The Lowdown on Markets to 23rd September 2016
World Markets at a Glance
In this week’s issue
- The Federal Reserve Bank hold interest rates at their current level but hikes are looming.
- The BoJ leaves interest rates unchanged but decide to tweak and cap bond purchases.
- Both the Fed and BoJ are watching economic events unfold before taking further action.
- Demand for emerging market exports has declined hitting a post-crisis low.
- Bond issuances are running at their fastest pace in nearly a decade.
- Clearly the risk trade remains intact even though global investors show signs of anxiety.
“Equity markets rise on central bank news, then pull back on sentiment”
Global equity markets continued to follow the holding pattern that they have tracked for most of the last twelve months, which has been “not to fight the Fed”, and to rise on any dovish comments, or monetary policy easing announcements given by any of the leading central bankers around the world.
Unfortunately, this constant tactical game of words and actions by the authorities, followed by periods of irrational investor exuberance, is beginning to feel more like playing “Russian roulette” given that as each month passes we get ever closer to the time when the Fed will pull their trigger on monetary policy tightening. Regrettably, it might be that global investors lose their nerve before this happens, encouraging a period of much higher volatility. In any run up to further US interest rate hikes we could experience a “flash crash” in global equity markets, or more likely, a “bond tantrum” as a period of nervousness generates a selloff in either or both asset classes.
The real problem is that the central banks have rigged the markets and therefore, it could get rather messy, especially if they are unable to preserve their creditability in the eyes of the global investor, given that many have already lost faith in their monetary policies but are still willing to play the game of Russian roulette for a little bit longer.
“Global investor sentiment remained bullish, with stock markets rallying”
Last week’s announcement by the Federal Reserve Bank that they have elected to leave short-term interest rates unchanged astonished some market watchers, but for many others, such as the traders on Wall Street, and other financial centres around the world, global investor sentiment remained bullish, with stock markets rallying further on the news, followed by a period of respite at the end of the week.
Whilst the Feds decision was to remain fairly dovish towards another rate hike in September there was a fairly heavy divide amongst the Federal Open Committee members, with three out of the ten US central bank policy makers voting in favour of an immediate interest rate hike. This clearly means that the probability for a rate hike in December has increased, in fact, the next time the Fed actually meets is in November, but this meeting is just days before the US presidential election, and unlikely to create any knee jerk decisions by the Fed in respect to raising rates then.
Speaking after the meeting, the Fed Chair, Janet Yellen said that the committee members were generally pleased with how the US economy was doing, and that the economy had more room to run than might have been thought, but they had decided to hold interest rates at their current level because there was more scope for further improvement in the labour market, and that inflation was running below the Feds desired 2.0 per cent target objective.
“Janet Yellen said that the committee members were generally pleased with how the US economy was doing”
Equally, the Bank of Japan left their main policy rate unchanged at minus 0.1 per cent whilst keeping the scale of its quantitative easing programme at ¥80 trillion per annum. However, the BoJ did unveil a strategy to steepen the yield curve through a designated purchase of domestic government bonds, with a pledge to cap the 10-year yield at zero per cent. This strategy would seem to imply that the bank will continue to facilitate its fiscal stimulus, whilst enabling them to reduce the countries real debt burden through the cap restriction.
In respect to Japanese inflation, the BoJ committed itself to overshoot its 2.0 per cent inflation rate target but this was greeted by scepticism by many in the markets given their failure to deliver in the past on this difficult pledge. Overall, the response from analysts regarding the new policy framework was one of doubt with the bond, equity and currency markets unsure at this stage as to whether this tweaking of Japanese monetary policy would be sufficient.
Moving on to other important issues, it would seem that the demand for emerging market exports has decreased in recent times and has hit a new post-crisis low. The current figures would indicate that US imports from China has dropped sharply in July and that a similar story has developed in the EU, the emerging worlds other leading source for exports. Clearly, this needs to be look at carefully, especially from the US perspective, given that expectations for the biggest economy in the world are seen to be on an upward trajectory.
“Expectations for the biggest economy in the world are seen to be on an upward trajectory”
We have seen a rise in the asset allocations of both emerging market debt and equities over the past few months, given that central bank policies appear to remain loose and that the US dollar seems to be behaving itself. However, if emerging market export figures are weakening it could lead to disappointments at the corporate profits level. This is why it becomes more important for these exciting regions to become less dependent on exports to regions such as the US and more reliant on their own domestic sales in future years.
Turning our thoughts towards other asset classes, it would appear that bond issuances are running at their fastest pace in nearly a decade as countries, and agencies, take advantage of the low interest rate cycle that has run for over a decade. Indeed, a total of just under US$5.0 trillion of global debt has been sold this year, and given that interest rates are near zero, or indeed below in some cases, it has meant that major companies such as Henkel and Sanofi have been able to sell this month their first ever negative yielding euro corporate bonds.
This would seem crazy given that investors are guaranteed to lose money if they hold these bonds to maturity, given that we have already seen yields on Treasuries, Gilts and Bunds begin to rise slightly, which in turn, has seen prices on the new 40-year bonds issued from multi-national companies such as Microsoft and Apple fall last month by between 6 and 7 per cent.
Another asset class which has once again attracted global investor interest this year has been in commodities, which has seen investment inflows of US$54 billion between the months of January and August, an all-time high for the first eight months of the year, and at this current rate of interest could see 2016 be the first year in the past four to record net inflows into commodities.
Understandably, concerns about the global economy has seen money flood back into gold bullion as a defensive hedge against any future volatile market conditions. Also the pick-up in investor interest in commodities has been used as a diversifier within portfolio’s, and an inflation hedging tool, that the investor is using as an asset class alongside the more traditional index-linked products.
“Another asset class which has once again attracted global investor interest this year has been in commodities”
Obviously, we are still experiencing some re-balancing in terms of supply and demand for some commodities, therefore, some caution is still advisable, and of course, China is a very key player in terms of commodities and directional price movements. Equally, it might take a considerable amount of time to convince some investors to re-enter this asset class given their experiences over the past five years. It would appear that institutional investors have yet to get involved in this recent rise of interest in commodities and this is likely to continue to be the case for some time to come.
And so to sum up this week’s Lowdown, the financial markets are still being influenced by central bank policies, and less so by fundamental issues, and therefore, markets remained fairly buoyant over the past five trading days. In respect to US, the Wall Street bulls took heart from the Federal Reserve’s cautious stance on interest rates, whilst in the UK the FTSE 100 Index recorded its biggest weekly rise for almost three months. In Europe the markets moved up positively on the outlook for US interest rates and in Japan the Nikkei 225 Index ran into some profit taking after rising earlier in the week after the Bank of Japan had announced their latest monetary policy proposals.
Clearly, the “risk trade” still remains intact with global equity markets nudging higher, nonetheless it is fair to say that at the current time it is rather like playing musical chairs knowing that the music will stop eventually and that a change in asset allocation will be needed to accommodate monetary tightening, and possibly higher levels of inflation, equally, that maybe a little way off given the levels of liquidity that continues to flow into the stock markets.
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 .