The Lowdown on Markets to 23rd October
World Markets at a Glance
In this week’s issue
- China’s central bank cuts interest rates again as their economy continues to slow.
- The European Central Bank threatens to take further QE action in December if deemed necessary.
- Both of these central bank actions ignite stock markets with equity prices moving higher.
- Likewise, European government and high yield junk bonds attract global investors.
- Industrial metal prices rally on the back of the actions taken by the Chinese authorities
- In the FX market the euro eases to its weakest level since mid-August.
What does this mean for the markets and asset classes?
“Once again central bank support ignites stock market euphoria”
As the summer equity market collapse fades away into the distance, and a relief rally appears to be underway, investors will now focus upon the Federal Reserve Bank meeting that will be held on the 27th & 28th October 2015. Understandably, the market focus will be on whether they decide to raise interest rates, or as expected keep them on hold until their final meeting in December. Even then, the prospects for an interest rate hike looks fairly slim as most market watchers, analysts, and the Fed Fund futures belief that the FOMC will now delay any actions until the first quarter of 2016.
This was perceived by the markets as a signal to buy equities, along with the announcement out of Beijing that their central bank, the Peoples Bank of China, had taken two measures of monetary action in a bid to support their economy that is forecast to grow at its slowest annual rate in 25 years
Firstly, they lowered their one-year benchmark bank lending rate by 25 basis points to 4.35 per cent, and their one-year benchmark deposit rate to 1.5 per cent from 1.75 per cent. Then secondly, they have cut the share of customer deposits banks must hold in reserve, adding around Rmb 560 billion of cash into the banking system to counteract the cash drain from capital outflows in recent months.
Arguably, the official Chinese third quarter figures announced earlier in the week did reveal that the Chinese economy has expanded at its slowest pace since 2009, clearly this in itself does outline the challenges that the Chinese leadership are facing in trying to achieve their economic growth rate of around 7 per cent this year. In fact, the gap is widening between the estimated Chinese official GDP growth figure of 6.9 per cent and Western analysts who now believe that the figure will be below 6.0 per cent. Equally, any positive actions announced by the PBOC to stimulate growth is likely to excite global investors and subsequently the Shanghai Composite Index.
Equally, the weakening Chinese economic growth rate has had a damaging effect on commodity prices, the emerging markets, currencies, and of course the Fed, who have voiced their concerns about outside forces that are delaying them from raising US interest rates, in the belief that any monetary actions taken now might have further unfavourable consequences for emerging markets and of course continually strengthen the US dollar. Arguably, whilst the latter might have damaging consequences for EM’s it could also act as a dollar magnet for global investors seeing US assets as a safe haven.
Whilst on the topic of China, the Chinese President, Xi Jinping, and his wife, visited Britain last week. This visit is already being applauded as the start of a “golden era” of bilateral relations between the two countries, strengthening economic and financial ties. His visit included a number of high profile meetings with the Prime Minister, David Cameron, meetings with the Queen and other members of the Royal Family and government officials. He also had the opportunity to address many dignitaries at numerous dinners and lunches held in his honour where he commented that China was hoping to see a prosperous Europe and a united EU, moreover, he hoped that Britain would remain a member of the European Union, given that he thought Britain would be stronger and safer within the EU, and certainly had major role to play within the Union, particularly, in the development of Chinese-EU ties and relationships.
Indeed, it wasn’t only the Chinese premier that made the headlines in last weeks media, indeed, the President of the European Central Bank, Mario Draghi, was very quick to point out that the ECB were ready and willing to expand on their current €1.1 trillion quantitative easing programme, and cut its deposit rate, in December if the slowdown in the emerging markets were to threaten the Eurozone’s economic recovery programme. Similar to his previous speech back in 2012 when he notably said “we will do whatever it takes” the markets immediately reacted positively to this recent statement.
Currently, the ECB are purchasing €60 billion a month of mostly government bonds, this programme will continue until September 2016, however, at the time of making this pledge the ECB stated that this was an open ended transaction. Decidedly, this had an instant effect on investor’s appetite for risk and the direction of European assets pushing the price of equities and government bonds higher and yields lower, whilst weakening off the euro against a basket of other major currencies.
Certainly the actions and comments taken last week by the ECB and the PBOC seemed very timely, given that the additional boost from stronger seasonal US corporate earnings all encouraged global stocks to rally, in fact, since the end of September global equity markets appear to have gathered some real momentum, possibly bottoming out from a rather traumatic summer retreat. Clearly, its early days but we might be at the beginning of a relief rally which could run through unto the end of the year.
Have global equity markets bottomed out after summer correction
In terms of third quarter US corporate earnings, we have seen some very strong results from the technology sector with the likes of Microsoft, Amazon and Alphabet, formerly Google, all rallying at least by 7 per cent, helping to push the benchmark equity index closer towards its May record high of 2130.82. Conversely, on the flip side in the UK we saw profit warnings from UK publisher Pearson, book maker William Hill, builders’ merchant Travis Perkins and Argos-owner Home Retail.
Technology stocks led the rally in the US
Also industrial metal prices rallied higher after the news broke out that the Chinese authorities had taken action to try and prevent any further slowdown in their economy. Understandably, if Chinese demand were to generally pick up over the coming 12 to 18 months then commodity prices are likely to begin reflecting this change of sentiment. Also commodity driven countries, or currencies, such as Latin America, Australia and New Zealand are likely to benefit. Admittedly, bulk commodities such as iron ore fell to its lowest level since July as weaker steel prices in China affected the market.
Commodity markets have been trading lower since the beginning of 2011
None-the-less, like most the global equity markets, the major indices of energy, industrial metals, precious metals and agriculture seem to have bottomed out since August and are showing some signs of an early recovery. Whilst this might be a touch premature Sir John Templeton believed that buying shares at “the point of maximum pessimism” was sensible and therefore looking at some of the big oil companies with attractive yields might be worth considering on a five year view. Clearly, crude oil is trading at around US$48.00 a barrel and could trade lower over the short-term, but over a longer-term time horizon it is likely to trade at a much higher level. Similarly, we are likely to see a general recovery across the commodity spectrum.
Have commodities bottomed out
Clearly, the words and actions from the leading central banks around the world is still igniting stock market euphoria, and acting as a short-term boost for the global equity and bond markets. Certainly, this prolonged period of “lower for longer interest rates”, monetary policy support, and quantitative easing has not only stimulated asset classes, but this period of “cheap money” has also led a wave of mega mergers and acquisitions. Indeed, in this year alone we have seen over US$3.0 trillion worth of M&A deals with the US benefitting from the bulk of these transactions.
Understandably, there has been a time throughout this year when the markets have been spooked by uncertainty, and higher volatility levels, but of course global growth has begun to wane, and the growth engine of the world, being China and the emerging markets have begun to suffer from those unpleasant financial events that have occurred in the developed world. Equally, we have seen a very deep correction in commodity pricing, and devaluations in some major currencies, as central bankers have orchestrated and shaped their monetary policies around a race to the bottom in terms of their FX exchange rates.
Obviously, for many global investors this has opened up a number of investment opportunities as many exporting companies have benefitted from weaker currencies, whilst the lower crude oil price has led to an increase in consumer spending. Also, this extended period of low interest rates, and lower yields on government bonds, has led to many investors chasing income through high yielding equities and high yielding junk bonds.
Obviously, interest rates will need to normalise at some point and QE will end but accommodative central bankers appear to be here for some time to come, consequently, this mature bull market is likely to continue for a while longer yet, certainly until the twelve US Federal Reserve districts and the old lady of Threadneedle Street becomes more hawkish towards monetary policy which doesn’t seem to be in their plans at the moment, but of course, there is still some time left this year for one or two more surprises to come out of the Fed.
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 a larger asset managers, primarily as an Investment Director with Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Committee.
This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed.
Investment Quorum is authorised and regulated by the Financial Conduct Authority