The Lowdown on Markets to 12th August 2016
World Markets at a Glance
In this week’s issue
- The Bank of England’s latest bond buying programme suffers from liquidity issues.
- Fears mount for the pension fund industry as gilt yields touch negative territory.
- Wall Street’s three leading equity market indices hit simultaneous highs.
- Disappointing economic data from the US and China cools investor sentiment.
- The Fed chair, Janet Yellen, will need to choose her words carefully at Jackson Hole.
- Both equity and bond markets remain buoyant but are vulnerable to disappointment.
“Sovereign bond yields continue to fall whilst global equity markets rise”
Once again there has been an unrelenting focus on the government bond markets, particularly, in the United Kingdom, where the Bank of England triggered their new £70 billion quantitative easing programme. Unfortunately, this incentivisation package has already run into early trouble given that the pension funds, and insurance companies, are reluctant to sell their gilt positions given their own difficulties and a deepening funding crisis. Clearly, the Bank of England’s attempt to buy £1.17 billion of long-dated government bonds fell into difficulty in spite of them offering prices significantly above the market levels.
This in turn, has seen the UK 10-year gilt yield fall by 2.0 per cent this year, and hit a record low this week of 0.52 per cent. In fact, we even saw some of our British government bond yields trade in negative territory in anticipation of further bond buying by our central bank and a compounding fear that a global collapse in government borrowing costs will have some potential long-term ramifications for the UK’s pension fund industry.
Indeed, the combined deficit of the UK’s 6,000 private-sector pension schemes has now risen to a new high of circa £408 billion, which is up by 6.0 per cent from the previous month, plus with the present record lows on gilt yields, and further interest rate cuts expected, the situation is unlikely to get better any time soon.
Clearly, the Bank of England will need to address this situation, perhaps focusing any future bond-buying programmes towards the wider gilt market, making additional purchases on shorter-maturity bonds, rather than just at the longer-end, especially, if as already suggested by the BofE governor, Mark Carney, that the next move for interest rates is likely to be down, with conceivably more QE to follow.
“We are in now in a bizarre financial period”
Equally, further easing is expected to follow in Europe and Japan, whilst the ever anticipated interest rate hike by the Federal Reserve Bank is by no means a foregone conclusion. Indeed, the Fed chair, Janet Yellen, will need to choose her words carefully at the forth coming Jackson Hole conference at the end of this month given that both the global bond and equity markets are in such a bullish mood.
Unquestionably we are in now in a bizarre financial period whereby negative real interest rates and loose monetary policy designed to manage inflationary expectations and assisting in the recovery of the global economy is now in essence created asset bubbles, which in turn, has generated a wall of fear amongst some global investors and market watchers. Furthermore, new records are constantly being set by some of our leading global indices, in spite of the fact that we are in a low productivity and growth phase which makes the current investment environment quite demanding.
Indeed, even regions such as the emerging markets, with their higher growth expectations, are once again starting to benefit from inflows in the belief that loose monetary policy and a steady US dollar remains intact. This in turn, has led to an increase in capital flows over recent months from those investors that are seeking out both higher capital returns, and an income solution, in a world that is suffering from lower growth expectations and depleted income flows. Indeed both emerging market bonds, and equities, have been sought after in recent months.
“Even Japanese equities are becoming more interesting for global income seekers”
In fact, even Japanese equities are becoming more interesting for global income seekers, given that the Topix stock Index is essentially yielding more than American S&P 500 Index. Admittedly, both of these stock markets have relatively low yields compared with many other regions around the world such as the United Kingdom, Europe, Asia and the emerging markets.
Equally, international investors that seek out global income do take on the additional risks, such as abnormal currency fluctuations, and of course, the Japanese yen is a good example of this, given its volatile movements in recent years, hence the need to consider hedging strategies at certain times, but of course, that can be expensive, and not always necessary.
Another asset class that has seen a wave of high demand, as investors reach for yield, has been in the corporate debt market. Indeed, with more than US$13 trillion of sovereign and corporate debt paper now in negative territory, and western central banks’ actively buying more, the likelihood of this figure rising further is significant, in fact, this continual wall of money is likely to put additional pressure on interest rates and risk premiums, which are clearly characterized by the current spreads between paper such as US treasuries and corporate bond yields.
“We did see further new highs recorded on Wall Street”
Now touching on last week’s global equity markets, we did see further new highs recorded on Wall Street, with the S&P 500, Dow Jones Industrial, and the Nasdaq Composite indices all simultaneously closing at new record highs, the first time this happened since 1999. However, some disappointing economic data out of the United States and China did affect investor sentiment towards the end of the week, which in turn, triggered a negative reaction in US treasuries, which saw yields back up, the FX market, that saw the US dollar retreat, and in precious metals, the price of gold bullion move up to nearer its two year high.
A similar story could be seen in both the UK and European equity markets, initially rising, but then retreating towards the back end of the week. Never-the-less, the upward trend still remains intact for global equity markets, however, the next big event that is likely to determine the medium term outlook for markets, and riskier asset classes, is the annual general gathering of central bankers at Jackson Hole Wyoming. Clearly, a hawkish Janet Yellen could trigger some downward pressure on the markets, given their relentless rise over the summer months. But of course, a more stimulative response from her might be the order of the day, similar to that seen recently in the UK, Japan and Europe.
“What is regarded as safe or risk asset these days”
Equally, whatever the outcome is in Wyoming the real conundrum going forward might actually be around the question of “what is regarded as safe or risk asset these days”. Currently with interest rates and bonds yields at perilously low levels, sovereign bond prices rising rapidly, global equity markets in their second longest bull market in history, currency markets becoming more volatile by the day, and commodities reacting nervously to global growth expectations, the methodologies of what is actually regarded as safe and what is risky seems to be wavering.
Certainly, the autumn months should turn out to be very interesting, but for the time being “the trend continues to be your friend” with both equity and bonds, delivering significant investment returns in a bizarre sort of way, and with the central banks continuing to be accommodative, this trend is likely to remain, until of course, the central banks decide to set a new passage of travel.
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 .