The Lowdown on Markets to 17th April 2015
- Global markets retreat at the end of the week on fears surrounding Greece and China.
- German bund yields decline to record lows whilst Greek bonds suffer from default worries
- In the Forex market firmer US inflation data sees the dollar rally against other currencies.
- The Shanghai Composite and Hang Seng markets rise aggressively as “hot money” flows in.
- Iron ore records its biggest weekly gain over the year as the Chinese restock their steel mills.
- Inflation, bond yields and interest rates will remain historically low for many years to come.
What does this mean for the markets and asset classes?
“Default fears send bond yields lower with global equity markets retreating”
Last week saw global investor confidence tested as a wide range of concerns hit both the equity and bond markets. In the eurozone tension mounted over a possible default from Greece, which quickly led to Germany’s Xetra Dax Index retreating by 2.6% whilst yields on 10-year German paper declined to 0.08% after hitting intraday record low of 0.049%. At the same time, fears surrounding a Greek default saw their bonds suffer their worst week since the country restructured its debt in 2012.
Indeed, yields on Greek 10 and 2 year paper closed out the week at 12.52% and 26.45% respectively leaving much concern over the ability of the Greek government to repay its forthcoming €1.0 billion debt to the IMF in May, along with its pension and salary expenditure to government employees. A technical default is now a strong risk with growing concerns that the country is now bust and will at some stage leave the European Union.
Clearly, such an action would leave the European Central Bank, selective institutions, and European Banks nursing some heavy losses, which in turn, might create some short-term uncertainty for many asset classes, equally, the euro is likely strengthen given the European Union would have finally lost its weakest member. Admittedly, there might be some concerns over contagion but it is unlikely that countries such as Spain, Italy or Portugal would suffer the same fate.
Understandably, the US has concerns over “Grexit” happening given that in the short-term Greece is likely to suffer badly seeing its economy return to gloomier times a big rise in unemployment and a further shrinking of its economy. Unquestionably, the rest of Europe is likely to feel some discomfort which could even lead to America losing some exports and jobs. Of course, this could be harmful at a time when even the US economy seems to be suffering from some activity weakness data.
Nonetheless, we have recently seen the US core inflation rate edge up to 1.8 per cent, year-on-year, as the effects of energy pricing, and some early wage inflation begins to have an effect. By the same token, the Fed are likely to keep a very watchful eye on events surrounding inflation given that they have met most of their targets for an initial rate hike. Equally, it would not be a surprise if they were to wait until the first quarter of 2016 before acting.
Certainly, when monetary policy changes and interest rates do begin to rise from their current levels of near zero we will be entering unchartered waters, indeed even last week the IMF highlighted their concerns over monetary tightening and the effects it might have on the bond markets given that if investors all rush for the exit door at the same time might we be faced with some nasty liquidity issues leading to panic and turmoil in both fixed interest and equity markets.
Regrettably, the suppression of interest rates over recent years has led to many income seekers pouring money into bond funds also foreign demand from regions such as Japan and China has been very influential leading to estimates that they both own around US$1.2 trillion of US debt. Also this appetite for bonds has led to an explosion of new fixed income instruments such as exchange traded funds which could also have serious liquidity implications for the market once interest rates normalise and inflation begins to rise.
Looking towards Asia we have seen a noticeable improvement in the fortunes of the Chinese and Hong Kong stock markets with the Shanghai Composite and Hang Seng up by around 35.0% and 17.0% respectively this year. These gains, particularly those seen on the Hong Kong stock market, were prompted by Beijing allowing investors to have up to 20 stock accounts, which have meant that they could open accounts with different brokerages promoting competition between the different houses. Consequently, Chinese investors have been opening stock trading accounts on the mainland at a breakneck pace.
Clearly, these markets did suffer from last week’s global events but there are bigger concerns that the “hot money” that has entered these markets might also be withdrawn at a rapid pace creating some volatility within the region. Conversely, traders are expecting these markets to trade higher over the coming months particularly given that the central bank of the Peoples Bank of China are likely to respond to economic conditions with further rate cuts and stimulative measures.
Unmistakably, over the past few weeks we have seen a clear indication of some strong trends and flows within the asset classes and the geographies of the world. A leadership rotation out of the US stock market and into the UK, Continental Europe, Japan and selected Asian and emerging markets has been in evidence supported by the returns seen in those respective markets. Likewise, in the fixed interest markets the continuation of falling sovereign bond yields has left income seekers with little alternatives than to harvest their income requirements by increasing their portfolio weightings towards riskier asset classes such as higher yielding equities, commercial property, and structured products.
Clearly, investors need to be mindful over the coming few months given that the markets and the global economy is still trying to digest the many divergences in central bank policies, geo-political upheavals and the re-balancing of the world order. Furthermore , we are living in a new paradigm whereby inflation , bond yields and interest rates will remain historically low for many years to come therefore the need to seek out practical and sensible investment strategies to capture both growth and income opportunities has never been more important.
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.