The Lowdown to 22nd May 2015
In this week’s issue
- Equity markets continue their march upwards but the Fed has their finger on the trigger.
- US treasury yields begin to factor in the first US interest rate hike for many years.
- The US dollar reacts to forthcoming monetary tightening as the euro weakens from ECB talk.
- The Japanese Nikkei 225 and China’s Shanghai Composite indices rally to new highs.
- In the commodity markets both gold and Brent crude oil prices drift lower.
- The month of May sees global investors remain loyal to equity markets.
What does this mean for the markets and asset classes?
“Fed chair Janet Yellen talks of rate rise this year with if as a precursor”
The continual debate as to whether the Fed will raise US interest rates this year rages on, which in turn, has seen the equity, bond and currency markets trying to anticipate Janet Yellen’s next move. This game of “cat and mouse” of “will they or won’t they” has become a rather tedious affair. If you look at recent US economic data, even if patchy at times, their economy is continuing to strengthen; therefore, raising interest rates by a marginal amount in June or September would seem a sensible decision. Equally, there are still some sceptics in the market place that believe that the Fed is already behind the curve and therefore heading for trouble.
Interestingly enough, in last week’s Fed statement, Janet Yellen, said that the US economy was “well positioned” for continued growth, even if expansion was likely to be moderate due to factors such as a slow improvement in the housing market, modest business investment and persistent weakness in the energy sector. However, more intriguing was her comments on unemployment and the inflation rate, where she acknowledged that the Fed could not afford to delay tightening until their objectives had been met. She then went on to say that “if the economy continues to improve, as she expects, then it will be appropriate at some point this year to take the initial step to raise the federal funds rate target and begin the process of normalising monetary policy”.
Unquestionably, the issues surrounding job creation, weak productivity data, and the tepid pace of wage gains has confounded the Fed on more than one occasion over the past few years. Indeed, just last month the job numbers were an improvement on the previous month, which in turn, completely surprised the market. Conversely, whilst the unemployment rate has fallen to its lowest level since May 2008, with the jobless rate down to 5.4 per cent, wage growth still remains the sticking point, given its modest pace of acceleration. However, some companies such as McDonalds and Walmart are planning to raise hourly pay for many workers to at least US$10.00 an hour from next year.
Equally, even looking at the subdued inflation rate, we have recently seen the numbers for the core US consumer price index, [which excludes volatile food and energy prices], rise by 0.3 per cent, its biggest monthly increase since January 2013. Undoubtedly, if the recent US economic data were to continue improving, then it would become quite difficult for the Fed to ignore it and leave interest rates at near-zero.
Clearly, this recent Fed statement and modification in their stance towards monetary tightening has already been reflected in the US government bond market, with yields on US 10-year bonds moving out to 2.21 per cent, whilst the more sensitive two- year paper has seen yields move out to 0.62 per cent. Also in response to this we saw the US dollar rallying strongly over the week, which has been a turnaround of fortunes for the greenback. Indeed, after its strong gains in the second half of 2014, and early part of 2015 the dollar has been rather subdued in recent times, however, once the Fed starts to raise rates it is anticipated that we will see further momentum return to the US dollar as a renewed bull market gains some strength.
Turning towards Europe, the ECB have confirmed that it will increase its asset purchases over the coming months to offset any uncertainty surrounding liquidity issues in the market over the summer months. This announcement was quickly followed up by a speech from Benoit Coeurè, a member of the European Central Bank’s executive board, who said that this action was not related in any way to the recent sharp selloff in eurozone bond markets.
Nonetheless, what this does mean for European markets, and its investors, is that there will be some support for riskier asset classes such as European equities, if of course, anything unforeseen were to happen over the next few weeks. And in terms of last week’s market sentiment, the Eurofirst 300 Index was up by 2.85 per cent, whilst the benchmark German 10-year government bond yield ended the week at 0.60 per cent with the euro falling by 1 per cent against the strengthening US dollar.
In Asia the Nikkei 225 Index continued to gather momentum as the ongoing optimism about the Japanese economy, and shareholder returns, saw the index close at a new 15-year high. Likewise, on Monday we saw China’s Shanghai Index post its biggest gain in four months, before setting a record seven year high at the end of the week. Furthermore, what seem to be stimulating this positive momentum has been the infrastructure and transport sectors, after Beijing invited private investors to help build projects worth US$318 billion, ranging from motorways to tunnels.
Clearly, the Chinese stock market is undergoing its biggest bull market run since 2007, with the Shanghai Composite Index already up by some 47 per cent so far this year. Unfortunately, this market is renowned for its volatility and “hot money flows”, therefore, global investors are likely to experience a roller coaster ride over the coming months, none-the-less this Chinese bull market could continue to run for some time to come.
And so as we enter the last four trading days of May it would seem that most global investors have continued to keep faith in the global equity markets rather than “sell in May and go away”. Clearly, with returns from bonds and cash looking so unattractive versus equities the latter does seem to be the correct strategy, at least for the time being, or until bonds and cash start to offer its investors a better risk adjusted return than equities, and that call seems to be firmly in the hands of the central banks and when they begin to change monetary policy and tighten.
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.