The Lowdown on Markets to 20th May 2016

May 23, 2016 IQ Admin

The Lowdown on Markets to 20th May 2016

World Markets at a Glance

 

In this week’s issue

  • The markets begin to focus upon a possible change in the Feds monetary policy.
  • Likewise, the polls still echo a tight outcome from the EU referendum.
  • In the energy market the price of crude oil continues to rise and is near US$50 a barrel.
  • In the corporate bond market default levels have risen at their fastest pace since 2009.
  • If US interest rates were to rise in the summer then the US dollar is likely to strengthen.
  • Bonds continue to outperform equities whilst the fear factor remains.

 “Markets begin to adapt to a change of monetary policy by the Fed”

 

As we approach the month of June, and half way through the year, the financial markets now seem to be pricing in the possibilities for further monetary policy announcements, and interest rate hikes, by the US Federal Reserve Bank. Clearly, the off and on interest rate dilemma that the central bank has created over the past 12 months has been a headwind for the markets even though they raised rates by 0.25 basis points back in December. Subsequently to that any further tightening that was expected in the early part of this year has not materialised, due to outside forces that the Fed chair, Janet Yellen, and her committee members have become wary of.

 

But it would now appear from the FOMC’s recent minutes that the central bank are now gently warming up the markets for further interest rate hikes, voicing their opinions that they are not far away, particularly if the economic data continues to improve, and inflation begins to move nearer the Feds 2.0 per cent target. Certainly, comments from William Dudley, the president of the New York Fed, suggested that it would now be appropriate for the US central bank to raise interest rates again, either at the June, or at their July meeting, as long as the economy rebounds from its fragile first quarter, which the Fed  are fully expecting.

“The central bank are now gently warming up the markets for further interest rate hikes”

 

Certainly, expectations from many of the Fed officials is that interest rates will now begin to rise, and that a summer hike is imminent, however, many of them also believe that perhaps the market had not fully priced in this distinct possibility. Equally, this may have now changed, given that last week’s more hawkish comments actually saw the market re-evaluate the chance of an interest rate hike in either June or July.

 

Clearly, other market forces are at work and the Fed officials are very aware that on the 23rd June 2016 the United Kingdom will vote on the EU referendum which for the British public has become a battle between passion and fear. Certainly like the Scottish referendum the polls in the run up are close but in respect to Scotland the status quo won out on the day. But with a few weeks still left for government officials, and politicians, to continue with their fear-provoking messages the vote could go either way on the day.

 

Consequently, it’s no wonder that the stock markets are gyrating around from week to week, being more optimistic one moment, then downright pessimistic the next, certainly, with the current trio of “fear factors” hovering over the markets like a bad storm cloud, the Fed’s next policy move, the EU referendum, and the Trump affect, it seems fairly reasonable to assume that the riskier asset classes in the market, primarily equities, will react rather nervously towards these events.

“For us Brits, and the UK financial markets, next month is now becoming the biggest domestic risk to the stability in our financial system and the economy”

 

Obviously, for us Brits, and the UK financial markets, next month is now becoming the biggest domestic risk to the stability in our financial system and the economy.  Unfortunately, political posturing, and playing to the gallery, has already increased nervous tensions between government officials and public voters, and whatever the outcome, market turmoil will be inevitable. Therefore, investors must be prepared to take the necessary actions to position themselves accordingly.

 

Another interesting turnaround has been in the price of crude oil, which is now within a whisker of US$50.00 a barrel, as bullish commentators have highlighted recent supply disruptions; for instance Nigerian output has hit a 22-year low, and growing demand has increased. Indeed, even Goldman Sachs has become less bearish on the short-term direction of oil given that it would appear that the secular trend is now to the upside.

 

Given that the crude oil price was nearer US$27.0 a barrel at the back end of January, and has been moving up ever since, has seen the consumer already noticing the effects at the petrol pumps as prices nudge upwards. Furthermore, given that the price of crude oil was such a key driver of equity markets in the early part of the year, could now become a major influence in their direction over the coming months.

“If US interest rates were to rise over the summer months, and again later in the year, then we are likely to see US Treasury bond yields begin to back up from their current historical lows”

 

Similarly, if US interest rates were to rise over the summer months, and again later in the year, then we are likely to see US Treasury bond yields begin to back up from their current historical lows, and the value of the US dollar rise against a basket of other major currencies, and this of course, this will have some ramifications for the direction of gold bullion, which is sensitive to the dollar. Admittedly, the yellow metal is held by global investors as a hedge against inflation, and any geo-political unrest.

 

Clearly, after so many years of central bank intervention, through quantitative easing programmes, and loose monetary policies, it has now left interest rates in many western economies at zero, or in some cases negative, whilst inflation and government bond yields are at historical lows and equity markets more volatile. This in turn, has left many global investors rather squeezed amid investment periods whereby they have had to take on more risk, followed by phases of de-risking to protect themselves against flash crashes.

 

Equally, plunging bond yields from safe haven asset classes such as government bonds has led to some income seekers having to switch their allegiance from the safety of govvies to the riskier asset classes of corporates, and high yielding bonds, as the demand for yield accelerates. This in itself can harvest problems given that more than 70 corporate borrowers have already defaulted around the world this year, the fastest pace since 2009.

 

Admittedly, the commodity and energy sectors account for more than half of these with oil and gas companies leading the way. Unfortunately, many of these were new businesses and never had any positive cash flow even before the collapse in the crude oil price; therefore, it is not a surprise that a number of these went to the wall. Never-the-less, investors need to be mindful of the risks attached to this part of the bond market.

“As we move into June the backdrop for the markets will clearly be focused on two outcomes, firstly, the Brexit vote, and secondly, the next move from the Fed”

 

And so as we move into June the backdrop for the markets will clearly be focused on two outcomes, firstly, the Brexit vote, and secondly, the next move from the Fed. But of course, after these events the markets will then focus upon other important issues such as, are we heading for a recession, will China’s economy experience a hard or soft landing, is the commodity bear market over, are central banks losing their influence, and perhaps more importantly, are we heading for a surprise in the US presidential election.

 

Finally in terms of the markets, the first five months of the year has been frustrating for both the bulls and the bears, however, whilst further near-term weakness might continue it is quite possible that the second half of the year might be more encouraging, particularly, if some of the current fears that have held back the markets finally resolve themselves. However by the same token, it is quite likely that global investors will continue to position themselves fairly tactfully over the remainder of the year.

 

Peter Lowman, Investment Quorum, Investment, The Lowdown

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 .

If you would like to hear more about our wealth management services please do not hesitate to call us on 0207 337 1390 or contact us via email.  We would love to hear from you.

The post The Lowdown on Markets to 20th May 2016 appeared first on Investment Quorum.

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