Finance and investment wrap - April 2016
The recovery from the February low has continued apace, but looks to be running out of steam. The S&P 500 has risen 15% in just over 6 weeks1, in pretty much a straight line, and a retracement of some sort is now a high probability.
If we are still in a bull market, as some pundits assure us, then a correction of around a third of the up move is likely. If it is larger, the omens become less favourable.
We break down the key events, market by market, that you need to know about in April.
Markets in brief – the movers and shakers
- The European Central Bank's (ECB) president, Mario Draghi, cut interest rates further in Europe as anticipated last month, and bulked up his economic stimulus program. More on this below.
- Brexit debate continues, with the odds shortening on Britain leaving the European Union. Bookies' odds currently have the two outcomes roughly neck and neck. More on this below.
Quantitative easing – does it work?
The central bank narrative would also be tested by a significant correction. No-one is quite sure where Europe's negative rates are going to take us, for example.
That’s not quite true – the Bank of Japan must take the accolade, as they have pursued quantitative easing (QE) since the early '90s with no success other than a truly heroic debt-to-GDP ratio. They too, like the ECB, have as good as admitted that QE has been a failure and played the negative rate card, which has so far back fired on them quite spectacularly.
You may point to the US as proof that QE works, but don’t confuse the initial Troubled Asset Relief Program (TARP) bail out, which saved the banks, with ongoing QE, which just added to the debt pile and has done little if anything to stimulate the economy. Despite rumours to the contrary, the US economy is still a weak and anaemic affair, in my view.
We are now 8 years on from the start of the last recession and the global economy is far from booming is it? Janet Yellen pointed to less-than-robust data at her last press conference, which was taken as a sign that a second interest rate rise is off the table for the time being and markets rose.
Strange when you think about it isn’t it? Economic data poor; stock prices rise. Hmm…
As if the Brexit campaign wasn’t enough to create divisions within the Tory party, along comes the chancellor with a budget delivered with a degree of hubris to which only he can aspire.
It really is about time the establishment stopped knocking the poor and underprivileged and took their fair share of austerity, if that is indeed what we need. Capital gains and corporation tax cuts paid for in part by reducing subsidies on prosthetics and benefits for the disabled. That can’t be right can it?
Iain Duncan Smith certainly thought not and resigned as Secretary of State for Work and Pensions. The “Draper” removed some of the offending items the following day, but not before the damage was done.
The bookies have reduced the odds on Brexit and the opinion polls have the two camps neck and neck, albeit with a large contingent of undecided / don’t knows. The main problem Brexit would hand us in the short term is that Article 50, of the European Union (EU) constitution, which allows for an exit, places the responsibility for the timetable with the EU Commission. We could be stuck in a no man’s land for two years and then handed an unpalatable ultimatum.
Very little has been written on the negative outlook for Europe if we leave though, which is one reason why the European bourses continue to be weak relative to the US. Europe does look cheap, but as we have said before it is cheap for a reason.
The US election machine rolls on, making House of Cards seem positively genteel. This will conveniently take some of the focus off the economic debate. Whenever the economy looks to be making progress along comes another piece of data to knock it back again. We have too much data and far too much government.
Take politics and central banking out of the equation and in short order we would know exactly where we stood. Until then it’s central bank watching time with occasional inputs from the “Hill”.
We could see a correction in US equity markets soon.
The interesting part of Draghi’s news conference, after the ECB cut rates and added another €20 billion a month to the QE pot, was his comment that he was now done with “whatever it takes” and it would now be up to the politicians to fill in the gaps.
The markets fell sharply, having risen on the QE extension news, and then just carried on upwards as if he hadn’t said anything.
If the European economy was not in such a parlous state, he could have probably talked his way out of the meeting without cuts or QE, but even the mighty German economy is suffering and France is rapidly becoming the “sale of the century”; everywhere you go you will see sales of 50% off and more.
The club Med countries are doing better, but unemployment rates are still dire and there is still a very long way to go on the debt recovery front. Greece is back in the spotlight again with rumours the International Monetary Fund (IMF) want to provoke the threat of a Greek default to frighten the German-led austerity camp into agreeing to debt write-offs.
More volatility to come in these markets too we suspect.
The move to negative rates, intended to weaken the yen, had exactly the opposite effect. As a result, the latest business confidence survey was much weaker than expected as yen strength hurts Japanese exports.
The consensus now is that the Bank of Japan will have to provide further stimulus. Just how it will achieve that after 25 years shooting in the dark is unclear, but it needs to do something other than QE or rate cuts. Maybe Abe will just have to fill up some helicopters with cash.
Asia Pacific and Emerging Markets
Asian and Emerging Markets generally had a good time of it in March and flows into the later are turning positive for the first time in some years. Longer term, we like this area to be invested.
We would like to see more than just rhetoric coming out of China, however. The latest 5-year plan promises much—as ever— and on the devaluation game they are still trying to finesse the forex markets, with a small degree of success it must be admitted. Longer term, they have an uncompetitive currency and they will have to devalue.
Commodities and Gold
After a 20% rise in dollar terms from the December low, gold is in a corrective phase. It feels very much like the start of a new bull market, especially as the critics of the “barbarous relic” are still seeing the bear case.
Oil has risen nearly 50% over the same period, but there are still supply issues, which have a been a drag on prices during March. The industrial metals have had a good run too, but in the main from very oversold positions; the shorts have been squeezed.
Bond yields, particularly in Europe, were edging higher, but then along comes Mario Draghi with a basket of central bank goodies and rates are now heading back down again, as they will continue to do while we have negative bank rates.
With another €20 billion in its war chest, the ECB has put a firm bid under the corporate bond market. This does take away some of the risk, but valuations are heroically expensive unless you believe in hyper-deflation, which is most definitely not on central bank agendas.
However, it is not something that can be waved away as easily as inflation, which eventually succumbs to ever higher interest rates. The unintended consequence of negative rates may be that it ushers in deflation despite the central banks ulterior motives.
1Data source, Fuller Treacy Money
Clive Hale, Director - 1 April 2016
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