it tough going to get above 20,000 (roundophobia is a curious quirk of investment markets), but, when it does so, there is not a lot of technical resistance until the 25,000." Today the index has passed the 20,000 mark and whilst the economy still languishes, there is little technically to prevent a further advance.
Asia Pacific and Emerging Markets
As expected, there has been some loosening of monetary policy in China as the non-performing loan issue becomes a bigger concern for the banking system. The market has been on a tear, but recently it has paused for breath. New account openings for share dealings continue to rise and until the People’s Party decide that enough is enough, the corrections will be just that; corrections. The rest of Asia had a quiet month possibly over renewed dollar strength and a slowing Chinese economy.
Commodities and gold
Last month we said of oil and copper that; the global economy is still fragile overall, so perhaps more sideways than up is the best we can anticipate.” And that is pretty much what has happened. If there was some real fire in the global economy, this index would not be in a downtrend below the long-term moving average.
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Value is almost impossible to find, and the other major concern in these markets is liquidity. In the sovereign debt markets, volatility is frightening off even the biggest players. Ironically the Basle banking regulations, which have set the capital requirement for holding “very secure” sovereign debt at 0%, allowing some significant gearing into these markets, may well turn out to be the catalyst for the next crisis: The law of unintended consequences always strikes where it is least welcome; the long term (30 plus years), downtrend in yields looks to be coming to an end.
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, and a US rate rise seems as far away as ever, although an unexpected earlier move would be unsettling to say the least.
• Government bonds still look expensive despite the ongoing bond “rout”. The long-term trend in yields is turning up.
• 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. There is also concern over liquidity risk.
• Western equity markets are still expensive and momentum does seem to be waning as we wait for the next round of GDP numbers to offer evidence of the trend in global growth.
• Property remains attractive as a real asset, offering a higher spread against most fixed interest markets, but not without risk.
• European markets are in a state of flux. ECB QE should be beneficial for financial assets and will remain so until the Greek issue is resolved; a fudge will be a temporary band aid. The Nikkei index is on the move upwards again towards our initial target at 21,000. Emerging and Asia Pacific markets are not overly expensive, but will continue to be volatile and negatively affected by dollar strength.
• 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 still an issue, 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 - June 2015
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