The Lowdown on Markets to 19th May 2017
World Markets at a Glance
In this week’s issue
- Global markets end the week in a positive mood but some frustrations were visible.
- The Vix records a 23-year low and biggest one-day rise for 11 months in the same week.
- Wall Street recovers from a Trump-fuelled sell off but it’s clearly priced for perfection.
- Asia and the emerging markets continue to out-perform the major western markets.
- Sterling is the best performing G10 currency against the US dollar as shorts are covered.
- The dilemma for investors is equity markets are not cheap but better value than bonds.
“Global markets remain resilient however there are signs of frustration”
The first nineteen weeks of this year have delivered some outstanding returns to those global investors that have embraced risk to the full. Indeed, events such as US president Donald Trump’s impact since entering the White House, the Federal Reserve Bank’s unhurried and precise methodology towards tightening, the reprieve from the recent European election results, and the surprising announcement from the UK government calling for an early general election has all been taken positively by the markets. Even the geo-political threat of a confrontation between the United States and North Korea has not triggered a meaningful sell-off of riskier assets in favour of bonds and cash.
At present, equity markets in Asia [ex Japan], the emerging markets and even continental Europe are leading the way in respect to this year’s equity performances, followed closely by sectors such as global technology that has delivered double digit returns, assisted by strong performances from the likes of Facebook, Amazon, Alphabet, Apple, Google and Microsoft. Equally, the sense of frustration in the market, and by its investors, can sometimes be identified by the gyrations within the Vix Index or the “fear gauge” as it is often referred too. In fact, only recently the Vix index closed at a 23 year-low, before soaring up last week by 46 per cent, its biggest one-day increase in 11 months, and then plunging back down by 18 per cent on Friday.
“An absence of volatility, or too little volatility, can indicate a lack of trading volumes”
Indeed, the nine or so times that this index has closed below 10, such as in late 1993 and early 1994, was then followed by a sharp spike in the index. On that specific occasion the Federal Reserve Bank raised interest rates faster and by more than the market was expecting which created a shock to the bond market. Then between late 2006, and early 2007, through what was perceived as period of relative calm, we saw the beginning of the financial crisis, which then led to the Vix rising to its all-time highest intraday level of 89.53 on the 24th October 2008 and a collapse in the equity markets.
These statistics in themselves could be perceived as irritating by some global investors given that at times the markets are so inconsistent. Firstly an absence of volatility, or too little vol, can indicate a lack of trading volumes, however, a rapid succession of violent spike-ups in volatility might suggest that the financial markets, and its investors, are becoming more perplexed by daily macro news and therefore enter into panic mode.
Clearly Wall Street’s upward trajectory of over 300 per cent on the S&P 500 Index since March 2009 is impressive, and whilst its P/E is still lower than it was back in March 2000, prior to the tech bubble bursting, the market certainly appears to be priced to perfection, actually, on a Graham and Dodd valuation its around 28x, so clearly not cheap, but of course, this methodology is based upon a value investing perspective.
“There does seem to be a huge amount of good will now attached to the US market”
Obviously, there does seem to be a huge amount of good will now attached to the US market, and of course since last November, the 14.0 per cent rise in the S&P has mainly been down to the promises given by the new president, Donald Trump, and his proposed economic policies. Admittedly, the US economy continues to recover but the Fed’s cautious path on tightening and the corporate earnings outlook would appear to be treading a path of restraint.
Likewise, it’s not just the US stock market that is showing remarkable resilience against a backdrop of hesitation, in the UK we have seen the FTSE All-Share Index travel in a similar direction to that of Wall Street registering a gain of around 185 per cent over the same time horizon. Admittedly there have been some differing bumps in the road over that time frame, including the surprising result of the European referendum vote, and recent call for an early general election. However, this has not deterred investors, indeed, since the vote last June they have benefitted from a 25.0 per cent rise in the market, and devaluation in sterling.
Furthermore, global investors have even been willing to increase their asset allocations towards the Eurozone, even though there were concerns over the French election, and the UK’s eventual exodus from the European Union. Quite clearly, these issues have not discouraged the investor in selectively buying European equities, but of course, the continued accommodativeness of the European Central Bank, better than expected European economic data, and the topical reflationary trade, are acting as an insurance policy, therefore, supportive towards increased investment in either European bonds and equities.
“Global inflows into the Asian markets has seen the MSCI Asia excluding Japan Index spike up by just over 18 per cent this year”
Similarly global inflows into the Asian markets has seen the MSCI Asia ex Japan Index spike up by just over 18 per cent this year, distancing itself massively from the likes of the S&P 500 and the FTSE 100 indices which are up by 6.4 and 4.6 per cent respectively. Admittedly the small and mid-caps in the UK have delivered better performances, rising by just over 9.0 per cent as many investors have tried to capitalize from the fallout of this asset class after the referendum vote.
Equally, in respect to global equity funds that have around US$1.0 trillion of assets at their disposal, they still remain under weight Asian equities. Regrettably, investors are still allocating their money towards Asia, and the emerging markets, on a short-term trend, rather than a long-term benefit.
Clearly Asia is not just about exports, or indeed, what might be happening to the US economy, or the US dollar. Unquestionably, the recent comments about US political populism, and President Donald Trump’s remarks saying that “US companies can’t compete with them now because their currency is too strong and its killing them” is a concern, but as a region Asia’s faster GDP growth should result in faster profits, and of course, their work ethic and rising consumer base will benefit both domestic and overseas businesses including those of the United States.
But of course, those asset classes which were heralded by many to face the strongest headwinds this year, given the anticipation that the US Federal Reserve Bank might tighten aggressively, were US Treasury bonds and the emerging markets. Clearly, this has not happened, in fact, the gravitational forces pinning down bond yields remain in place whilst the MSCI Emerging Market Index is up by just over 15.0 per cent, whilst cross border inflows into both EM debt and equities still appear to be very strong.
“Equities still appear to be very strong”
Understandably, this uptick in investor sentiment might be down to a number of reasons; firstly, the cyclical upturn in the global economy, secondly, central bank liquidity, given that the Fed’s proposed tightening strategy seems to be much longer term, and thirdly, the persistent savings glut.
Clearly, whilst Wall Street continues to breach new all-time highs, on historically low volatility levels, the frustration for many investors is that with no meaningful value, or returns, left in bonds and cash they do need to explore other opportunities in both equity markets and alternative strategies. This is likely to mean that a continuation of “buy on the dips” will support the markets in times of volatility or meaningful falls.
Finally, in respect to the UK’S forthcoming General Election, it is worth mentioning that outside of the political debates we have seen a significant rise in the value of the pound, indeed, since sterling’s devaluation of 22.0 per cent between June 2016 and January 2017 it has subsequently strengthened by just over 8.0 per cent becoming the best performing G10 currency against the US dollar this year.
This directional turnaround for sterling was initially kindled by the surprising announcement by the prime minister calling for an early General Election, which in turn, led to FX traders having to cover their sterling short positions, followed by many UK exporting companies having to take out sterling hedges. However, the strengthening of sterling will be welcomed by UK the importers who have struggled to meet their budgets since the pounds devaluation, given that they have been reluctant to pass on the increased costs to the consumer.
“Most believe that sterling might hover around its current level”
Whilst there are some analysts suggesting that the £/US$ rate might breach the 1.35 level most believe that sterling might hover around its current level given that there is so much uncertainty surrounding the Brexit discussions once a new UK government is formed.
And so to conclude, investment sentiment continues to be dominated by lots of political noise and nervousness about the levels that some markets have reached. Clearly, in some cases the valuations look fairly stretched and are priced to perfection meaning that any real disappointments from both an economic or corporate perspective might be harshly treated.
Therefore, any investors that are worried about the current levels of the markets as a possible entry point might want to consider drip feeding monies in carefully rather than throw caution to the wind, indeed, whilst the central banks remain accommodative, bond markets behave themselves, and new technologies continually drive us forward then this current bull market, or though mature, might not abate and continue for a little while longer.
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 .