Finance and investment wrap - March 2016
With an atmosphere of gloom pervading every market, except gold, it should have been no surprise to see a decent attempt at a rally and that kicked off in the middle of February.
China currency devaluation remains a key concern, the next US interest rate decision looms and the Brexit debate promises to keep us occupied in the coming months.
We break down the key events, market by market, that you need to know about in March.
Markets in brief – the movers and shakers
- The G20 meeting in Shanghai came and went without any consensus on what to do next. No surprise, as the combatants (for that is what they are now – with every man for himself in central bank world) are pursuing different options in an attempt to make their economies more competitive; a policy doomed to failure.
- The next important event on the horizon is the European Central Bank meeting during the second week of March. Draghi is already reiterating the “we will do whatever” platitudes, which resulted in a brief rally and then the markets fell away again. More on this below.
- Debt is, of course, the 'Big Issue'. There is more of it globally than in 2007/08; much more. It may be that negative rates are a cynical way of reducing government servicing costs on their debt. More on Japan, China and US debt below.
The headlines have been consumed with Brexit now that Boris has joined the 'leave' camp along with Michael Gove and nearly half the remaining Tory MPs.
The initial market reaction was to sell sterling and we have gone below a long-term support level at $1.43 last seen in 2010.
We are now approaching the 2009 low of $1.38 – that, at least, should hold given the sharp recent falls; the market needs to pause for breath and take stock.
The arguments for and against are finely balanced. A report commissioned by Woodford Investment Management from Capital Economics came to the conclusion that despite some short term sterling weakness (the foreign exchange markets like to get there early), which would be quite beneficial for our exporters, the long term effects are pretty much the same either way.
We have four months of debate to “look forward to”.
The Federal Reserve (Fed) famously raised rates in 2015 but, with the European Central Bank (ECB) and the Bank of Japan (BoJ) now taking the negative rate pill, that decision looks increasingly suspect, to put it politely.
The attention is on what the Fed will do next. Janet Yellen, like previous incumbents, says that policy is “data dependent” and recent employment and inflation numbers suggest they might even raise rates again! Although given the volume of statistics available, they will be able to find something to hang their hat on if they feel less inclined to do so.
The market has had a strong rally since the middle of February, but may run out of steam as it approaches 2,000.
If the Fed does persist in rising rates, the dollar will maintain its strength, which will mean continued weakness in oil and commodities, more pain for emerging market currencies and economies, and a continuing headwind for US exporters.
It does, however, support the argument that the Fed needs to be vigilant on the inflation front and there are signs that recent deflationary moves are coming to an end. Oil prices are tentatively picking up and the year-on-year figures will cease to benefit from falling prices.
However, trade is the driver of economic growth and the US needs it as much as everyone else.
Much like Japan and China (although somewhat less extreme), US corporate debt has been climbing, more often than not to pay for share buy backs at inflated prices to boost earnings per share, or used to buy into asset plays of now dubious value – think oil exploration.
What's more, in the US they have their own form of referendum to occupy their minds; the Presidential primaries. After Super Tuesday it looks like the contest will be between Trump and Clinton—not an enticing prospect for many―with some notable Republicans saying they will vote for Hilary!
The markets really don’t know what to make of this and given that the office of President actually has very few powers that are not bestowed upon it by Congress and the Senate, it shouldn’t be a surprise.
All eyes are on the European Central Bank (ECB) meeting in the second week of March and the hope is there will be something more than negative interest rates on the table.
Draghi is already reiterating the “we will do whatever” platitudes, which resulted in a brief rally and then the markets fell away again.
This is typical of bear markets and, in Europe in particular, there is no evidence yet the trend has changed. The meeting will in all probability herald further rate cuts deeper into negative territory. If he finds a rabbit in his hat (more bond purchases – although he is getting on for cornering that market) then we may see a stronger rally.
Longer term, Brexit would be a huge problem. In France, Marine le Pen has already said that 'Frexit' would become a reality if the UK leaves the EU. That statement alone will bring out all the big guns to make sure that we stay in.
It may come as a surprise, and some may disagree, but Europe needs the UK far more than the UK needs Europe.
Last month we again said Japan is becoming a case for concern and that continues to be true. The yen strengthened on the back of the BoJ seeming reluctant to help out and the market took a tumble. This was all too much for the powers that be and as we mentioned last month the BoJ had to cut rates into negative territory.
Last week’s 10-year JGB (Japanese Government Bond) auction went at minus 0.1%; buyers paid the government for lending them money!
Despite some concerns, we have not changed our stance here as the underlying market valuations are attractively cheap on a longer term view.
Asia Pacific and Emerging Markets
Asia Pacific and Emerging Markets were two of the better performing sectors in February despite concerns over China, oil prices and currencies. Valuations are beginning to look very cheap but perhaps still too early to go “all in” here.
The People's Bank of China (PBoC) has said they will not be in any hurry to devalue the currency, but that has given the foreign exchange markets a target to aim for and the slow erosion of China’s foreign exchange reserves cannot go on ad infinitum.
It is quite conceivable they will devalue all in one go, as they did back in 1994, which triggered massive inward capital flows and the start of the latest Chinese renaissance.
It would, however, have a massively deflationary effect on the rest of the world and the US repost would almost certainly be to join the negative interest rate club.
Not the most promising strategy, but “as long as the music is playing, you’ve got to get up and dance”, as Chuck Prince, the CEO of Citigroup, said in 2007 about subprime debt trading.
On the note of debt, it continues to be a key issue in China and people are particularly wary of the banks. Debt in the Chinese banking system has gone from $3 trillion in 2008 to $34 trillion.
Commodities and Gold
The good news for oil is that it has stopped going down and we are enjoying something of a tentative rally.
The same is true for other industrial commodities, and oil and mining stocks have been market leaders over the past month.
The trend is not yet up and we need to see further confirmation (price above a rising long term moving average) before calling an end to the bear.
Gold has taken a rest after a significant rally from the 2015 lows. Goldman Sachs have suggested shorting the barbarous relic. Given their track record thus far in 2016 it must rank as a buy!
With further moves towards negative interest rates in the offing, bonds had a generally good time in February, although US Treasury yields have started picking up again after the latest inflation report.
Bonds generally are extremely expensive compared with historic norms, but we are very far from being in a normal environment, so the great bull market may still have some life in it yet.
In terms of risk-reward, perhaps not one of the safest options. Ironically investors are now looking at bonds for capital appreciation and equities for income; this is not normal!
Clive Hale, Director - March 2016
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