The Lowdown on Markets to 15th July 2016
World Markets at a Glance
In this week’s issue
- Global equity markets continue to nudge higher supported by central bank policies.
- Better-than-expected US economic data and Chinese GDP growth figure help the cause.
- Low interest rates and bond yields sees demand for income intensify.
- Whilst sterling has fallen to a 31-year low expectations are that it will fall further in time.
- Gold bullion loses some of its shine but not before setting a two-year intraday high.
- Both bond and equity markets look fairly valued but the “trend remains your friend”.
“Global Equity markets remain positive but do show some signs of fatigue”
Global equity markets have continued to nudge higher over the week, firstly, helped by the belief that interest rates will remain lower for longer, secondly, by a promising start to the second quarter of the US corporate earnings season, and thirdly by better than expected US economic data and GDP growth figures from China. However, in the European markets the travel and leisure stocks fell after the horrific attacks in France.
Equally, in the fixed interest markets there was a meaningful rise in bond yields, perhaps more down to global investors trying to take advantage of the rally in the equity markets than any strategic asset allocation call, in fact, risk averse, and yield hungry global investors, have still been accountable for investing a vast amount of money into the bond markets in recent months whether in sovereigns, corporates, or high yielding bonds.
“The fundamental relationship between bonds and equities now seems to be broken”
Clearly, this similar rise in the investment appetite for both global equity and bond markets at the same time is extraordinary, given that the fundamental relationship between bonds and equities now seems to be broken. The intensified pressure on global investors to try and capture both risk adjusted capital and income returns, in an ever expanding world of negative interest rates, has led to a very irrational period. Indeed, adding to the mix the extreme movements in the currency markets has seen investors face some very volatile times and surprising movements in all three asset classes.
The continuation of low interest rates and falling bond yields has meant that the demand for income assets has intensified, especially from pension funds and insurance companies that buy longer-dated paper to balance out against their liabilities. Also at the same time, it would be considered in the financial industry that they are investing into an asset class that is measurably seen as low risk.
Therefore, in United Kingdom the likes of 10 and 30 year government debt yielding around 0.85 and 1.70 per cent remains attractive versus cash, nevertheless, you are buying long-dated fixed rate coupons, and so you need to be wary of the possible dangers, for instance, if the Bank of England were able to create a much higher, and sustainable inflation rate, then interest rates would likely rise and put some pressure on the long end of the gilt market.
“The alternative approach in investing for income is to buy good quality companies that increase their dividends regularly”
Obviously, the alternative approach in investing for income is to buy good quality companies that increase their dividends regularly, understandably, there are risks attached to this strategy such as equity market volatility, dividend cuts, or individual corporate profit warnings, all of which can put a global investors capital, or income requirements in danger. But with a continuation of plummeting government bond yields the attractiveness of some of those global equity yields are compelling.
Also the other challenge that has become very apparent in recent months, and certainly since Brexit, is the severe movements that we have seen in currencies, with the like of sterling falling to a 31-year low against the US dollar, and the strength of the Japanese yen. Logically, sterling was always going to experience a difficult time on any British exit, and of course, a further significant fall in the pound cannot be ruled out especially if the Bank of England cut interest rates over the summer months.
Also now that we have a new elected conservative cabinet to get their heads around article 50 and the start of the negotiations between Britain leaving the European Union, it is likely that sterling will suffer from further weakness which in turn, could create higher import costs and the potential for a higher inflation rate. Clearly, all of this will create complications for Governor Carney at the Bank of England, but with the prospect of weaker GDP data over the coming months, loose monetary policy is likely to be the order of the day.
“Turning to a weaker pound this should be good news for UK exporters”
Therefore, turning to a weaker pound this should be good news for UK exporters, and the FTSE 100 Index, but of course, other fundamental issues are likely to emerge that might affect some of those individual stocks, hence the importance of balance sheet analysis and company meetings. Similarly, the same can be said for the mid and small caps that conceivably have fewer benefits from export earnings, but investors are able to capture exciting new businesses with both growth and acquisition potential.
Equally, Brexit and the weaker pound are creating opportunities for overseas investors, and we have already seen Japan’s SoftBank agree to buy Arm Holdings for £24.3 billion. This particular transaction is being heralded by SoftBank as helping them to become a world leader in smartphone technology through Arm’s chip design. This is likely to be the first of many mega deals involving UK businesses.
“There were four record closing highs set by Wall Street’s S&P 500 Index”
And so as we take a look at last week’s markets, we can see that there were four record closing highs set by Wall Street’s S&P 500 Index, as positive data, and the potential for looser monetary policy set the investment scene, which in turn, stimulated global investors’ to increase their appetite for risk assets. Equally, we did see the yields on 10-year government bonds rise, and in particular, German Bunds where they climbed out of negative territory by the end of the week.
In other market we saw the upward trend flowed through with Japans Nikkei 225 Index rising by over 9.0 per cent, and the MSCI Emerging Markets Index climbing by just under 5.0 per cent. And in terms of the UK equity market, we saw the FTSE 250 and small cap indices rise by 3.70 and 3.90 per cent respectively which outstripped their larger brethren, the FTSE 100 and All-Share indices, which gained 1.20 and 1.50 per cent over the week. Once again, a similar pattern emerged with the UK Gilt market turning in negative returns over the five day trading period. Similarly, we also saw the price of gold bullion retreat over the week but not before it set a two-year intraday high on Monday.
But of course, last week’s events in the stock markets fall into meaningless significance as the terrible events unfolded in France and Turkey. Firstly, the terror that struck Nice’s Promenade des Anglais, late on Thursday night left over 80 people dead, including children and hundreds injured, then secondly a failed coup attempt in Turkey saw hundreds of people killed and 6,000 people detained as havoc prevailed in an attempt to overthrow the current president.
Clearly, there are many forces still at work whether it be economically or geo-politically which is likely to keep the markets fairly nervous over the summer period and therefore global investors need to be prepared for further uncertainty in the market place over the short-term. Looking further out, the bull market continues to march on but with both bonds and equities less attractive than they once were it is becoming a much more difficult place to find opportunities but opportunities we will try and find.
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 .