The Lowdown on Markets to 5th February 2016
World Markets at a Glance
In this week’s issue
- Global equity markets continue to track the crude oil price and Chinese economic news.
- The US non-farm payroll numbers for January are below expectations but show promise.
- Are negative or ultra-low yielding government bonds signalling a global recession?
- Industrial metals respond positively to the dollar’s recent decline adding a slight boost to oil.
- The US dollar responds positively to the US jobs number after its recent fall against its peers.
- Global equities provide investors with a greater return potential than bonds but with a higher volatility rate and risk profile.
“Global equity markets trend lower even with better US employment data”
Global equity markets and the price of crude oil seem to be correlated to each other at the current time, and this can be witnessed each day in the movements in many individual stock market indices. Indeed, a fresh retreat in the price of crude oil last week saw the major stock indices fall between two and five per cent, while the US dollar sold off and US Treasury yields hit multi-month lows.
Whilst there appears to be two current canaries in the coalmine, the direction of crude oil prices, and doubts over the actual economic growth rate of the Chinese economy, there are clearly other important forces at work, of course, none being greater than the health of the largest economy in the world, the United States of America, and the well-being of their corporate companies.
This is why global analysts and professional investors continually scroll over the monthly economic data that is announced by the US authorities to try an glean as much information and knowledge on what the Federal Reserve Banks intentions might be going forward in terms of their future monetary policy and views about the outside forces that have become a more crucial element in their decision making over the recent years.
“In respect to the January numbers the report showed that 151,000 US jobs had been created”
Indeed, last week was no different to any other week when important monthly data such as the US non-farm payroll numbers are announced. Therefore, in respect to the January numbers the report showed that 151,000 US jobs had been created, which was well below the forecasts, but adequate to pull the unemployment rate down to 4.9 per cent, the lowest figure since February 2008, and well below the 10.1 per cent figure that was recorded back in October 2009.
In fact what perhaps was more significant in last week’s data was the 0.5 per cent rise in average hourly earnings, and an increase in the aggregate hours worked, which not only supports the rise in US interest rates in December 2015 but more importantly could support further gradual monetary tightening over the coming months.
“Wages are now growing faster than the official Fed target of 2 per cent inflation, therefore, any further evidence that hourly earnings rates are on an upward trajectory is likely to be good news”
Also wages are now growing faster than the official Fed target of 2 per cent inflation, therefore, any further evidence that hourly earnings rates are on an upward trajectory is likely to be good news for future consumer spending and more importantly a main driver for US economic growth which still appears to be rather anaemic from a historic perspective. Undeniably, the latest US manufacturing survey does support that view with the US economy is still petering on a path towards contraction and a possible recession.
Clearly, the major government bond markets around the world are reacting to the probability that central banks will continue with their monetary easing policies, which in turn, might see the global economy slide into a recessional period. Indeed we now have a situation where government bond yields in many parts of the world are in negative territory. For example, in Germany, the average yield on all government debt is now negative, whilst in Japan they are on course to become the first leading market with a 10-year bond that yields nothing. Likewise, across much of Europe yields have fallen perilously close to negative yields or have breached the line.
“Many global investors think that inflation will remain much lower than 2 per cent over the next 10 years”
Indeed, if you now look at the government bond markets in Europe and Japan nearly $6 trillion of their sovereign paper now trades at such high levels that the owners and continual buyers will make losses if they hold them to maturity. Therefore, what this really means is that many global investors think that inflation will remain much lower than 2 per cent over the next 10 years, therefore, are still prepared to buy bonds even at these unattractive levels.
Regrettably, many analyst and professional investors have thought that firmer growth would begin to appear as we entered 2016, led by the US, and stronger consumer spending buoyed up by cheap energy but unfortunately weaker trends in consumer spending in the US and Asia and continual falls in basic materials has scuppered that theory at the current time. To a certain extent, the consumer has probably decided to pay off some debt, rather than spend more, and of course, the slowdown in the Chinese economy, and over- supply in commodities, particularly oil, has been responsible for the correction in risk assets such as equities.
Justifiably, we have seen a fresh wave of negativity hitting the global equity markets since the turn of the year and this is currently being reflected in the MSCI World Index which has fallen by just over 8 per cent whilst the JP Morgan Global Bond Index is up by just over 10 per cent in sterling terms.
Unquestionably, the recent fund outflows from equities into bonds goes someway to supporting the disbursement in performance between the two asset classes and obviously there is plenty of gloomy macro news around to support this turnaround in investor sentiment. However, it does depend on what side of the economic equation you might feel more comfortable sitting.
Clearly, government bond markets are pricing in that we will remain in a low growth, low interest rate environment for some time to come, as most central banks continue with their loose monetary policies. Also they appear to be pricing in the possibility that the Fed might have made a monetary policy error by raising rates too soon, therefore, increasing the risk of a global recession.
“A selective approach to investing; focusing on those companies that can deliver unexpected surprises on earnings growth, and increased dividends, will continue to be a sort after asset”
Admittedly, the global macroeconomic environment does look highly uncertain for 2016, with the backdrop for global equities challenging, however, a selective approach to investing; focusing on those companies that can deliver unexpected surprises on earnings growth, and increased dividends, will continue to be a sort after asset. With this in mind, and the belief that from a negative situation a positive outcome can emerge, perhaps through a potential surprise, the long-term global investor should take advantage of these downturns in the global equity markets.
We believe that equities provide investors with a superior return potential than bonds, but with greater volatility along the way, and certainly over the past couple of decade’s volatility levels has picked up, leaving many investors nervous and unsure. Unquestionably, in times like these bonds are showing their defensive qualities, but on a risk to reward basis they offer very little value, in fact, with negative or ultra-low yields currently on offer they appear very unappealing.
“This is now becoming a stock picker’s market with an opportunity to capitalise on the current situation and invest into some excellent businesses”
We feel that this is now becoming a stock picker’s market with an opportunity to capitalise on the current situation and invest into some excellent businesses, based upon their price and valuation perspective that only comes along every few years. Unquestionably, we will continue to experience a number of bumps in the road over the coming months but over the longer term equities still look attractive relative to bonds, with the obvious caveat that global equities do come with a higher volatility rate and risk profile.
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 .