Market Commentary - January 2015
December was dominated by discussions over the price of oil, which has fallen every month since the end of June, when it was at $115 a barrel. It has declined by nearly 50% and it shows little sign, thus far, of slowing down. Relative to the 75% fall in 2008, we could easily see a price somewhere in the 40’s. The big issue is whether this is good news or bad for the global economy. As we are witnessing, almost daily, prices at the pumps for fuel are leaving us with more in our wallets for other things. Goldman’s have estimated that every 10% fall in gas (petrol) prices is equivalent to a $70bn tax cut in the US. On the flip side employment growth over the past five years has been almost exclusively centred on the oil and energy industries. With many of the shale oil plays across the US now “under water” (the price of oil is now below the cost of extraction) job growth has stopped and gone into reverse.
Markets have been somewhat muted as the pundits opine endlessly on the pros and cons and we are not going to add to the volumes of hot air. Small-cap indices have tended to do better than large in the UK and US; Europe as a whole has been in negative territory, as Greece yet again moves centre stage and emerging markets have fallen, mainly on oil and commodity-related issues – notably in Russia and Brazil.
Western sovereign debt has again put in a good performance as deflation has become the order of the day, reinforced by lower oil prices. High yield bonds, especially oil related in the US, have moved firmly in the opposite direction. The New Year brings an “interesting” assortment of issues ranging from Russia, the Ukraine, China, Japan and, as ever, the ongoing debate over the fate of Euroland.
The election debate is warming up, but we shouldn’t expect more than platitudes and sound bites from the right and the inevitable spend more policies from the left. As the next round of UK austerity starts to bite, we expect to see more social unrest. Osborne has talked a lot about the success of his austerity measures, but, in truth, he hasn’t really started yet as most will kick in between now and 2017 – if he is still at No 11. There will be a focus on benefit cuts, but whilst there are undoubtedly some who will game the system, the cuts will create hardship amongst folk who genuinely need all the support we can give them. Theresa May has been adding to the powers available to her should the peasants start revolting in earnest and Boris’s acquisition of water cannon last year will be seen in some quarters as timely! Until the election is over, the UK market is likely to go sideways at best.
Apparently the US economy, as measured by GDP, rose by a staggering 5% in the third quarter of 2014. Well it did post some statistical juggling, which added back in Obamacare payments, which were left out of the Q1 numbers, in a kitchen sink clear out that just added to the low growth number, caused allegedly by the bad weather. These payments were added back in in Q3 and the unadjusted number was a less than remarkable 1.5%. Given the forecasts for some pretty cold weather in Q1 this year plus the slowdown in job creation, as the shale industry comes to terms with $50 oil, and the prospects for the US economy don’t look quite as bright as the talking heads would have us believe.
The rise and rise of the S&P 500 has been relentless, but is approaching levels where valuations are getting expensive and are predicated on corporate profit margins remaining at current high levels ad infinitum. As ever, it is all in the timing and, whilst the US continues to grow (ex-statistical fudging), it is our favoured “best of a bad bunch”.
After telegraphing their intentions for some time the ECB has finally laid an egg and they will be buying ECB sovereign debt to the tune of €60bn per month until September 2016. So far the response has been luke warm although euro weakness has continued which again is no surprise. Once the bond buying actually starts next month we may see some more positive action in equity markets. On a separate but very much related issue the Greeks have voted for an end to austerity but as yet the incoming government under Alexis Tsipras has yet to formally lay out its policies. The ECB bond buying programme specifically excludes Greek debt so they may find themselves very much "on their own".
Is Abenomics a busted flush? The third arrow of reform has misfired and the effect on the economy of the hike in the sales tax in April has been disastrous. However “don’t fight the Fed” has been replaced with the slogan “don’t fight the BoJ”. If they are true to their promise of more QE involving purchases of Japanese equity ETFs as well as JGBs (Japanese government bonds) then the market is headed higher and our target is 21,000.
Asia Pacific and Emerging Markets
The Asia Pacific region has been trending downwards since the summer and is becoming relatively cheap again. The same could also be said about emerging markets, but, as we have mentioned before, volatility will make the journey feel uncomfortable. With oil and commodities in a slump, it is no surprise that the larger emerging markets like Brazil and Russia have fallen hard this month, but the smaller bourses, and the frontier markets in particular, have shown some positive performance.
Commodities and Gold
It has been all about oil this month, as we mentioned earlier, but copper and steel also remain under the cosh, suggesting that the global economy is still in sluggish mode overall. China will continue to grow apace, but not at the 7-8% levels, probably more like 3-4%, but that is still pretty respectable isn’t it?
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Draghi has fired the QE bazooka, as well as reducing the ECB deposit rate further into negative territory, and as a result yields across Europe have continued to fall. Many sovereigns now have a negative yield out to five years and the Swiss curve is negative to 10 years. We will likely continue to see yield compression i.e. lower rates across investment grade corporates and Asset Backed Securities (ABS) issues too. Even high yield will attract flows, but when rates do eventually rise again they will be the first to fall in price terms. This low rate regime is likely to continue for some time but doesn’t solve the north south divide in Europe (NB Greece) however Draghi has bought some more breathing space.
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.
• Draghi has announced 1.1 trillion euros of quantitative easing.
• Japan is again the land of the rising sun, with Chinese equities playing catch up too.
• Gold and gold mining shares have turned down again but there may be a buying opportunity after the Swiss referendum.
Clive Hale, Director - January 2015
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