Market Commentary - December 2015
After the bounce from the very panicky lows, which played out in October, November has ended up pretty flat for equity markets, which disguises the ongoing volatility. During the month the UK Large Cap index fell over 150 points and then promptly clawed its way back up again. The MSCI World index is a good proxy for what is going on. US equity markets have been generally stronger in the recovery phase and Emerging and Asia Pacific markets weaker. Overall the prognosis is that we have seen a peak in May and a significant fall, similar to that experienced in 2011. The problem then was contagion fears over European sovereign debt. Italian 10-year yields spiked to 7.5%; today they are at 1.6% and rising again.
The current issue exercising everyone’s minds is when will the Fed start raising rates and if they do in December, which is almost a foregone conclusion (“almost” - but then we are dealing with central bankers), what will the accompanying statement say? The market will need to understand the trajectory of rate rises from here. If the Fed makes a mess of the forward guidance, and its track record of late has not been good,, then we can expect more volatility and an 'interesting' start to 2016.
In Europe the ECB has moved in the opposite direction; cutting rates by 0.1% and extending their QE programme by 6 months. The market reaction suggests disappointment and yields have spiked up in the sovereign bond markets. However, the reality is that Draghi will continue to do “whatever it takes” and as long as the markets continue to believe in central bank omnipotence, then yields shouldn't go a lot higher given the anaemic state of growth across the eurozone as a whole.
Geopolitical risk has been adding to volatility and at another time we would be less concerned, as markets usually resume their course after things quieten down. Currently, however, we are experiencing quite the opposite. The list of combatants in the global battle for ideological, political and economic superiority grows daily. Game theorists believe there should be an optimal outcome and we have to hope that they are right.
The autumn statement has produced another piece of “magic” from the chancellor. He has managed to keep to his austerity budget despite something of a reversal over benefit cuts, but mainly as a result of some rosy predictions on economic growth from the Treasury. The UK has ploughed a lonely furrow as the strongest of the G7 economies, but it cannot be sheltered from a very anaemic global affair for much longer, can it?
All eyes are on the Federal Reserve Banks FOMC meeting on the 16th and 17th. A string of members have opined that economic conditions are now right for an interest rate rise (apparently they weren’t in September) based mainly on “improving” employment numbers. On the Fed’s economic database there are nearly 2,000 measures of employment so there is bound to be something there to suit all tastes! However, in spite of Rosy Scenario making further appearances, the GDPNow data from the Atlanta Fed is deteriorating and how embarrassing would it be for rates to rise only to be cut again in the New Year? At least they’d have something to cut…
Data across Europe is improving, but is still a long way off a proper recovery. Mario Draghi holds all the cards and at the latest ECB meeting rates were cut by 0.1% to minus 0.3%. If minus 0.2% was not enough to get the credit machine (the banks) lending, then a further 0.1% will not make much difference. As a result, the equity markets have sold off. Europe is not expensive relative to the UK and the US, but the uncertainties continue to give us pause for thought. The markets in Europe bounced strongly on Draghi’s suggestion of further monetary loosening and it may be an example of buy on the rumour and sell on the news.
One of the few bright spots in November has been Japan where the Nikkei index has revisited the 20,000 level and moved above the long-term moving average. The economy is technically in recession again, for the fifth time since 2008, but such are the vagaries of statistics that given any sort of error rate Japan is doing as well as many economies. With the prospect of cheap oil for some time to come (they have none of their own), and valuations being very reasonable, we anticipate further progress.
Asia Pacific and Emerging Markets
These markets have taken the brunt of the global decline with a strong dollar and very weak commodity prices being the main drivers, not to mention a slowing in the Chinese economy. There will be a time to increase weightings to these markets, but for the time being the trend is down.
Commodities and gold
Commodities continue to fall as dollar strength picks up again. Exporting countries have to increase production to earn the same in local currency terms, so the world is awash with oil, copper, aluminium and steel in an environment of low growth and shrinking demand. Arguably we are close to some sort of bottom, but any sharp upward moves are likely to be geopolitical in nature and not a sign of a more significant global recovery.
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There is a distinct schism between European and US bond rates. In Europe the German 10-year Bund is at 0.47% and the US Treasury at 2.23%. The Bund is at the bottom of its 5-year trading range while the UST is bang in the middle. If Draghi disappoints then that disparity will begin to unwind. Long term, bond yields across the fixed interest spectrum look set to go higher and do represent good value. Short duration issues are fine if bond exposure is required but in most cases the real rate of return after inflation will still be negative. In Europe some issues have a negative nominal yield. You pay the issuer to hold your cash; extraordinary.
The central banks, as ever, hold the key to market movements. ECB and Fed meetings in December will be crucial to the next phase of market price expansion (or contraction) and will attempt to maintain the façade of invincibility.
• Government bonds still look expensive despite deflation yet again being discussed as the bigger problem.
• 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? Defaults this year in the US outside the energy sector account for more than 50% of the total. There is also significant concern over liquidity risk.
• Western equity markets have started a long expected correction. Whether it turns into something more extreme hinges on central bank action as well as the nerve of investors.
• 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. Conventional wisdom says that ECB QE should be beneficial for financial assets, but the Greek issue is yet to be fully resolved. The Nikkei index has reached our initial target and is still relatively cheap. Emerging and Asia Pacific markets are not overly expensive now, but will continue to be volatile and negatively affected by dollar strength and Chinese economic weakness.
• Central banks are committed to supporting the markets but their aura of invincibility is beginning to slip. 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; even China is succumbing to the malaise.
• 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.
• Commodities generally will not see a sustained trend change until the global economy shows more signs of life although in the short term expect geopolitically induced rallies.
Clive Hale, Director - December 2015
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