The Lowdown on Markets to 20th February 2015
In this week’s issue
- Global equity markets around the world continue to rally higher on Greek debt deal.
- Greece and the eurozone cut an 11th hour deal avoiding bankruptcy and market turmoil.
- Markets will now focus upon this week’s two-day US Congressional Testimony.
- Falling bond yields have left many pension funds pondering over their liabilities.
- Central Bank support still remains imperative as the global economy recovers.
- Arguably investors have entered 2015 in a fairly bullish mood adding to equity positions.
What does this mean for the markets and asset classes?
“The Greeks and the eurozone agree upon a short term rescue programme”
Whilst stock markets had remained nervous over the week it was the late news on Friday that the Greeks and the eurozone had agreed an 11th hour deal to extend the country’s €172 billion rescue programme for the next four months that calmed the anxieties throughout the region.
This last minute agreement effectively circumvented the Greeks going bankrupt and buys further time for the 19 eurozone finance ministers to find a longer term solution to the problem. Certainly the decision by the Greek Prime Minister, Alexis Tsipras, to request an extension seemed by many to be a compromise from the previous hard line tactics that he used, however, the potential for further confrontation between now and June when a further €3.5 billion debt repayment comes due is now the concern.
In the meantime the latest economic data from the eurozone would suggest that there is signs of some recovery with the eurozone “flash” composite purchasing managers index rising for the third successive month, reaching a seven-month high of 53.5. This unexpected rise was driven by further significant improvements in the service sector, especially new orders, signifying that this positive momentum should be sustainable over the coming months. Admittedly, some news at the company level is less inspiring and the threat of deflation is still very real and therefore the ECB’s proposed quantitative easing programme that is due to start next month is still justified.
Meanwhile, in the United States we are still getting mixed messages with regards to the timing for the first interest rate hike in many years. Clearly, the market will now focus on next week’s two day Congressional Testimony, given that Fed chair, Janet Yellen seems to have modified her language of late over the question of interest rates suggesting “patience” is needed. Certainly, the politicians will try to pin her down as to the timing of rate hikes; however, she is unlikely to give much away as the timing will much depend on upcoming US economic data and certain events outside the US such as the current Greek debt crisis.
Most economists are still predicting that the Fed will raise interest rates mid-2015, however, with the drop in energy prices, the current reluctance for the inflation rate to rise nearer the Fed’s target rate of 2 per cent, and fears of weaker overseas growth the word “patience” might be a word that Ms Yellen continues to focus upon for a little longer leaving the possibility for an interest rate hike being nearer the end of the year, or indeed, early 2016.
Certainly this extended period of lower interest rates, and bond yields, has created a challenge for those investors such as pension funds and income seekers that want to generate suitable investment returns from their portfolios whilst retaining the correct level of risk. In fact, across parts of Europe we are now undergoing a period where negative interest rates and bond yields are creating added problems for institutions and investors.
Arguably, this is a real dilemma for the pension funds, particularly for those in Europe, where the drop in bond yields, which are used to calculate their liabilities, has forced numerous schemes into deficit. Even in the UK there has been an increase in the number of private sector pension plans that have fallen into deficit. This predicament has more than likely pushed some schemes into higher risk assets classes to try and gain the returns that they require to cover their liabilities. This in turn, could lead to some rotational volatility at a time when some markets and assets look fully priced.
In terms of asset class rotation it has been an interesting start to the year with investors apparently “embracing risk” to try and generate an adequate investment return from their capital. In the UK the leading equity market indices are certainly out-performing conventional and index linked gilts, after underperforming them substantially last year. In fact the FTSE 100 Index is now a whisker away from its all-time high in 1999, and likewise in Europe, equities are delivering better returns than European bonds with the Eurofirst 300 Index rising to its highest close in seven years.
Similarly both of these regions still look attractive for very different reasons, in the UK the economic backdrop is encouraging and many UK businesses should benefit from this over the coming months, admittedly, there is one elephant in the room which is the outcome of the UK election. Equally, in Europe the benefits from lower energy prices and a weaker currency might not be totally priced in therefore any corporate profit surprises from European companies might bode well for share prices.
In Japan the Nikkei 225 Index ended the week at its highest level for nearly 15 years whilst in the US the S&P 500 Index remained resilient hitting a record high earlier in the week. Certainly, in Japan we might see further central bank stimulus, and with the lower crude oil price, and weaker yen, we are likely to see forecasts for Japanese corporate profits rise substantially. Admittedly, the US market now seems priced for perfection, therefore, any corporate profit disappointments might be harshly treated, especially, if we do see a much stronger US dollar that might jeopardise earnings forecasts.
Clearly, central bank support still remains imperative as the global economy continues to expand over 2015. Balance sheet repair is still evident in sectors such as banks whilst lower energy prices should feed through into the pockets of the consumer and subsequently to many of the consumer discretionary and transport stocks. In terms of the forex market we do expect to see further rotation in currencies with the US dollar continuing to strengthen over 2015 as the Fed starts to tighten.
Arguably, investors have entered 2015 in a fairly bullish mood in the hope that the global economic recovery will continue to gain momentum whilst monetary policies remain favourable and inflation controllable. Obviously, deflation still remains a threat together with some unforeseen geo-political event that could destabilise the recovery, however, in the very short-term it would appear that the “risk on trade” remains fairly intact with the likelihood of further new all-time highs being recorded in many of the world’s leading 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 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.