The Lowdown on Markets to 10th June 2016
World Markets at a Glance
In this week’s issue
- The “Brexit” polls show a notable 10 point lead over “Bremain” but are they reliable.
- Global equities, crude oil and industrial metal prices retreat as investors buy bonds.
- Government benchmark bond yields continue to fall as central banks continue to buy.
- Sterling falls as the polls show that “Brexit” leads but the bookies are unconvinced.
- Will the Fed now keep interest rates on hold until after the US presidential election?
- Can bond markets continue to out-perform equities or will they have a resurgence.
“Government benchmark bond yields reach record lows”
With the latest European referendum poll showing that “Brexit” has a notable 10 point lead over “Bremain”, and that the backdrop for the global economic recovery is looking less optimistic, created some nervousness in the markets last week. In fact, risk aversion was the order of the day which led to global equities, crude oil and industrial metal prices retreating as global investors switched their allegiance from riskier assets to the safety of government bonds and cash deposits.
Indeed, inflows into bonds over recent weeks have been a very strong investment theme which has been supported by central bank policy, such as the European Central Bank, who is involved in the purchases of not only government debt but also corporate bonds, in fact, the ECB’s corporate bond buying programme makes up almost one in five trades that is being struck in the current market.
“When you have a mega investor in the game such as the central banks then it will mean that bond markets will be squeezed”
And so, this continuation of government and corporate bond buying by central bankers, and frenzied buying by concerned global investors scurrying into “safe haven assets”, has created a current bond market with over US$10 trillion of government and US$380 billion of corporate bonds that are now in negative yield territory. Understandably, when you have a mega investor in the game such as the central banks then it will mean that bond markets will be squeezed, and this is likely to continue for some time to come, as they as they ratchet up their quantitative easing programmes.
“Over the next couple of weeks the direction of financial assets are likely to be dictated by one theme, Brexit mania”
However, over the next couple of weeks the direction of financial assets are likely to be dictated by one theme, “Brexit mania”, given that it is the primary risk to the markets. Equally, irrespective of whether the UK exits the European Union, or stays in as an EU member, it’s the size of the majority, either way, that could have further implications for the UK government, the pound, property and other sterling assets.
“What can be said is that the political landscapes, and potential risks, to financial assets have been heightened in recent months”
Doubtless to say that a UK exit would create some nervousness within Europe about the possibility of contagion, whilst a marginal “remain” could have ramifications for another EU referendum at a later date. Clearly, what can be said is that the political landscapes, and potential risks, to financial assets have been heightened in recent months, along with the addition of some significant fiscal and monetary policies being added to the mix. As a result of this, there would now seem to be greater geographical instability, with some fairly recent radical political movements seen in some countries such as the United States, Greece, Spain, and Portugal.
Visibly, economic momentum is slowing down worldwide and the flight of money into “safe haven assets” such as bonds, gold bullion, selective currencies and cash is understandable, however, the problem with these asset classes is that they deliver very little income, if any, and in a world where populations are getting older the need for regular income is increasing. Although high yielding global equities can assist in an investors hunt for income, the economic backdrop remains volatile, which means that investors might need to embrace higher risk tolerances, and have a longer term time horizon, given that equity investing over the coming years is likely be a roller coaster ride with higher levels of uncertainty and at times volatility.
“The price of gold bullion moved higher, recording a three week high”
And so moving on to last week’s markets, we continued to see outflows from equities, and inflows into bonds, which in turn, pushed sovereign debt benchmark yields down to record lows. Likewise, the price of gold bullion moved higher, recording a three week high, as global investors continued to de-risk their portfolios ahead of the European referendum, whilst in the energy sector we saw the price of Brent Crude Oil fall sharply retreating from its eight-month high of near US$53.0 a barrel.
But of course, it was the global equity markets that came under the most pressure as deterioration in risk appetite from investors was very apparent, with the European markets perhaps suffering the most. Never-the-less, US equity bulls did help push the S&P 500 Index to its highest level in 2016 as it was thought by many professional investors that US dollar assets were the place to be in times of uncertainty whether it was through US treasuries, US equities, or indeed, the US dollar.
And in respect to US central bank policy, the interest rate futures market quickly moved to a “zero probability posture” as to the Federal Reserve Bank raising their official borrowing costs at this week’s meeting, that marks a sharp contrast since the recent US jobs data where it was thought that the Fed might raise interest rates in June or July.
“Speculation now turns towards a US interest rate hike in September”
Indeed, speculation now turns towards a US interest rate hike in September, but of course, that is very close to the US presidential election in November, and with the US polls showing that the gap between Hillary Clinton and Donald Trump is narrowing, and that the global economy slowing, it is more that they will hold off until December.
Finally, with the bull market in global bonds still very much intact, and the likelihood of additional government bond benchmark yields turning negative over the coming weeks, global equity markets are likely to remain unpredictable over that period of time. However, that is not to say that equity investors will be unable to make money, it just means that the equity investment environment over the short-term will continue to be demanding.
Clearly, there will come a time when bond markets are going to face some stressful times, and it’s debatable whether “Zero Interest Rate Protocol” or “Negative Interest Rate Protocol” can actually boost growth and stimulate recovery. Obviously, a normalisation of interest rate policy is needed before the next financial dilemma appears on the horizon given that monetary took boxes of many western central banks must be running on fumes by now.
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 .