Market Commentary - August 2015
Last month we were waiting upon the dénouement in Greece and, if you believe anything you may have read in the newspapers, the problem has been solved. The naughty Greeks have been put back in their box and are taking their medicine. As we said in the previous bulletin “If the Greeks vote to stay inside the euro camp and take their medicine the symptoms of pain will go away…temporarily… as the root cause of the issue has not been addressed. The Eurozone’s problem is the euro. Without total (totalitarian?) political union it’s a dead duck and, one by one, the existing members will come to that conclusion, but not before a lot more pain and anguish has been heaped upon those who are least capable of dealing with it.” Nothing has changed for our long term prognosis.
In the short term the European bourses have been enjoying a relief rally; equity markets have bounced and bond yields have come back down, but not to the unrealistic levels we saw back in April. Investors have been allocating more to the region and with the ECB deploying its “treasure chest” we expect some stability to return. However the IMF have thrown a potential spanner into the works by saying that they will not participate in the bail out unless debt forgiveness in some form is on the table. This is not what the Germans want to hear as they believe it will give the “wrong” message to other potentially recalcitrant countries; Italy, Spain and Portugal please step forward and let’s not forget that France has broken more austerity pledges than Greece on a good day! It’s August in Europe and that means it’s holiday time. It may well be a different story come September and October.
In the US, four years of GDP numbers have been revised downwards. In effect a cumulative 12% of economic growth has been erased by the statisticians and the markets haven’t batted an eyelid; quite extraordinary. The Atlanta FEDs GDPNow forecast came in almost bang in line with the official release of 2.3% but its earlier prognostications suggested growth of a mere 0.5% so pretty useless really and by the time the 2015 Q2 number has been endlessly revised will we really care? The real news is that corporate earnings have started to turn down despite share buy backs. Lower oil prices aren’t “trickling through” to the economy as anticipated either.
The big issue this month has been China. Economic activity continues to slow, which is having a deleterious effect on the commodity complex, not to mention the stock market. The Chinese authorities would like to ban all mentioning of the stock market and some large circulation western newspapers have, allegedly, been “persuaded” to keep schtum. Not so your intrepid reporter! The chart of the Shanghai A shares index is reminiscent of many tech stocks in the 2000 bubble era (see chart later) and we would not be at all surprised to see a retracement to the 2500 level, which is where it stood only last November.
The budget was something of a non-event and the chancellor has spent more time visiting his European counterparts, along with the PM, to garner support for EU reform. They obviously haven’t been tuned into the Greek saga, which unequivocally demonstrated that reform, especially in terms of further politicisation of the EU project (without which the sacrosanct euro is a dead duck), is not on the agenda now or ever.
The debate over interest rate rises is not just an American affair. In fact it is quite possible that the Bank of England might take the lead, which is why sterling has been strong of late. This trend will not help our exporters, something the Americans are already finding out.
The lack of momentum we highlighted last month continues and the S&P 500 is back close to the 200 day moving average, which has provided much support in the past. The market is still technically in an uptrend and a break of the MAV and a close below 2000 is needed to encourage the bears into action. We have already mentioned the GDP conundrum early. Here it is graphically. As the Fed’s balance sheet has risen so to, pretty much inlock step, has the S&P 500. Now that QE has ceased the Fed’s balance sheet will stop growing, which puts the index under a bit of pressure does it not?
Much is made of the improving economic back drop in Europe, but it is still an anaemic affair and helped in the main by a weak euro that keeps the export engine going. There is undoubtedly some value in the bourses; a stock pickers market, not one for the passive brigade and do listen out for dissenting messages from the IMF.
Abenomics is having a tough time in Japan and the index has stalled around the 20,000 mark. Relative to the rest of the world this market is cheap, certainly on a price to book basis which has often been the catalyst to bring in the value buyers. In the short term the index is still looking a little extended and there may well be buying opportunities here if we see a further pull back.
Asia Pacific and Emerging Markets
The continuing falls in the Chinese stock markets together with the weak economic data have impacted on the Asia Pacific region as a whole and we expect this downside volatility to continue a while yet. The Chinese government are learning the lessons of capitalism the hard way, but, as ever, they have time and the potential of the world’s largest economy on their side. There will be a time to get back in to this market when all the speculative froth has been blown away; it won’t happen overnight.
Weaker oil prices and dollar strength, which is making a comeback, will impact negatively on Emerging Markets as a whole although there will be some bright spots; notably India and Vietnam.
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.” For once we were too optimistic and the whole commodity complex has started another leg down. If there was some real fire in the global economy this index would not be in a downtrend. Since 2013 there has been a disconnect between the World equity index and the commodity complex. Either equities are too expensive or commodities are too cheap. A bit of both perhaps?
Gold has decisively fallen through the key $1200 support level and $1000 looks likely to be the next stop. What is “intriguing” is that while demand for physical gold is rising, the paper futures market, which is usually settled in cash not physical, continues to be driven down by the bullion banks. We may never find out who is doing the selling, but placing billion dollar sell orders in the market during the normally quiet overnight sessions is not the hand of a price sensitive investor.
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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, on top of burgeoning regulation, 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. Who would have thought that over 30 years you could have made as much in bonds as in equities?
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. The next major move will be the much anticipated US interest rate rise, followed by, or quite possibly preceded by, the BoE. A September move might come as a “surprise”.
•Government bonds still look expensive despite the ongoing bond “rout”. The long term trend in yields is beginning to turn up.
•Spreads on corporate bonds are still tight. They are not cheap either and default risk can only rise from here, making high yield potentially less attractive. Is the yield premium adequate? There is also significant 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 fully resolved, to the satisfaction of the IMF. The Nikkei index has reached our initial target at 21,000 and may now see a retracement of some of the gains. Emerging and Asia Pacific markets are not overly expensive, but will continue to be volatile and negatively affected by dollar strength and Chinese economic weakness.
•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 has fallen through support at $1200 driven down by unusually aggressive and abnormal selling on the futures market. Physical demand remains strong and there will be a significant buying opportunity when this market shows signs of bottoming, but not, we suspect, for a while.
Clive Hale, Director - August 2015
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