The Lowdown on Markets to 15th May 2015
- Is the recent sharp sell-off in bond markets a “bond tantrum” or something more sinister?
- Equally, we have now seen the Brent Crude Oil price rise by nearly 50% from the bottom.
- In Europe we are likely to see a continuation of balance sheet expansion but not in Japan.
- In the US the Michigan consumer confidence index and retail sales figure disappoint.
- The US dollar weakens further against the basket of leading currencies.
- Global investors need to be more mindful but equities are still more attractive than bonds.
What does this mean for the markets and asset classes?
“Bond tantrums and an anxious seven year equity bull market”
The sharp sell-off in government bond markets over recent weeks has posed the question, “has the 30 year bull market in bonds finally reached its peak”. Arguably, if you look at what has happened recently then there is some justification in thinking that this might be the case.
Indeed, if you look at German 10-year government bond yields they have risen from 0.05% to 0.63% in quick time, equally, since the middle of April bond prices on 30 year paper in Germany, the United States and the United Kingdom have fallen by 15%, 5%, and 7% respectively leading to a substantial rise in yields.
Clearly, this turnaround of fortunes for bond markets could just be another “bond tantrum”; similar to what has happened in recent times. For example, back in June2013 when the then chairman of the Federal Reserve Bank, Ben Bernanke, signaled that the era of US Quantitative Easing was near an end the bond and equity markets took freight and a subsequent “flash crash” occurred followed by an ensuing recovery when it became clearer that this action was some way off.
Certainly, the recent fall in European bond yields has been a deliberate result of two central bank policies, firstly, the cutting of interest rates to historical lows, and secondly, the announcement in January 2015 that the ECB would start their open ended €1.1 trillion QE programme, this not only led to a fall in bond yields but in some cases we have seen them turn negative, which in itself is an extraordinary event. Admittedly, a negative yield does make some sense in a deflationary world but not if growth and inflation is positive or recovers rapidly. Clearly, European bond yields have fallen to unwarranted levels and therefore the recent rise can be justified.
And so on a wider aspect what other issues could be attributed to the recent correction in the bond markets, firstly, the nervousness surrounding the enormity of the central bank buying which could pose a question that we run out of bonds to buy, secondly, the obvious valuation analysis that bonds look expensive against equities on both a valuation and yield perspective, thirdly, the problematic period that could be created when the Fed chair, Janet Yellen announces the first rate hike for many years, or fourthly, the recent near rise of 50% in the price of Brent Crude Oil.
Certainly on the latter point if the crude oil price were to continue with its upward trajectory, and perhaps breach US$75.0 a barrel then we might see some concerns begin to arise over inflation expectations, given that motor fuels, and food prices, impact heavily on the consumer, particularly given that in recent times we have seen a sizeable drop in the price of crude oil which has led to the consumer price data hitting a multi-year low.
Also what has become apparent is that the price of crude oil has not necessarily been driven up by just a demand over supply issue, indeed, hedge funds and opportunists have been quite influential in recent times with a number of market traders suggesting that some very large multi-billion US dollar macro funds had been buying oil futures as a hedge against the weaker US dollar, rising government bond yields, and concerns over the future direction for inflation.
Certainly, there appears to be many market forces at work at the current time linking movements in the equity, bond, currency and commodity markets. For example, it is quite interesting to note the recent strong correlation between the rise in the price of Brent crude oil and bund yields and the continued impact that the US Federal Reserve Bank is having on most asset classes as to the timing for interest rate hikes, especially when we are still getting unclear signals as to the strength of the US economy.
Indeed, last week we saw the month of May’s University of Michigan consumer confidence index figure come in sharply lower than was expected and news that retail sales had been flat for April, this could discourage the Fed in regards to an early rate hike given that this data suggests that US consumers have been saving rather than spending that extra money they have received from the fall in the crude oil price, perhaps preferring to pay off some debt.
Equally in Europe the economic data has been improving, which in turn, led some investors to think that the ECB might reduce their balance sheet expansion. However, Mario Draghi, the ECB president, talked down such thoughts reaffirming the central bank’s commitment to future asset purchases or until they see a sustained improvement in the direction for inflation.
However in Japan, ahead of this week’s BoJ monetary policy meeting, Governor Haruhiko Kuroda seems to have indicated that there has been a steady improvement in inflation, corporate earnings, and a sufficient weakening of their currency, therefore, analysts and the market is not expecting any further stimulus for the time being.
And in terms of global equity markets, we are now in the seventh year of the bull market and macro themes such as diverging monetary policies, currency fluctuations surrounding the dollar, the crude oil price and structural reforms are all still having a major influence on their direction. Consequently, we have become less bullish on US equities, favoring the markets of Europe, Japan and the UK. This is based upon better expectations for corporate earnings growth, a recovery in economic data, and accommodative central bank policy.
Whilst we are still cautious on emerging markets some considerations need to be made for specific regions such as India where further reforms are likely to benefit their economy, similarly, the regions of the ASEAN look interesting giving that global investors can gain exposure to attract growth rates.
Clearly, global investors do need to be more mindful going forward given that the recent sharp sell-off in government bond markets could create some uncertain and volatile times for equities over the coming months, and of course we still have the Greek problem simmering away in the background, along with the ongoing geo-political risks in the Middle East and a possible tightening of policy from the US. Never-the-less, we still think that there are some interesting opportunities in equity markets for the long-term investor and the stock picker.
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.