The Lowdown on Markets to 23rd January 2015
In this week’s issue
- The European Central Bank unveils a €60 billion per month bond buying programme.
- This programme will include the purchase of both sovereign and private sector bonds.
- A further €1.0 trillion will be added to the ECB balance sheet under the programme.
- In the forex market the euro hits an 11-year low against the US dollar.
- Core and peripheral Eurozone government bond yields retract, some to record lows.
- Meanwhile equities rally on the news with Europe markets being the biggest beneficiary.
What does this mean for the markets and asset classes?
“The ECB fires the big bazooka?”
What another extraordinary week for markets and central bank policy. Understandably, the main event of the week came on Thursday when European Central Bank president, Mario Draghi, finally unveiled a European bond buying programme that far exceeded market expectations. Whilst the presidents expected announcement of further QE was to a certain degree leaked into the markets a few days earlier it was the actual size of the programme that was surprising.
Unquestionably, Mr Draghi ‘s announcement that the ECB would launch into a €60 billion per month bond buying programme, including government and private sector bonds had the markets rejoicing given that the programme would extend to at least September 2016 therefore expanding the ECB’s Q€ balance sheet by more than €1 trillion. Clearly, by this action the ECB are in a determined mood to raise the eurozone inflation rate to nearer the bank’s target of just below 2 per cent.
Admittedly, this bond buying pro
gramme, which will begin in March, has been hard fought for by the ECB given that the Bundesbank have been less enthusiastic about quantitative easing. Indeed, after strong pressure by the Germans it was agreed that national central banks would take responsibility for any losses that might occur from defaults or restructuring of their national debt. This in itself is a break from eurozone tradition set out in previous sovereign bond buying schemes. Also there will be some risk-sharing on 20 per cent of the assets, largely debt issued by European institutions and bought by national central banks.
Certainly, last week’s move by the ECB has brought the European central bank more in line with the US Federal Reserve Bank, and Bank of England, who both actioned the buying of sovereign bonds much earlier after the global financial crisis hit in 2008. Actually, it could even be said that perhaps last week’s ECB actions have come 12 or even 18 months too late. Certainly, the US and UK have both withdrawn from bond buying programmes and appear to be on the road to economic recovery.
In terms of forex market reactions, the size of the Q€ programme did hit the single currency hard and by the end of the week the euro had stumbled to an 11-year low against the US dollar and fell below parity against the Swiss franc. Actually, the euro has now fallen by around 19 per cent against the franc since the Swiss central bank withdrew its peg against the single currency. In fact, on that very point the recent rise in the Swiss currency will certainly have some serious ramifications for the Swiss economy, quite possibly threatening it with a period of deep recession.
Inevitability, when you do enter a period of “currency wars” then there is likely to be some severe consequences for some countries, and businesses. In the case of Switzerland; they could be facing a recession with Swiss exporters becoming less competitive, on the other hand, the weakness of the yen and euro, along with the fall in the crude oil price, should assist the likes of Japan and the Eurozone where exporters and even tourism can benefit from the weaker currency.
Equally, the ECB announcement helped global equity markets gain some momentum with the FTSE Eurofirst Index registering a 5.1 per cent gain over the week, this happened to be its strongest five-day performance in more than three years. Admittedly, Wall Street had a rather subdued week; this was attributed to some disappointing corporate earnings numbers which seemed to cool investors’ appetite, none-the-less, the S&P 500 Index still advanced by around 2.0 per cent over the week. In Japan the Nikkei 225 Index recorded its highest close of the year.
Meanwhile, in the bond markets we saw a further contraction in yields, particularly, in eurozone “core” and “peripheral” government bonds, which obviously reacted to the ECB government bond asset purchase programme. With many eurozone bond yields now at record lows, and in some cases offering negative yield returns, investors will need to seriously consider their investment options.
Arguably, after 6 years of near zero interest rates, and US$10 trillion of money printing by central banks around the world, we still seem to be no nearer to interest rate normalization, in fact, the central banks of the US and UK would appear to have shifted back from their recent hawkish bias to a more dovish stance, indicating that interest rates are likely to remain at lower levels for some time to come. Even countries such as Denmark, Canada and India have begun to cut their interest rates.
This constant downward pressure on government bond yields and interest rates is making life even more difficult for those investors that are seeking regular income, especially now that many people are living longer and require a stable and regular income distribution. Certainly in recent times some investors have had to “embrace risk” to capture their income and growth requirements, investing in other asset classes such as high yielding equities, commercial property and structured products.
In an economic backdrop where central bank monetary policy remains loose, global growth modest, inflation low, currency stability unpredictable, and a recovery that seems to be showing some signs of a disinflationary boom, is likely to make any investment strategy volatile at times.
Certainly, the markets addiction to quantitative easing is likely to present investors with further investment opportunities in 2015, and similarly as we saw in 2014, much of the investment returns might be stimulated more by central bank and government policies than fundamentals or corporate news. Clearly, equities now offer a greater potential for returns than bonds especially on a valuation basis. Liquidity conditions should remain supportive, whilst the timing for the first interest rate hikes in the UK and US uncertain.
In terms of market opportunities, European and Japanese equities still look interesting on valuation grounds and potential positive earnings upgrades, although the Syriza party’s victory in the Greek elections at the week-end will undoubtedly create some uncertainty over the coming weeks given their demands for extensive debt relief and an end to austerity. Alexis Tsipras, Syriza’s leader said that “Greece is turning a page it’s leaving behind five years of humiliation and misery; we are putting together a government of social deliverance to carry out our programme and negotiate with Europe”.
Eurozone finance ministers will now meet on Monday to discuss the Greek position but early indications are that some sort of deal will be forthcoming, nevertheless, the question still remains “how will Greece and Syriza handle its pending debt obligations of €4.0 billion over the coming months with more than €6.0 billion of government bonds expiring by the end of the summer.
In the US any further recovery in their economy should generate additional interest in US equities, and in the UK, we are likely to see the equity market driven by political events in the run up to the General Election in May, or maybe outside forces such as the Eurozone crisis. Looking at sectors, consumer discretionary and transportation stocks should benefit from the lower oil price, whilst commodity prices are likely to remain weak given the uncertainties surrounding demand and the Chinese economy. Clearly, the risks are still tilted towards deflation but central bankers seem adamant that they “will do whatever it takes” to steer the global economy back towards steady growth.
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 larger asset managers, primarily as an Investment Director within Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Investment Committee.
This article does not constitute specific advice and investors should bear in mind that capital invested is not guaranteed.
Investment Quorum is authorised and regulated by the Financial Conduct Authority.