The Lowdown on Markets to 11th September
In this week’s issue
- World stock markets stay in a cautious mood pending announcements from the Fed.
- Whilst the US labour market seems robust the outlook for inflation remains subdued.
- The emerging markets and commodity prices continue to suffer from economic uncertainty.
- Japans stock market slides into negative territory for the year before climbing 7.7 per cent.
- For now short dated US government bonds appear unfazed by any imminent Fed tightening
- Any further significant corrections in the markets should be viewed as a buying opportunity.
What does this mean for the markets and asset classes?
“Global stock markets react cautiously ahead of the Fed’s decision on rates”
Global equity markets aired on the side of caution last week pending the Federal Reserve Bank’s decision as to the timing of their first interest rate hike since 2006, indeed, the range has remained unchanged since December 2008 when it was cut to between 0 pc to 0.25pc. Clearly, over recent months it was thought that the FOMC might announce a small increase in the federal funds rate, perhaps in June, but most likely in September, however, uncertainty over this issue has now become rather tiresome and therefore they really need to become much more transparent in their thinking to avoid any loss of credibility or market tantrums.
Performance from global equity markets so far in 2015 (click on chart for full version)
This will they, or won’t they, dilemma has been affecting market sentiment for most of this year, and of course we have experienced some rather volatile days. Unquestionably most of the US economic data does support the concept for higher US interest rates, but unfortunately, outside forces such as the economic slowdown of the Chinese economy, the collapse in commodity prices and the general concerns surrounding the emerging markets has dampened the Fed’s appetite for rate tightening.
Admittedly, higher interest rates usually help to cool down a countries economy, preventing it to overheat, slowing down growth and inflation. Similarly higher interest rates benefit creditors whilst affecting debtors; however, this is not always the case. Indeed, at the current time the US economy is not overheating, inflation remains stubbornly low, and if interest rates were to increase, if only by a modest amount, it is unlikely to assist savers but may well affects those with mortgages and higher debt levels, therefore it is difficult to calculate how higher interest rates will be received this time.
Conversely, what we have already seen in the emerging markets and commodities is a rather severe correction given that the threat of higher interest rates is likely to lead to a stronger US dollar, which in turn, weakens assets priced in dollars, this could make things very difficult for countries which pay their debts in dollars consequently creating a slowdown in growth and prosperity for the likes of the developing world. This threat from rising interest rates has not only been experienced recently in the emerging markets, we saw a similar wobble in those markets when former Fed chair, Ben Bernanke, spoke of ending QE purchase back in 2013 which consequently created some turmoil in the foreign exchange markets.
Performance from the BRIC’s for 2015 (Click on chart for full version)
Obviously, any premature move by the Federal Reserve Bank could threaten the emerging markets and subsequently have a detrimental effect on global growth and this is why the likes of the World Bank and International Monetary Fund have been rather vocal of late with regards to raising rates too early, even id by a small margin. Equally, many of the governing bodies from the developing world have recently called for the US Central Bank to get on with it, therefore, extinguishing the flames of uncertainty. Furthermore given that the “new norm” is likely to be much lower than the historical interest tightening programmes of the past perhaps the recent collapse in EM asset prices is already overdone?
Understandably, concerns around the slowdown in the Chinese economy is of vital importance given its global economic status but for this country’s economy to switch from an export driven to a more domestic consumer driven economy then there was always going to be a lengthy period of pain to benefit any future gain, and of course commodities have been in the “eye of the storm” concerning the slowdown of demand from the likes of China, and of course the consequences that this has on commodity regions such as Latin America and commodity driven currencies such as the Aussie and New Zealand dollar as prices collapse.
Performance of copper, gold, oil and general commodities for 2015 (click on chart for full version)
Certainly, next week’s decision by the Fed will be important for the markets and is therefore likely to set the course for riskier asset classes for the rest of the year. At present, the consensus view is that the Fed will leave interest rates at their current levels, and review the situation nearer the end of the year. If this is indeed the case, then it is likely that we will see a “relief rally” sometime between now and the end of December as the customary “Santa Claus Rally” takes hold.
But of course if the FOMC were to surprise the market on Thursday then just be mindful of the bond markets, even though they appear rather unfazed at the moment by any likely Fed tightening, given that they will have a big influence on global equity markets once interest rates begin to rise and of course global asset allocators start to adjust their exposure accordingly for 2016 and beyond.
Clearly, the credit and equity markets are likely to remain quite volatile over the coming few months irrespective of central bank policy in the US, and the UK. Indeed, early last week global and Japanese investors were trying to gauge the Japanese governments appetite for more quantitative easing as some irrational trading firstly saw Japan’ Nikkei 225 Index slid into negative territory for the year, to then ascend by 7.7 per cent, the next day, its biggest one-day gain in nearly seven years. This left the index with an overall gain of 2.65 per cent over the week, however, Japanese stocks are down about 12 per cent from their peaks in late June.
Performance of the Japanese Stock market for 2015 (click on chart for full version)
Conversely, the Chinese market, which has been extremely volatile over recent times had a rather inactive week climbing a mediocre 1.3 per cent over the five trading days. Arguably, the volatility in the Chinese stock market in recent times has been predominately down to worries about the slow down within the economy, however, the 56 million new trading accounts that have been opened in the first half of 2015, by mostly retail investors, record stock market turnover, and the subsequent suspension of hundreds of Chinese company shares over the summer months has really not helped.
In terms of the UK, we are now unlikely to see any interest rate hikes much before 2016. The rather subdued inflationary picture, slightly worsening unemployment outlook, and the continuous sell off in the markets since April, has dampened down the MPC’s sentiment to raise rates this year. Indeed, expectations from some leading economists are that interest rates will rise to perhaps 1.0 per cent by the end of next year and to around 2.5 per cent by 2018, with long-term expectations being that it will be 2025 before we see UK interest rates at a meaningful 3.0 per cent.
This would certainly have significant ramifications for income seekers given that cash deposits and sovereign bond yields are likely to remain historically very low for the foreseeable future, which in turn, could see the already crowded trade for equity income gather further pace. None-the-less with the recent pull back in the UK stock market this should give long term investors some opportunities to capture some good quality businesses with increasing dividends whether they be in the large, mid or small caps sectors. Arguably however we are seeing a dramatic out-performance from the small caps over their larger brethren so far this year.
Performance of the UK stock market for 2015 (click on chart for full version)
And so as we brace ourselves for probably another week of doubt and indecision it is imperative that global investors focus upon some of the opportunities that have appeared over the last few months of downward pressure on equity markets. Undoubtedly, there are still some very important global issues that still need to be addressed around the world, consequently, markets could still continue to trend downwards, however, the global economy is still in better shape than it was back in those dark days of 2008, and therefore, it is very important for any long term investor to remain focused and continue to buy on any further significant corrections.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum he worked within larger asset managers, primarily as an Investment Director within Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Investment Committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority.