The Lowdown on Markets to 12th February 2016
World Markets at a Glance
In this week’s issue
- Global equity markets end the week in a positive mood helped by banks and crude oil.
- The central banks look to further stimulus measures to boost global economic growth.
- Fed chair Janet Yellen has a grueling time in front of US Congress over current policies.
- Global investors continue to de-risk their portfolios in favour of bonds, gold and the yen.
- The oil price rebounds by over 12 per cent on suggestions that OPEC might cut production.
- A resurgence of the yen will be closely watched by the Bank of Japan and other central banks around the world
“Negative Interest Rate Protocol and Central Bank policy scares investors”
Over the past few weeks there has been a series of events that have unnerved the markets and of course global investors. From concerns over the collapse of commodity prices, in particular crude oil, to the anxieties hanging over the Chinese economy, the effects on riskier asset classes such as global equities have been overwhelming. The unrelenting sell-off over the first 6 weeks of 2016 has left the MSCI World Index rather bruised, and down by just over 10 per cent for the year. Admittedly, equity markets such as the Chinese Shanghai Composite Index and Japan’s Nikkei 225 Index have suffered more falling by over 20 per cent over the same period.
If we then look at some specific sectors around the world we can see for example that European bank shares have fallen nearly 30 per cent, US financials by almost 20 per cent and Japanese banks by a staggering 35 per cent. Clearly, the above issues have not helped over the past few weeks, and added concerns over the US economy, disappointing corporate earnings, currency wars and a sell off in assets from the Sovereign wealth funds have all added to the mix. However, looking at the trend of global equity markets over a slightly longer time frame it is quite clear that we have been moving lower since around May 2015 and for many individual regions, and markets, they are now in “bear market” territory.
“Whilst equity markets have been pulling- back the reverse has been happening in the government bond markets”
Conversely, whilst equity markets have been pulling- back the reverse has been happening in the government bond markets. Indeed, prices have been reacting more like equities pushing bond yields down in some markets into negative territory. Similarly, the price of gold bullion has shot up in the last few weeks as global investors have scurried back into “safe haven” assets of cash, govvies, and gold and in the last couple of weeks the Japanese yen.
Now it’s fair to say that all four asset classes have gone some way to giving investors a “get out of jail card”, whilst equities have been out of favour, and have certainly given them a return over the past few weeks, none-the-less, none of these asset classes are yielding much, if at all, and in the case of sovereign bonds, whilst looking rather expensive versus equities , could indeed experience a quite volatile time over the coming months or years if global investors decide to re-enter the global equity markets at a rapid pace.
“When the Chinese authorities devalued the Yuan recently the reactions in both the equity and currency markets were wide-ranging”
Likewise, if the central banks react to the current unstable market conditions, with further monetary stimulus, currencies could similarly experience a real roller coaster ride. Certainly, when the Chinese authorities devalued the Yuan recently the reactions in both the equity and currency markets were wide-ranging. Certainly, the Bank of Japan, under the leadership of Mr Kuroda, will be very mindful that the yen has spiked up by a meaningful amount in February, which in turn, could begin to erode corporate profits growth going forward if the trend were to continue. Also any reversal in fortunes for the crude oil price, a substantial rise in the price, could start to have a more negative effect on the Japanese economy, given that they importer most of their oil.
Unquestionably, over the last few years central banks have become the major creditors of western governments, guarantors of the financial system, whilst setting the cost of borrowing, this in turn, potentially controls access to housing finance, and in recent years has become a major contributor to the daily movements within our financial markets. Whilst in those dark days of 2008 and 2011 the effectiveness of quantitative easing, and monetary loosening, helped to stabilise the markets it has subsequently been responsible for asset bubbles, this has meant that markets have risen much quicker than corporate earnings.
“What has happened is that central bankers have cut interest rates to the bare bone and not been able to normalise them so far”
Clearly, what has happened is that central bankers have cut interest rates to the bare bone and not been able to normalise them so far, in fact, some central bankers have now incorporated “Negative Interest Rate Protocol”, which in turn, has led to around US$6.0 trillion worth of top tier sovereign debt falling into negative yielding territory, this is not great news for income seekers. Admittedly, we have seen some investors switch out of high yield [junk bonds] into government paper as they begun de-rising there portfolio’s in the belief that they have been too positive for the outlook on the global economy.
In respect to Negative Interest Rate Policy, and global growth, the US Federal Reserve Bank chair, Janet Yellen, had to appear in front of US congress last week and was confronted by a barrage of questions around the Fed’s current stance on interest rate policy, and the future possibility that they might need to consider NIPR. Understandably, there was some criticism voiced by certain congress members about the Fed’s actions last December when they raised interest rates by a quarter of one per cent.
Whilst she did not side step those issues she did emphasis that the Fed were concentrating on the real side of the labour market, noting that the continued rise in the employed versus a fall in the unemployed was significant, indeed in the recent data it showed that there has been a 0.5 per cent rise in average hourly earnings, and an increase in the aggregate hours worked, which supports the rise in US interest rates in December 2015.Admittedly, she did say that they would be guided by future incoming data rather than following a pre-set course. She went on to say that disappointing economic news would result merely in a “lower path” for rates.
“A pause in the path of rising interest rates would be preferred”
Clearly, with the Feds acknowledgement that the global economy has recently weakened, and that financial conditions have worsened for the United States, a pause in the path of rising interest rates would be preferred, rather than a cut, signifying a change of direction, or worse still, taking the NIRP route which would clearly create a wave of pessimism in the equity markets, and of course , with the likes of Goldman Sachs already declaring that they has dropped most of their recommended trades for this year, Citigroup describing the situation as a death spiral for the global economy, and the likes of RBS advising clients to sell everything it’s no wonder that panic has set in and volatility flown up in daily market movements.
And so on to last week, like previous weeks we did see a sell-off in the first four trading days of the week followed by a sharp rise on Friday. Certainly, Europe and Japan felt the full force of investor selling, and market weakness, early on in the week as they appeared to be pricing in a deep and long recession. Indeed, it was the financial sector that felt the potency of indiscriminate selling. Arguably, this frenzied selling would seem questionable given that consumer spending in January accelerated and that some recent data does not appear to be signalling a recessional period.
“Even the financial sector seemed to receive a boost at the end of the week”
Indeed, even the financial sector seemed to receive a boost at the end of the week after JP Morgan announced that chief executive, Jamie Dimon, had bought US$25.0 million of bank stock seemingly voicing a vote of confidence in the sector. Equally, Citigroup, Zions, Huntington Banc, Keycorp, and Radian Group were all other companies that saw their senior executives buying and supporting their shares.
Other events that helped the markets rebound strongly at the end of the week were the 12 per cent rise in the crude oil price. This turnaround in sentiment came as news hit the market that there was a suggestion that OPEC might finally agree to cut production to reduce the world’s glut in oil. Clearly, with the price of oil falling by around 75 per cent since mid-2014, and dipping to a level last seen 12 year ago, any meaningful uptick in the price is likely to have an effect on global equity markets.
“What is most likely to happen in the short-term is that the price of crude oil will remain very volatile”
However, it must be remembered that it would be necessary for all of the OPEC members to agree to a cut in production and at the moment it is unlikely that Iran will sanction such a changed some time soon, and as for Iraq, they are currently suffering from a US$5.0 billion increase in their budget deficit each month. Also in respect to Venezuela they are anguishing from an inflationary rate of 700 per cent, consequently, what is most likely to happen in the short-term is that the price of crude oil will remain very volatile, ebbing and flowing, on many more market rumours.
Understandably, whilst global equity markets lagged, due to negative sentiment, the same could not be said for government bonds, gold bullion and the yen, as global investors continued to de-risked there portfolio’s in favour of “safe haven assets. Certainly, over the next few weeks we are likely to see further intervention from some of the leading central banks from around the world as they try to stabilise and boost global economic growth and investor sentiment, however, it maybe that previous monetary policies have lost their effectiveness and therefore other tools in the tool box may need to be found or used to re-stimulate the bull and de-neutralise the bear.
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 .