Market Commentary - November 2015
The market “recovery” continues, but on a global basis – see MSCI World index below – it’s not as exciting as some pundits would have you believe. There is of course a diverse range of returns and leading the way we find the NASDAQ 100 technology index and the S&P 500, both US equity indices which are close to the highs made earlier in the year. Both contain many of the world’s largest and most liquid stocks and hence are the easiest to trade and use by the larger speculators. The small and mid-cap indices tend to lag and may give a useful signal, by catching up, that the recovery is continuing and the chances of a bear market are receding. At present we cannot make that assumption and believe that it would be dangerous to do so.
On the plus side of the equation (conundrum?) we have the central banks. The European Central Bank (ECB) has hinted that at its December meeting on the 3rd it will consider further monetary accommodation (QE) as apparently €1 trillion already pledged may not be enough! The issue in Europe is the banking system where insufficient capital has been raised to give the banks the cushion they need to start lending again in earnest. In the US, and to a lesser extent in the UK, this has already happened. Small businesses are beginning to get access to cash, but their larger brethren have tapped the bond markets for all their worth and used the cash raised for share buybacks and “special” dividends. This of course has helped to keep the stock markets buoyant and this is what might come to pass in Europe too. The markets did spike up on Draghi’s press conference news, but this could well be a case of buy on the rumour of more QE and sell on the news on December 3rd. We wait and watch.
On the negative side we have the central banks! The Federal Reserve (Fed) in particular is giving the impression – a very good one – of a headless chicken. Will they? Won’t they? And if they do, do they really know what the consequences are? We fear not. The latest bulletin in “FedSpeak” is that the economy, the labour force in particular, is picking up strongly and the global instability they cited in previous missives is now deemed irrelevant so interest rates can and should go up “soon”. We watch and wait with slightly more trepidation than our brief with the ECB.
There is also the small matter of Syria which is back on the hot plate with US troops “on the ground”. That there will be only 30 or so of them matters little to the other combatants. Obama is calling Putin’s bluff and we can only hope the US Department of Defense know what they are doing. The assumption that they, and the government, not to mention the Fed, are “all-knowing” should be a moot point. We watch and wait with ever more trepidation.
October, so often the witching month for markets, has been one of the strongest for years. However, we don’t think that we are out of the woods yet. The correction in August was quite savage and has changed the dynamics of the markets.
If there is a rate rise in the US sometime soon then expect the UK to follow suit. The housing market is being buoyed by the increasing ease with which mortgage lenders are plying their wares. However, UK GDP dipped last month so again we have no clear steer. The chancellor has been rebuffed by the Lords which has been declared a constitutional crisis. It is an unwritten rule that the Upper House would never block taxing legislation, but they have, so Osborne has been sent back to No. 11 for a rethink. Who said the democratic process was dead?
US Q3 GDP was disappointing – 1.4% - but is very likely to pick up in Q4 according to the Atlanta Fed GDPNow forecast which has been consistently more accurate than the consensus estimates. It is currently suggesting 2.5% and could be another trigger for the Fed to raise rates. A small increase by itself will have few repercussions; it is the long-term outlook for rates that will become the issue once the Fed actually push the button.
Data across Europe is improving but is still a long way off a proper recovery. Mario Draghi holds all the chips and the next ECB council meeting will be watched with more than the usual level of interest. More QE, in whatever form, will exert further downward pressure on the euro which has already started to weaken in anticipation. Europe is not expensive relative to the UK and the US but the uncertainties continue to give pause for thought. However, if Draghi reinforces the “whatever it takes” doctrine then expect the markets to catch up with alacrity.
Whilst the Nikkei succumbed, along with global markets generally in the summer, it had a very good October and the uptrend is still in place. Relative to western markets, valuations are still attractive. We are still inclined to maintain our weightings here unless the August lows are broken which would negate the bullish case.
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 increase weightings to these markets but for the time being the trend is down.
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 $1,200 to reverse the current downtrend.
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As equities regained some poise, bond market defensive qualities were less in demand and government bond prices declined during the month. The search for yield continues unabated and high yield issues in the US, UK and Europe saw rises of between 1.5% and 3%. Deflation is still a concern but with bond yields well into negative territory in both nominal, and in parts of Europe, real terms the attractiveness of this asset class as a whole is very limited.
The central banks, as ever, hold the key to market movements. ECB and Fed meetings in December will be crucial to the next phase of market price expansion (or contraction) and will attempt to maintain the façade of invincibility.
• Government bonds still look expensive despite deflation yet again being discussed as the bigger problem.
• Spreads on corporate bonds are still tight. They are not cheap either 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 but is still relatively cheap. 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 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 $1,200, 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 - November 2015
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