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Market Commentary - October 2015

After August’s “fall out” global markets have attempted three rallies, which, so far, have not managed much by way of recovering the down draft. The latest is quite a strong affair, but this is not untypical of counter moves in a bear market, if that, indeed, is where we find ourselves.

MSCI World Index

A number of new factors to consider in fathoming where we go next include a quite extraordinary case of corporate malfeasance at Volkswagen, something of a rocky ride for Glencore, a global mining conglomerate, and Russian and Iranian “manoeuvres” in Syria.

Volkswagen have owned up to cheating on diesel emission tests. Their now ex CEO ‘“knew nothing”, the European Commission in Europe and the DEFRA (Department for Environment, Food and Rural Affairs) in the UK allegedly knew, but did not tell and thus one of the most trusted and revered names in the auto industry is now dust. And that dust is a very long way from being in a settled state. The potential fines, penalties and costs of recalling 11 million Passats and Jettas et al, let alone the class action suits that will be legion, will pale into relative insignificance when put alongside the damage done to the German auto industry and the diesel brigade across the world (we suspect VW are not the only culprits) and the knock on effects to the economies at large.

Glencore, a FTSE 100 company and no stranger to controversy it must be said, has been laid low by a combination of over indebtedness allied to the ongoing fall in commodity prices; copper in particular where they command over 50% of the broker market. Currently they are being targeted as a takeover candidate, but whether anyone will be able to fathom a price that will be acceptable given the “unknown unknowns” is debatable. Were there not to be a resolution then the financial fall out could be troublesome, but not perhaps in the same league as the Lehman’s debacle, which some are suggesting, and which was one of the triggers for the financial crisis in 2008.

Geopolitics are probably the least easy cup of tea leaves to divine, but there is no doubt that it is warming up in the Middle East and, perhaps, the one reason your correspondent is pleased to be back from sunny Cyprus is that the island lies a mere 60 miles off the Syrian coast. Having been let off detention by the Americans, the Iranians have repaid the compliment by teaming up with Russia to support Assad, who is fighting against IS amongst a host of other rebel factions. This was not in the Washington script and we await the response with some trepidation.

So what are we to make of the current market gyrations? There is much talk of value being spotted, but unlike previous "buy the dip” episodes where the recovery to new highs was marked in days, we are now six weeks into new territory. This is a new pattern which could still resolve higher, but to quote Chou En Lai - the Chinese Foreign Minister during the reign of Chairman Mao - when asked what effect the French revolution had on the development of socialism, he said, “It is much too early to tell."

United Kingdom

Much hot air is being blown about the UK’s renegotiation stance with the EU. Everyone is saying that changes are necessary but we suspect when the politicians get together with the largely unelected members of the Commission there will be impasse. The refugee debate is high-jacking the process, which should be about decentralisation of the EU, not how many misplaced souls should be given shelter and where. It is looking increasingly likely that the referendum won’t happen until 2017. The FTSE 100, containing as it does many oil and mineral related companies, is prone to significant volatility. The small and mid-cap indices have been relatively resilient as a result.

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United States

Conversely in the US the mid cap indices have led the way down. This is perhaps a function of the Fed “put” which plays out on the S&P 500. The US central bank tacitly targets financial market stability as one of their primary goals and any “wobble” is met with significant buying of S&P futures by the euphemistically named “plunge protection team”. The economic data is all over the place and for every positive item there is a negative number to choose from so the bulls and bears are practising selective hearing, as was ever the case.

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Europe

Data across Europe is arguably improving but is still a long way off a proper recovery. The VW debacle will rumble on for some time and the reversal in sales volumes from this global giant will undoubtedly have a significant effect on the German economy. Greece has been parked for the time being and we now await the Spanish elections in December. The Catalonians already have a mandate to secede from Madrid but support for Podemos, the anti EU party, has waned since “an example” was made of Greece.

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Japan

The Nikkei has succumbed along with global markets generally but the uptrend is still in place and relative to western markets valuations are attractive. Unless the August lows are broken, we remain bullish.

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Japan Nikkei 225 Index

Asia Pacific and Emerging Markets

These markets have taken the brunt of the global decline with a strong dollar and very weak commodity prices being the main drivers, not to mention a slowing in the Chinese economy. There will be a time to get back in to these markets when all the speculative froth has been blown away; it won’t happen in a hurry.

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MSCI Emerging Markets Index

Commodities and gold

Commodities overall are pausing for breath after some precipitous falls, but we don’t expect much more than sideways ranging price action for the time being. Gold has found some support from the Fed’s inaction on interest rates but needs to clear $1200 to reverse the current downtrend.

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BlackRock Gold & General

CRB Continuous Commodity Index

Bonds

Bonds have held up very well as the conventional bolt hole in times of equity market angst but “value” is almost impossible to find, unless one believes in rampant deflation, and another major concern in these markets is liquidity. In the sovereign debt markets, volatility, on top of burgeoning regulation, is frightening off even the biggest players. Ironically the Basle banking regulations, which have set the capital requirement for holding “very secure” sovereign debt at 0%, allowing some significant gearing into these markets, may well turn out to be the catalyst for the next crisis; the law of unintended consequences always strikes where it is least welcome.

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In summary

The central banks, as ever, hold the key to market movements. ECB and Fed meetings in September left interest rates on hold and the betting is that there will be no move until 2016; but can they maintain the façade of invincibility?


• Government bonds still look expensive despite deflation yet again being discussed as the bigger problem.
• Corporate bonds are not cheap and default risk can only rise from here, making high yield potentially less attractive. Is the yield premium adequate? There is also significant concern over liquidity risk.
• Western equity markets have started a long expected correction. Whether it turns into something more extreme hinges on central bank action as well as the nerve of investors.
• Property remains attractive as a real asset offering a higher spread against most fixed interest markets, but not without risk.
• European markets are in a state of flux. Conventional wisdom says that ECB QE should be beneficial for financial assets, but the Greek issue is yet to be fully resolved. The Nikkei index has reached our initial target at 21,000 and has started to see a retracement of some of the gains. Emerging and Asia Pacific markets are not overly expensive now, but will continue to be volatile and negatively affected by dollar strength and Chinese economic weakness.
• Central banks are committed to supporting the markets but their aura of invincibility is beginning to slip. Ultra loose monetary policy will create inflation eventually, but currently deflation is still an issue and it is getting harder to see where anything other than tepid growth is going to come from; even China is succumbing to the malaise.
• Gold has fallen through support at $1200 driven down by unusually aggressive and abnormal selling on the futures market. Physical demand remains strong and there will be a significant buying opportunity when this market shows signs of bottoming, but not, we suspect, for a while.
• Commodities generally will not see a sustained trend change until the global economy shows more signs of life.

Clive Hale, Director - October 2015


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