The Lowdown on Markets to 8th April 2016
World Markets at a Glance
In this week’s issue
- The global equity markets react to a rise in the crude oil price and strengthening yen.
- Will the Japanese authorities intervene on the back of a strengthening currency?
- Last months Fed policy minutes confirm that they remain dovish on interest rate hikes.
- In the UK the “BREXIT” conundrum continues to affect market sentiment and sterling.
- Have commodity prices now bottomed or will they test their previous lows.
- Global equities offer the best potential for returns over the medium term.
“Global equity markets continue to move in a narrow trading range”
Whilst global equity markets experienced an eventful quarter, their narrow trading range was mostly down to the direction of the crude oil price, central bank intervention, and volatile currency markets.
Indeed, last week was no exception, as we saw a strong rebound in the price of crude oil, the release of last month’s Fed policy meeting minutes, and some erratic moves in the foreign exchange market, particularly, in the yen and emerging market currencies.
“It was the yen that rattled and dominated the markets and headlines the most over the week”
Admittedly, it was the yen that rattled and dominated the markets and headlines the most over the week as it hit its highest level against the US dollar in 18 months, similarly, it has moved worryingly against sterling. This disturbing move in the yen fuelled speculation that the Japanese authorities might need to intervene in the markets to try and confine its strength.
Clearly, a strong yen is a two edged sword, firstly, it hurts Japanese exports because their goods become less competitive, and erodes the value of their overseas earnings when repatriated back into yen, however, at the same time the strong yen does reinforce the countries purchasing power, an advantage most visibly exploited by Japanese corporations that are looking to expand through mergers and acquisitions.
“Part of the Abenomics plan has been to weaken the yen against a basket of international currencies”
Obviously, part of the Abenomics plan has been to weaken the yen against a basket of international currencies, with the Bank of Japan currently printing money to buy bonds at the rate of ¥80 trillion per year, and more recently, announcing that they would implement the policy of negative interest rate protocol NIRP] a strategy currently used by the Swiss authorities, and smaller European central banks.
Regrettably, the yen’s recent strength has been partly due to the fall in the outlook for Japanese inflation, which has driven real Japanese yields higher against their US and European counterparts with nominal Japanese yields falling into negative territory. Another issue of contention is that the strengthening yen might begin to create disinflationary pressures within the Japanese economy.
Therefore, the market is now expecting the BoJ to intervene over the coming weeks, perhaps by announcing that their current quantitative easing programme will include the purchase of Japanese equities, or conceivably, if the Federal Reserve Bank turn more hawkish, and surprise the market by raising US interest rates, then this could have the desired affect and weaken off the yen again, but with the Fed chair, Janet Yellen, continually showing her concerns about the global economy this is unlikely to happen in the near future.
Indeed, this became very apparent in the release of last months Fed policy minutes when it was highlighted that the Fed officials remain very concerned about the risks to the US economy from global developments and uncertainties surrounding the likes of the Chinese economy.
“Only last week we saw the price of oil surge by 8 per cent”
Similarly, the volatility surrounding the crude oil price is having a major effect on the direction of global equity and commodity markets, particularly, Wall Street and the S&P 500 Index. Indeed, only last week we saw the price of oil surge by 8 per cent, sighting that the oversupply in the oil market might be declining, and that the global economy might be improving.
Clearly, the oil market in recent times has become susceptible to huge swings, which in turn, is forcing traders to bet both ways, and perhaps, setting a president for further instability over the coming months. Equally, oil traders are keeping a watchful eye on Federal Reserve Bank policy, the global economy and the dollar. Indeed, an unhinged US dollar tends to create periods of volatility for the oil price, emerging markets and currency markets.
“The strength, or weakness, of the Chinese economy is incredibly important”
In a similar way, copper is a commodity that sets a trend, given that it is seen as a leading indicator for the direction of the global economy. Certainly over recent times we have seen the price collapse from US$10,000 to below US$4,700 a tonne, this was mainly due to the uncertainties surrounding the demand from China. Therefore, the strength, or weakness, of the Chinese economy is incredibly important. Admittedly, there could be some slightly better news for the copper miners, and traders, if the recent reports from Tesla motors are to be believed that they have S$10 billion of pre-orders for their mass-market vehicle, the Model 3.
Why is this? Well at last week’s annual copper conference in Santiago, Robert Friedland, founder of Ivanhoe Mines, showed pictures of the Tesla vehicle saying that it would consume 65kg of copper per car and that based upon the worlds environmental issues every single solution tends to direct you to copper, solar power, wind power, and of course electric cars. Understandably, whilst the future growth in electric cars, and renewable energy, would help copper demand it is unlikely that it would make up for the weakness in demand from the Chinese construction industry, or indeed, any other of the developing markets appetite for the metal.
Quickly returning to the question of currencies and recent fluctuations, it would be wise to keep a vigilant eye on the direction of the dollar over the coming months, given that we have seen a gradual recovery in inflows towards the emerging markets, both in equities and bonds. Unquestionably, any upheaval in the foreign exchange markets could see this trend reverse out rather quickly, especially if the Fed were to turn more hawkish at a similar time and raise rates.
“We have now entered the corporate earnings season for the second quarter of the year”
Whilst we have just entered the second quarter of the year it would still appear that a similar trading pattern is developing. Daily market and investor sentiment is being driven by macro events, such as the oil price, Fed policy and currency fluctuations, conversely, we have now entered the corporate earnings season for the second quarter of the year, which is likely to add another dilemma given that the markets expectations is rather gloomy.
However, despite the possible headwinds that the stock markets might experience over the coming weeks, and months, it is likely that the global economy will continue on its path of moderate growth and therefore we believe that global equities offer the best potential for returns on a risk adjusted basis over the medium term. Never-the-less, in times of volatility we are likely to see government bonds, gold and selective currencies being accumulated as “safe haven” asset classes.
“The “BREXIT” conundrum will continue to gain pace as we head nearer to June”
Finally in terms of the UK, the “BREXIT” conundrum will continue to gain pace as we head nearer to June, and of course, if we see a pick up in the “no vote” then sterling is likely to experience a further period of weakness, therefore, UK investors should maintain their exposure to overseas markets as the benefits from sterling weakness has already boosted returns from overseas assets.
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 .