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Market commentary - November 2014

October has been a truly unusual month. Markets have gone from full speed astern to full speed ahead; well at least in the US they have. The monthly range in the Dow Jones Industrials has not been this wide since 1903.

Dow Jones Industrial Average Index

Since the previous all-time high in mid-September, the Dow has swooned 1,495 points and then exploded upwards by 1,535 points; total travelling distance over 3,000 points in just over a month. Apart from last Friday, which saw the usual end of month reshuffling of portfolios, the volume on the latest up leg has been falling. In fact since the start of the bull market in 2009 volume has been slowly drifting downwards and a lot of that has been high frequency trading of doubtful validity.

Yet again ignoring central bank action has been costly. The Fed have now officially stopped QE, although the huge interest payments on their Treasury bonds will find a way back into the bond markets, but the Bank of Japan have stepped into the breach. They have raised their QE target from Y60 trillion to Y80 trillion. At the same time the $1 trillion Japanese Government Pension Investment Fund will raise its equity holdings (foreign as well as Japanese hence the rip in the S&P) from 24% to 50%. It will also reduce its Japanese Government bond holdings (JGBs) by nearly half, but of course they have a willing buyer to facilitate this! This is tacit admission that the sales tax rise in April was a mistake, as GDP declined more than expected, and, ex the tax rise, inflation has been falling again. Europe please note; austerity measures aren’t going to work, although does QE do anything other than push the stock market higher?

United Kingdom

Cameron is becoming increasingly marginalised on Europe. He has bleated about not paying more into the EU coffers but the latest demand from Brussels for €1.7 billion is enshrined on page one (literally) of the EU contributions manual. He failed in his attempt to prevent Juncker becoming President and the principle of freedom of movement across the EU is not open to debate either. He talks about negotiating from within the EU as a position of strength when in reality he has none.

So more continued uncertainty ahead for UK plc which is why FTSE has not bounced like the Dow. A weaker pound will help large-cap dollar earners, but any revival in Labour’s standing in the polls will not go down well in the City and, with Mark Carney at the BoE keen to pull the interest rate lever, the 7,000 target for FTSE is still a challenge.

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United States

QE is over…until the next time; ask the Bank of Japan! Still lots of good news coming out of the US; more than half of the companies reporting for Q3 have beaten expectations, fuel costs continue to fall (not a plus for the marginal shale oil producers) and, despite no QE, monetary policy is still very accommodative; the date for the first rate rise seems as far away as ever. There is a strange desperation to stay invested as if the news is almost too good to be true. In over 30 years your correspondent has not seen market behaviour so unfathomable…

Bond market rates have been as volatile as equities this month but the trend is still down. The next few Treasury auctions will however be an indication of how much the markets are missing the Fed.

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US 10-year Treasury bond yield

Europe

With apologies to feline fanciers, Europe looks to be having the proverbial dead cat bounce. Putin is gradually raising the stakes. His recent speech in Sochi (not widely reported) made it clear that he is not going to go quietly and, again generally unnoticed, Poland has moved troops to its eastern border. The European bank stress tests have been announced and pretty much ignored as those failing were either in intensive care, Banca Monte dei Paschi di Siena, or had done some “shoring up” already.

Draghi has seen the effect further QE has had on Japanese markets (stronger equities and a weaker currency) and will find a way to engineer the same result in Europe. The German constitutional court will surely have to cave in if the alternative is further financial stress.

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Japan

Finally the BoJ has blinked; well five of the nine members at least, as the vote to go ahead with further QE was a close one at 5-4. The additional traction gained by the government pension fund adding its weight to equity purchases has put a very solid floor under that market. The yen is of course taking a hammering, so equity exposure will require a currency hedge.

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Asia Pacific and Emerging Markets

The numbers out of China still suggest a slowdown, but the powers that be are driving through a number of reforms at local government level to head off a funding crisis there, so for the time being all should be relatively serene in the middle kingdom. The Shanghai A shares market also benefits from easier access by foreign investors and valuations make this another value play, but not without volatility.

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China Shanghai A-Shares Index

Commodities and Gold

The commodity complex continues to indicate 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. Support at $1,200 looks to have broken down but at the end of the month there is a Swiss referendum to force the Swiss National Bank to double its gold holdings and repatriate bullion from vaults abroad. If the vote succeeds gold will likely have something of a renaissance.

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Bonds

Bond yields have been as volatile as equities, but are still in a down trend. The next few Treasury auctions will give us an idea what it will be like in bond world without the Fed as the main buyer. JGBs are well supported too. Gilts and Eurobonds, however, may suffer more fall out as a result.

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Summary

The central banks as ever hold the key to market movements. The BoJ has taken the reins from the Fed and Draghi is under pressure to do the same in Europe.

• 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 still expensive and the recent correction is just that; a correction. Some froth does need removing, notably in the US.

• Property remains attractive as a real asset offering a higher spread against funding costs, but not without risk.

• Europe has corrected and hardly bounced. If Draghi pulls it off, a la BoJ, then this is a buying opportunity, but will he? Japan is again the land of the rising sun, with Chinese equities playing catch up too.

• 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 have turned down again, but there may be a buying opportunity ahead of the Swiss referendum.

*Clive Hale, Director - November 2014*


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