Interest rate rise: keep calm and carry on
The Bank of England increased interest rates today for the first time in a decade. The Monetary...
Last month we said the rally from the February low was losing momentum and that is still the case. More significantly, the bull run from early 2009 is showing the same propensity.
We break down the key events, market by market, that you need to know about in May.
As we mentioned, the bull run we’ve had since 2009 is showing signs of slowing. The S&P 500’s rise of over 200% from the low of 666 (significant, maybe, for fans of ‘The Omen’) to the most recent high of 2130 (almost a year ago now) spans 7 years, which is one of the longest bull markets of all time. We may not have seen the final peak yet, but each attempt at a new high is done on the back of a lower volume of shares traded each time – a discouraging sign.
Another concern is that corporate earnings are also on the decline and one of the main props for the market is via companies buying back their own shares. More often than not, they are using borrowed money that does little for debt to equity ratios, which are now much higher than they were in 2008.
There is also a litany of known unknowns: Brexit, which is not just a UK issue, but has global implications; the return of the Greek tragedy; the US electoral farce; the Middle East; the oil price and implications for Russia and Iran; the Chinese economy and its bloated banking and corporate debt problems; and the Italian, German, Spanish and French banks (but don’t shout too loudly … it is illegal in France to openly mention the name of any French bank that may have solvency issues).
All that and we haven’t even mentioned the central banks and their inability to wean themselves off the quantitative easing (QE) heroin. As the Bank of Japan (BoJ) have discovered, they need to do more and more to have any effect and then it just stops working altogether; negative rates should have weakened the yen and boosted the market according to central bank folklore, but just the opposite happened.
It’s bad enough having to put up with, in my view, misinformation from our current European bedfellows, but to be lectured to by some American dude shows the extent to which the US thinks it rules the world.
The admonition over Brexit and the threat of a 10-year ‘delay’ before any trade negotiations can be entertained disguised the real purpose of President Obama’s visit, which was to promote the TTIP (the Transatlantic Trade and Investment Partnership). The partnership is being negotiated on our behalf by the EU, in secret – something our government finds quite normal, apparently. That’s one to fuel the Brexiteers’ fire, no doubt.
All round, though, the economy is not doing too badly, especially when compared with the European Union. GDP expanded 0.4% in the first three months of 2016, slowing from 0.6% growth in the previous period and in line with market expectations, preliminary figures showed.
The services sector led the expansion, while industrial production, construction and agriculture shrank. Year-on-year, the economy advanced 2.1% – the same as in the previous period and higher than market expectations of a 2% expansion, but significantly lower than for the same time period after previous recessions. We are not out of the woods yet.s
The latest Fed minutes suggested the economy was not quite as strong as they would like and they removed the concern that their actions might in any way have a negative effect on the global economy, which is struggling with lower growth rates without their ‘help’. The effect on the markets in the short term was positive until the realisation dawned that a weak economy was hardly the stuff to drive up waning corporate profits. Higher oil prices are something of a mixed blessing too.
Meanwhile, the US election machine rolls on and continues to make the House of Cards dramatisation of political machinations seem positively genteel. It is beginning to look like Trump and Clinton on the November ballot paper, unless the Republicans come up with some way to derail their voters’ favourite.
Noise from Athens is on the increase again. They are due to make an International Monetary Fund (IMF) repayment in June and as of now there is nothing in the bank to pay them with. Dijsselbloem, the Dutch Finance Minister and chairman of the Eurogroup (an informal group of EU finance ministers), has refused a request by the Greeks for a meeting to discuss the issue as he believes that, “there is nothing to discuss”.
Until there are debt write-offs, which the IMF are advocating to the intense irritation of the Eurogroup, this problem will not go away. Any escalation will be likely to end the rise in the euro, which has implications for the rest of the world.
The move to negative rates, intended to weaken the yen, had exactly the opposite effect. As a follow up, Haruhiko Kuroda, the governor of the Bank of Japan, has said there will be no further QE for the time being and rates will remain where they are. This was not what the market wanted to hear and the Nikkei has shed over 1000 points in two days, while at the same time the yen has strengthened again.
He must be wondering just what he has to do next, other than resign! The case for Japan based on its relative cheapness is beginning to wear a bit thin, but there is considerable support at 15000 and we expect some sort of rally to kick in before that level. How the market reacts from there will be an important indicator of the likely direction of travel.
Asian and Emerging markets generally have had a good time in 2016. Their short-term fate rests upon the dollar exchange rate – a weak dollar is usually positive for these markets. The key support level for the dollar is at €1.15; the euro is the largest constituent of the dollar index. If the euro breaks up from here then these markets will continue to shine.
Long term this is our favourite place to be invested and we are looking for an opportunity to open new positions, but we would like to see more than just rhetoric coming out of China. Its latest five-year plan promises much, as ever, and on the devaluation game they are still trying to finesse the forex markets, with a small degree of success it must be admitted. Longer term they have an uncompetitive currency and they will have to devalue.
The corrective phase in gold appears to have been rather short lived as we are now homing in on $1300. We expect some consolidation and we would not be surprised to see the bullion banks try to take the price lower. That they are finding it less easy to do may have a lot to do with China being involved with the daily gold fixing and the opening of a gold exchange in Shanghai where gold is traded in yuan.
Oil has also risen significantly over the past couple of months, despite the Doha summit resulting in no agreement to cut production. At $50 we expect some consolidation of the move. US shale producers are starting to switch supply back on which then puts pressure back on the price unless demand (global growth) improves dramatically. The industrial metals have had a good run too, but in the main from very oversold positions; the shorts have been squeezed.
Over $70 trillion of global bonds are priced at negative yields and the 35-year US Treasury bull market remains unabated. Deflation has returned to Japan and is adjacent in Europe. In the US prices have been edging up and the return of daily rises in the oil price may help to conjure up some inflation, which the central banks have been trying desperately to produce.
High yield bonds are still priced like equities and will behave like them when the markets take flight. With the European Central Bank and the Bank of Japan still trying to corner the market, bonds are still the favourite ‘risk-off’ play, but for how much longer?