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Market Commentary - March 2015

The relentless rise and rise of equity markets continues, with the FTSE 100 making a new all-time high, towards the end of February, for the first time since the end of the millennium. The S&P 500 has been doing that almost every week and is now approaching levels that require an act of faith in companies earnings generation, which are beginning to come under pressure. Europe has been “saved”…again…and we wait with baited breath to see whether Draghi will be able to buy all the euro bonds that his QE programme demands. Certainly club Med yields (ex Greece), not to mention negative nominal rates in Germany, Switzerland et al, suggest the weight of ECB buying power will win the day. Countries with no official QE policy, for the time being, notably the US and the UK, have fared less well over the month, with the 10-year Treasury now back at 2%.

The oil price has made a very modest recovery but has had little effect on the falling rig counts in the fracking zones of the US and the associated economic fallout. US consumers also seem reluctant to spend the dollars they have saved on other products defying the consensus “wisdom” of the economists. China has cut rates as property prices fall and their economy “weakens”. The yuan is beginning to depreciate against the dollar and it would be no surprise to see yet another central bank give up on pegging their currency in an arbitrary fashion. That would seem to put the Fed in a very hard place as they really should be raising rates, given data on unemployment as one example. This would just perpetuate the rise in the dollar, with very unpleasant consequences for countries which are faced with paying back dollar loans (think emerging markets for one). Maybe the Fed know the data coming through is not going to be so robust and the expected rate rise gets pushed further back. With other countries cutting, the US rate, on a relative basis, is rising anyway!

It would not be a complete commentary without mentioning Greece. Yanis Varoufakis, the Greek finance minister, who bears a striking resemblance to the late lamented Mr. Spock, was unable to win the Vulcan mind game theory competition. He was of course up against very tough opposition in the form of Wolfgang Schauble, his counterpart in Germany and longest-serving EU finance minister, Christine Lagarde, managing director of the IMF since July 2011, around the time when the third candidate, Mario Draghi, ECB chairman and Goldman Sachs alumni, pledged to “do whatever it takes”. And lastly Jean-Claude Juncker, president of the European Commission, who’s propensity to be “economical with the truth” when his vision of European federalism is challenged is a matter of public record. They solved nothing by backing the Greeks into a corner; they just postponed the inevitable.

United Kingdom

The FTSE 100 has made an all-time high and is within spitting distance of 7,000. Very often “roundophobia” sets in at such a level but recent action in Germany, Japan and of course the S&P in the US, now well through 2,000, suggests that we may go on a tear if that level is breached. The driver is likely to be a return to fashion for oil and mining stocks, which have been much unloved, but command a significant weighting in the index. Having chased the “darlings” in the equity income category to mouth-watering valuations, investors, in the now eternal search for yield, are turning to relative value. The danger, of course, is that stocks are cheap for a reason; rapidly declining input prices and a weak global economy would seem to do it for the oil and mining stocks, so any potential rally may run into a headwind.

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United States

Depending on to whom you talk, US economic data is improving strongly or it is deteriorating rapidly. So which is it? We think a bit of both, but that economic trends have started to weaken and can be summed up in the following chart. Sales growth is also anticipated to be negative in 2015 for the first time in seven years.

The rise and rise of the S&P 500 has been relentless, but is approaching levels where valuations are getting very expensive and are predicated on corporate profit margins remaining at current high levels ad infinitum. One of the drivers has been share buyback programmes, with February posting the largest tally on record - $98 billion. For 2015, Goldman Sachs estimates a total of $450 billion. With the bond markets insatiable appetite for yield, corporates have had no problem in borrowing at historically very low rates (but higher than Treasuries) and using the proceeds to buy back shares or pay dividends, which does little for corporate profitability ex the financial engineering aspect, i.e. it looks good on paper... Corporates have become the Fed’s surrogate QE and as a result net debt is higher now than it was going into the financial crisis.

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6-month change in 12-month EPS vs US real GDP growth


The Greek can is where we expected it to be and European bond and equity markets, with the exception of Greece had a very good February. If the ECB’s asset purchase scheme is on track then markets will be underpinned, but in the short term we expect them to have a breather, perhaps until June, when the Greek debt negotiations return to the stage. There could of course be ructions along the way as the Troika seems determined to make life as difficult for the Greek government as it can.

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The BoJ has been rather overshadowed recently by its counterparts at the ECB and the SNB, but the Nikkei has started to move upwards again towards our target of 21,000 and we will be looking to take profits as it does so. Cheap oil may be one of the short-term drivers, but in the long term Japan is still dependent on the rest of the world for its energy until it turns its nuclear power plants back on again.

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Asia Pacific and Emerging Markets

The Asia Pacific region has started to make some progress since the December lows, having been left behind by the US market in particular. In emerging markets the two main commodity countries, Brazil and Russia, are looking very much oversold and they too may try to play catch up, but it will, as ever, be a volatile ride. The Chinese government introduced a ban on opening new margin accounts (that enable speculators to borrow money to trade the market) which resulted in a sharp drop in the Shanghai Composite in January. However, the ban is only in place for three months and the index has already started to recover its poise.

There is some concern, that we share, that although governments have, to some extent, learnt the lessons of earlier currency crises, corporate emerging debt is at historic highs and a stronger dollar will make it increasingly hard for them to service those loans.

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Commodities and Gold

Oil is trying to make a bottom, but until we see production cuts from OPEC (the Saudis) or the US shale operations, we can’t see a sustained rise in the near future. Gold has seen some good support at the $1,200 level and is still seeing strong physical buying, as ever from Asia, and may well become the currency of necessity, let alone choice, in the Ukraine, where the hryvnia is rapidly going the way of the old Zimbabwean dollar.

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European bond yields, having fallen on the rumour of QE for some time, have started to rise, albeit modestly, on the news. The logic being that if sellers of bonds then receive a negative interest rate from the ECB on their disposals will there be sufficient sellers to meet the Draghi’s target? We suspect most of the proceeds will end up in equity markets, as has been the case with QE, notably in the US, rather than being lent into the economy. QE never seems to work the way it was intended to does it?

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The central banks, as ever, hold the key to market movements. The ECB has gone all in with a €1 trillion QE programme stretching out until September 2016 and a US rate rise seems as far away as ever.

• Government bonds still look expensive; sovereign yields surprised on the downside 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 December correction was just that; a correction. Some froth does need removing, notably in the US, but short term 2,250 on the S&P looks possible.

• Property remains attractive as a real asset offering a higher spread against most fixed interest markets, but not without risk.

• The German and French markets, potentially the main beneficiaries of QE are showing some signs of renaissance, but can Greece still throw a spanner in the works?. The Nikkei index is on the move upwards again towards our target at 21,000. Emerging and Asia Pacific markets are not overly expensive, but will continue to be volatile and negatively affected by dollar strength.

• Central banks are committed to negative real yields; the ECB, the SNB and the Danish central bank have all gone for negative nominal rates! 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 are still in a bottoming out phase as long as support at $1200 holds.

Clive Hale, Director - March 2015

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