November has seen a continuation of the bounce in both equity and bond markets. The Main US indices have reached yet another series of all-time highs and the NASDAQ Composite (the “tech” index) is almost back to the 2000 TMT (technology, media and telecoms) bubble peak. In bond world Western sovereign bonds continue to surprise investors, as they have for most of 2014. German and French 10 year bond yields are firmly below 1%. Spanish debt is below 2%, lower than both UK Gilts and US Treasuries, on the back of more rhetoric from Senor Draghi.
The ECB is still in limbo over quantitative easing. The Germans are vehemently against as the bonds the ECB are most likely to acquire would, in the main, be peripheral debt ie Spanish, Italian and Greek; potentially of dubious quality. Certainly, as far as the Germans are concerned, they would be obliged to put their hands in their tax-payers pockets should there be a default along the way. If they can find a way around this impasse, then European equity markets will go to the races. The debt markets are arguably hugely overvalued as Draghi’s jaw boning has reduced peripheral yields to heroic levels, as we have mentioned above.
So the central banks still hold all the cards. The BoJ have come out fighting, the Fed are prepared to allow loose monetary conditions to remain for some while longer and the ECB will probably be forced into a corner by events unknown.
The Faragistas (UKIP) now have two seats in parliament and the UK political establishment is in full election mode. Well the Tories are. Labour are still half asleep and, after the recent by-election result where the Lib Dem vote fell to 289, only one hundred or so more than the Monster Raving Looney Party, few seem to care what they have to say if anything…It is a sad state of affairs and another coalition government looks likely. Sterling is already heading for $1.50 and we may even see Mark Carney at the BoE having to unlock the interest rate lever mechanism; we haven’t had a good sterling crisis since Norman Lamont jacked rates up twice in a day back in 1992.
So more continued uncertainty ahead for UK plc, which is why the 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 as we have suggested, the 7,000 target for FTSE is still a challenge.
Despite the Fed ending the QE3 programme, the equity markets continue to roar. The NASDAQ Composite is nearly back to its all-time high. Some of its constituents have fared very differently. Nokia, once the darling of mobile phone users, reached $60 in 2000 and now languishes at under $10. The current title holder Apple could have been bought for less than $1 in 2003 and now trades just shy of $120!
Arguably the S&P 500 is expensive at current levels, but would not reach an historic extreme until the 2,250 level. For the time being the trend in both the equity and bond markets is up, but it should be mentioned that policy mistakes in one form or another have usually been the start of a trend change and tend to happen all of a sudden.
We have already opined on the fact that unless the ECB can get their balance sheet growing – by buying assets, thus far undefined, from the institutions – the European economy and its stock markets are going nowhere fast. A full blown QE announcement will have an immediate galvanising effect, but will the markets then mull over the consequences or go all in as investors have in the US?
The latest round of QE has been given a kicker by the postponement of the next VAT rise in Japan. The first rise in April this year sent the economy into negative territory for Q2 and Abe did not want to see his economic policy compromised by a repeat. This does of course mean that the budget deficit carries on growing, which it cannot do ad infinitum, can it?
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.
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. Support at $1200 was looking vulnerable, but the reaction after the Swiss referendum resulted in a vote not to force the Swiss national bank to increase their gold reserves, has given the barbarous relic a new lease of life.
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Bond yields have been as volatile as equities but are still in a down trend. Deflation is now seen as a bigger threat than inflation, which suggests that the Fed and the ECB will have to find a way of getting more money circulating in the system. They haven’t had much luck so far, so the next move could well be a policy mistake too far.
The central banks, as ever, hold the key to market movements. The BoJ has taken over 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, but short term 2,500 on the S&P looks possible.
• 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 after the Swiss referendum
*Clive Hale, Director - December 2014*
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