Market commentary - July 2014
Summer is upon us and in the UK we are actually enjoying some sunshine as are equity markets, notably in the US. Fixed interest markets too are still sitting close to all time low yields and "shock horror" Spanish ten year rates are now below both UK gilts and US Treasuries. No we don't know why either but Dr. Aghi is sitting comfortably at the European Central Bank (ECB) having told the markets yet again that the sanctity of the euro is sacrosanct and woe betide anyone who disagrees with him.
Without a doubt the central banks are now running the show which is unfortunate as their track record, particularly in avoiding stock market excesses, is patchy to say the least. Janet Yellen, the latest incumbent chair at the Fed is quoted as saying that she is not at all concerned about valuations on Wall Street. In other words she is complacent about complacency, but no different from her predecessors who couldn't see a housing bust coming (Greenspan) and thought that the sub-prime debt market was under control (Bernanke).
The Bank for International Settlements (BIS – the central banks’ central bank whose mission is to serve central banks in their pursuit of monetary and financial stability) agrees with our view,
“Financial markets have been exuberant over the past year, dancing mainly to the tune of central bank decisions. Volatility in equity, fixed income and foreign exchange markets has sagged to historical lows. Obviously, market participants are pricing in hardly any risks.”
Political tensions are also simmering away so whilst we like the prospect of a long hot summer, we would prefer it to be on the beach rather than a meltdown in the markets.
The UK was the exception to the rule this month that equity markets only ever go up and this was most pronounced in the mid and small cap indices, which have both reached important support levels. There has been a rotation back into large caps and the lesser indices need to hold their ground if the correction here is not to gather momentum.
On the politico/economic front there has been little change. Cameron continues to lack any discernible skill in dealing with our European “partners” and the lame duck coalition is making life easy for the Ed Miller band. The chancellor is hoping that the economic “recovery” will really get going before the next election. He trumpets “growth in jobs” but the total hours worked are still going down, and over 35% of those "working" would like more hours of work.
The voters are beginning to see the slip betwixt cup and forelock…. FTSE has failed again to make new highs above 7,000 and with the monetary spigot in the off position at the Bank of England and the suggestion that rate rises might come sooner rather than later the market is facing something of a headwind for the time being.
The price earnings ratio on the S&P 500 at 25 is now 6 points above its long term average yet the bulls demand that this is not expensive; well it is certainly not cheap! Long term technical innovation and entrepreneurial high spirits will eventually prevail, but the markets are discounting a lot of good news already. The mid-term elections are now arriving at centre stage as the Grand Old Party (GOP) aka the Republicans push for a majority in the Senate.
They already control Congress and this would give the President more headaches in trying to raise the debt ceiling without too much cutting of expenditure on the other side of the equation.
The elections have come and gone and as anticipated nothing has changed very much in the corridors of power. Junker looks set to become EU President which is a blow to Cameron’s hopes for a reformer to accede to this position, but it was never going to happen was it? Dr. Aghi is still all powerful at the ECB, but will his recently announced measures to create negative deposit rates (NIRP supersedes ZIRP) in an attempt to encourage lending (of the right sort) work in practise. Judging by the ever lower yields on short term bond paper the answer is a resounding “No”. Equity markets have begun to roll over and whilst not as expensive as the US a corrective phase is very much on the cards.
The news from Japan is beginning to get troublesome especially for supporters of Abenomics (if there ever was such a thing). The third arrow of reform essential for further economic progress has turned into a series of needles. Tourist visas are now easier to come by (is tourism really going to save the day?) and a further series of special economic zones have been set up as a test ground for further reforms. Japan has always worked on consensus views. Abe has a majority in both houses of parliament, but steam roller politics doesn’t work here. If there is not agreement all round reforms will mysteriously not work. Rumours abound that later this month the BoJ will be turning on the printing presses again and then normal service will resume in equity and currency markets; Nikkei up and yen down.
Asia Pacific and Emerging Markets
These markets continue to make progress despite concerns over the Chinese economy and geo political upheavals in many parts of the world. It has been a case recently of relative catch up. Russia for example had looked ridiculously cheap and whilst Putin has played some brilliant hands in the Middle East he is still a communist, megalomaniac, control freak at heart so some profit taking here might not go amiss.
Commodities and Gold
The commodity complex is still indicating that global growth is still a rather weak affair. While western economies are showing signs of recovery China is slowing down under the weight of a bad debt laden banking system. Gold is still being subjected to “unaccountable” swings despite the banks owning up to manipulation of the London gold fix. High frequency traders are now being blamed…Support at $1200 is key for the yellow metal.
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Bonds have surprised everyone. Yields are heading back to 2012 lows for the major sovereigns and for the peripherals, notably Italy, Spain and Greece, they are well below; a degree of complacency has set in to bond markets. The ECB and the BoJ may well start printing again in one shape or form, but remember that the Fed will have stopped providing QE by the late autumn and at some stage they – and the Bank of England - will be obliged to start raising rates.
The central banks as ever hold the key to market movements. The Fed will have completed the tapering exercise by October and will be contemplating a rate rise in early 2015 if the economy has not suffered a relapse; the Bank of England may well beat them to it. However if there are economic jitters Janet Yellen has as good as said that monetary policy will continue to be accommodative so any market weakness is likely to be temporary. The ECB have moved rates into negative territory in an attempt to encourage borrowing and the Bank of Japan is rumoured to be planning more QE measures later this month.
• Government bonds still look expensive; sovereign yields have surprised on the downside so far in 2014. Low interest rate sensitivity is the strategy to follow for “fear” assets.
• Spreads on corporate bonds are still tight. They are not cheap either and default risk can only rise from here making high yield in particular less attractive.
• Western equity markets are all beginning to look increasingly expensive, but see earlier comments.
• Property remains attractive as a real asset offering a higher spread against funding costs but not without risk.
• Although it has been playing catch up Europe is still relatively cheap as are some emerging markets, but they too are due a corrective phase at least.
• Central banks are committed to negative real yields; the ECB has even gone for a negative nominal rate! Ultra loose monetary policy will create inflation eventually, but currently deflation is back on the agenda and it is getting harder to see where anything other than tepid growth is going to come from and as a result rates are likely to stay lower for longer.
• Gold and gold mining shares may have seen a turning point but we don’t rule out some more short term downside
*Clive Hale, Director - July 2014*
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