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Market Commentary - April 2015

A rather mixed month for the major equity markets; UK and US were down (although the latter was positive in sterling terms) but Europe (ex Greece), the Nikkei and the Shanghai Composite were all strongly better. This can all be explained by quantitative easing. The UK and US are now devoid of that particular stimulus hence the equity markets, which have been far and away the main beneficiaries – monetary induced inflation has to turn up somewhere after all, are looking rather flat. On the other hand Draghi has €1 trillion to spend and the BoJ are printing for all they are worth. In China the slowing economy and the “refinancing” of the shadow banking economy – someone is going to have to bail out all that property speculation – will almost certainly result in some further government stimulus. The Shanghai Composite has risen sharply on that rumour and “selling on the news” is likely to be the reaction; the Chinese like a gamble and the level of margin debt is back to record levels.

Economic data in the US has begun to show signs of a slowdown. It could be weather related – it has been a very cold and icy winter like 2014 – and we could have a rerun with GDP going negative for a quarter. Or it could be more long lasting. The dramatic fall in oil prices has meant significant curtailment of activities in the major fracking regions of Texas and North Dakota. It is also apparent that the savings in gas (petrol over here) consumption are not being spent in the wider economy at the rate anticipated. It is also a generally unreported fact that when commodity prices fall, buyers of end product know their suppliers have been getting the benefit and start demanding lower prices; deflation begets further deflation and so on ad infinitum – not literally one hopes! If the US is not growing as fast as the optimists hope then the stock market is beginning to look very expensive. We know that China is slowing – from 7% to a publically admitted 5% - and this has had repercussions amongst the commodity-producing countries, Australia, Brazil and Russia. One country seemingly bucking the trend is the UK but with the electioneering in full swing don’t count on that lasting either. A Labour - SNP government is not one that industry or the City is relishing.

Europe is, as ever these days, an enigma. The Greek debt talks have been rumbling on for far too long and we suspect the dénouement is rapidly approaching, along with the scheduled IMF and sovereign debt repayments. The rumour mill is suggesting that they will default on the IMF loan, due very shortly, and revert to drachmas, which, apparently, have already been printed. Easter weekend looks like an ideal time to make an announcement as they will have an extra bank “holiday” on Easter Monday. It may be just another tactic by Syriza to “persuade” the Troika to give them some leeway; a most dangerous tactic for both sides. If their bluff is called then Draghi has €1 trillion burning a hole in his pocket and this gives him plenty of ammo to help him through a Greek tragedy; in the short term at least. The majority of Greeks would dread a return to the drachma although in truth they should never have been invited to this fated party should they? It seems crazy to say it but another fudge, can-kicking exercise, call it what you may, is probably the best solution for now.

United Kingdom

The FTSE 100 has backed off from the rarefied air above 7,000. As we mentioned last month “roundophobia” can be a significant barrier to progress and we suspect that we will have to wait until after the election on May 7th until it has a further attempt; although quite what combination of coalition would trigger that remains to be seen. In his budget statement the chancellor said that economic growth is estimated to be 2.5%; currently the best amongst the G7 nations. Why is it that the UK is the stand out economy? It is running out of oil, it has a perniciously weak currency and is on course to have another ineffective government. The Tories think they have navigated their way through the financial crisis, but the recovery has been glacially slow for many parts of the economy especially for the lower paid. This election is likely to have one of the lowest turnouts on record as the populace “votes” with its feet.

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United States

The S&P 500 has had its first down quarter since 2011. Nothing to write home about, but momentum is noticeably slowing. The ISM manufacturing PMI report was quite ugly- manufacturing employment is not growing and export orders are falling (less than 50). Strong dollar, weakening global growth, West Coast ports labour mess, bad weather? Pick one. Great time for a rate hike?

Rate rise expectations have now moved out until December but if the Fed were to press the button in June as was the first intimation then bond markets would be in for significant disruption.

Politically, the sooner the better as the US election campaign gathers pace, but the Fed is an independent central bank…allegedly!

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ISM Manufacturing Indices

Europe

A lower euro is helping the European exporters i.e. Germany but it is little Greece that holds the key to the future. We have said enough already on this subject and a changing of the guard is we think close at hand. Until then we will steer clear of European markets.

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Japan

The Nikkei has had a very good start to 2015 and finds itself just shy of 20,000 and our long-term target at 21,000. The yen continues to be weak against the dollar but not against sterling which is more a reflection of UK election uncertainty than anything else. The opinion polls here may tempt us to switch into unhedged Japanese share classes if a Labour led coalition is looking the more likely outcome. On a relative basis Japan still has one of the lowliest rated stock markets. The chart below shows the long-term relative strength (weakness mostly here) against the MSCI World index. That’s quite a lot of catching up to do!

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Nikkei 225 Index

Asia Pacific and Emerging Markets

Asia Pacific is not enjoying the Chinese slowdown in the short term and emerging markets are still suffering from dollar strength and commodity price weakness; a very unpleasant double whammy for some, notably Brazil and Russia. If the Fed hold off in June then we may be in for a reversal of dollar fortunes and thus of the emerging sector, which in the long term, being the area of fastest consumer growth, has considerable attractions.

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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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Bonds

Bonds are still hanging in there as talk of deflation is on the increase although in the US and Germany long-term expectations have bottomed out and are rising again. We continue to find it very hard to find value in this sector other than through very short duration or pure credit plays.

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In summary

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 and of course could continue to surprise. 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 $1,200 holds.

Clive Hale, Director - April 2015


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