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Market commentary - September 2014

As you were! August was a good month for equities; the rise and rise of the US stock market is relentless it would seem. We have not had a correction worthy of the name since the middle of 2011, three years ago now, and the market is up over 200% since the bull market started in early 2009. The UK and Europe, ex Germany, are still struggling to overcome their 2007 peaks. The UK is becoming a two track economic region; London and everywhere else. It’s the same story in Europe; Germany v. the rest, although even the World Cup champions are beginning to see signs of a slowdown, and deflation is back on everyone’s lips judging by the fall and fall in bond yields. What else can explain the fact that Italian, Spanish and French 10-year bond yields are below US Treasuries and UK Gilts? German 10-year Bunds are sub 1%.

S&P 500 Index

The Federal Reserve is due to finish the tapering of their bond buying programme (quantitative easing) by the end of next month, which should remove a prop to the market, but has had little negative effect so far. Speeches by Draghi (president of the European Central Bank) and Yellen (Chair of the US Federal Reserve) at the Jackson Hole economic summit were mildly reassuring, although whether they have any idea exactly when interest rates will start to rise is open to question.

United Kingdom

The UK equity market has traded sideways since the middle of 2013. A number of pundits, and not a few fund managers, are of the view that it has some catching up to do. Then along comes Tesco with a profits warning and a dividend cut to remind us that our economy is nothing like as robust as we are led to believe. Tesco are hardly at the high end of the grocery chain, but their original motto, “pile it high and sell it cheap” has been usurped by the likes of Lidl and the Co-op. And they don’t sell rubbish by the way. The range is not exactly exciting but the basics, which the 95% of us who aren’t living the life of Riley, courtesy of bank bail outs and jobs for the boys, can’t go without, are all good quality. Cucumbers were on sale in my local out of town Lidl at 29p (£1 in Waitrose in West Street) and I had to wonder why I bothered growing them on my allotment at that price. The answer apparently is so that the slugs have something to eat after destroying the courgettes….

Later this month we have the Scottish referendum and, like the play that must not be named, there is no word from Scotland about what will happen if they are denied the use of the pound, or entry into the EU, if they win the vote. Equally mute is our own government.

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United States

Like Greenspan in 1996, the utterances of Janet Yellen, the present incumbent at the Federal Reserve (Fed), that “certain sectors of the market may be overvalued” have fallen on similarly deaf ears. Bio tech is booming and Apple now sells for over $100 a share; not entirely due to my recent order of the latest MacBook Air! Only a relatively short time ago, in 2005, Apple shares traded at the equivalent of $1…

Meanwhile, Obama tries to enjoy a relaxing holiday in Hawaii, whilst his foreign policy is under threat from all quarters and the fallout from the shootings in Ferguson Missouri are relegated to the back pages.

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In Europe, the spectre of deflation is alive and well. In Italy, the inflation rate is very close to zero and, for Europe as a whole, it is not much higher. The European Central Bank (ECB) is constrained to some extent by the German constitutional court that believes that quantitative easing, as practised elsewhere, is illegal in the eurozone. In the US the Federal Reserve’s independence allows it to act arbitrarily and, if needs be, the President can change the state of the playing field with a flourish of his pen. No such luxuries in Europe where the ECB’s balance sheet continues to shrink. Draghi has however announced a further cut in interest rates and introduced a cunning bond buy back scheme which gets around the rules but unless they can restart the bank lending program, soon, then deflation Japan style is a given, along with long-term sub-par economic growth.

We said pretty much the same last month, but as Europe goes on holiday en masse in August nothing much was going to happen anyway!

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Still no additional action from the Bank of Japan (BoJ) on the money printing front. The necessary consensus is obviously taking longer to obtain than Prime Minister Abe would like. The question is, will he ever get it? Another speaker at Jackson Hole, not widely reported, was Haruhiko Kuroda, the governor of the BoJ. He said that if additional monetary measures are required then the BoJ will be accommodative. Well Kurodasan, time to step up to the plate like your near namesake Hiroki Kuroda, the current pitcher for the New York Yankees!

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Asia Pacific and Emerging Markets

These markets, along with Western sovereign debt, have been the surprise of 2014. Despite the geopolitical shenanigans in many parts of the third world, emerging equities have done well, but not in quite the same relentless way as the S&P 500. They are beginning to mark time as their relative valuations catch up, although both Russia and China are still cheap, but undeniably risky.

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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 $1,200 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 another, but remember that the Fed will have stopped providing quantitative easing by the late autumn and, at some stage, they – and the Bank of England - will be obliged to start raising rates. Only the spectre of deflation, particularly in Europe, is keeping the bond markets buoyant. If equity markets do have a meaningful and overdue correction then high yield bonds may catch a cold as well.

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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. The ECB have moved nominal rates into negative territory in an attempt to encourage borrowing and the BoJ is rumoured to be planning more quantitative easing measures.

• Government bonds still look expensive; sovereign yields have fallen so far in 2014. Low interest rate sensitivity is the strategy to follow for “fear” assets.

• Corporate bonds are not cheap 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 whilst they appear overdue some form of correction, they may remain strong for some time.

• Property remains attractive as a real asset, but is not without risk.

• Although it has had a reasonable run, Europe is still relatively cheap, as are some emerging markets, but they too are due a corrective phase at least. Monetary policy is still very accommodative in Japan. The “catch up” baton has been passed to China.

• 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.

• Gold and gold mining shares may have seen a turning point, but we don’t rule out some more short-term pain.

*Clive Hale, Director - September 2014*

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