Market Bulletin (21/12/2015)
Easing and squeezing
The beginning of the new millennium’s first financial crisis is usually dated to the bursting of the housing bubble in the US in 2007; identifying the close of a crisis is a trickier business. Endings are less abrupt and there are numerous indicators that together amount to a recovery. Yet one of the greatest signs of improved confidence comes when the world’s leading central bank dares to raise rates once more.
Last week, the US Federal Reserve broke with nine years of habit to do just that. Fortunately, it had also given markets plenty of warning. The S&P 500 initially rallied as the dollar strengthened, but ended the week up only 0.21%. “The Fed’s first increase in nine years had been well-flagged,” said Richard Peirson of AXA Framlington. “Indeed, risk assets would have panicked if they had not moved on.”
Last week’s short-term indicators were not all rosy, however; production of durable goods flatlined in November, and the US’s current account deficit increased 11.7%, thereby delivering the largest shortfall since 2008, although the number of Americans filing for unemployment benefits dipped.
Economic growth and rising employment offered plenty of rationale for the rate move, but the Fed is meant to target inflation of just below 2% and official US consumer price inflation remained unchanged in October, although ‘core’ inflation (which excludes food and fuel) looked far healthier.
Janet Yellen acknowledged the “significant shortfall” in inflation but is not alone in forecasting much higher inflation in 2016. Her prediction of 1.6% goes some way to explaining why it has also forecast interest rate rises amounting to a full percentage point in 2016. For markets, that medium-term rates trajectory is what matters most – Fed judgments about inflation are likely to be crucial in determining how closely that trajectory is tracked in 2016.
“The outlook for 2016 depends on the pace of the ‘normalisation’ of interest rates,” said AXA’s Peirson. “Equities will take two or three small rises in their stride but if growth or inflation are stronger than expected, which leads to more aggressive tightening, then all bets are off. In the event of the latter, bond yields would rise significantly and could threaten the valuation basis of equities. A Goldilocks outcome, however, which looks possible, might even extend the already-high valuations of proven growth stocks.”
Half the world away
Meanwhile, the Bank of Japan (BoJ) was setting its tiller to a very different course. Earlier in the week the Tankan Business survey, a highly-respected quarterly review beloved of the country’s central bank, showed business sentiment unchanged in November against the previous month – a dip had been expected. The results come only a week after Japan’s supposed recession was shown to have simply been the result of inaccurate interim figures. Japan’s trade deficit fell by 58% in November (annualised), beating market expectations.
It was perhaps figures such as these that led the Japanese government to respond warmly to the Fed’s decision. A spokesman told press last week that the rate hike “isn’t a bad thing for Japan’s economy. Japanese corporate profits are at record levels, while job and income conditions are recovering moderately.”
Yet neither the Fed’s example, nor a few mildly positive indicators, were able to stay the hand of Haruhiko Kuroda, Japan’s central bank governor. Instead, two days after the Fed squeeze, he announced easing measures.
In fact, the purchase of some longer-dated government bonds and an extra $2.4 billion in equities was hardly Christmas excess. Kuroda himself later claimed the policy did not constitute easing, although the technicality on which Kuroda hung his hat was not widely accepted.
“These purchases are due to start in April 2016 and are designed to offset the impact of the BoJ selling the stock holdings it still owns as a result of its equity purchase programme some 10 to 15 years ago,” said Richard Oldfield of Oldfield Partners. “[It] was a minor easing, but overall there was little change in policy. Moreover, we would not expect any significant easing unless the currency appreciated dramatically or economic conditions deteriorated markedly.”
The Nikkei was jittery after the decision and ended the week down 1.27%, but Kuroda’s decision is probably most important for its global implications – baby steps they may have been, but moving against the Fed highlights the growing divergence between the world’s major central banks. Other advanced economies may follow the Fed – Taiwan did so last week and Hong Kong will be obliged to do the same due to its dollar currency peg (and despite domestic economic conditions that hardly invite a rise).
Through much of the rest of Asia and a number of other emerging markets, the direction of travel is likely to be that of Tokyo’s – China’s central bank gave indications of a forthcoming currency devaluation last week. Countries with dollar-denominated debt will face particular pressure in 2016, since the value of their debt will rise in domestic currency terms.
The UK economy has had a positive year, and last week unemployment figures came in at 5.2%, the lowest since January 2006. The FTSE 100 ended last week up 1.67%. UK pension reforms continue, and last week the government announced a second-hand annuity market from April 2017, which should affect five million pensioners.
Yet worries are afoot. Inflation last week was up only marginally at 0.1%, and so the expected rate rise next year will need to be expertly timed. Moreover, despite unemployment and growth encouragements, productivity levels remain disappointing.
“In terms of the implications of the Fed rise for the UK, Mark Carney continues to be cautious, but the market will look towards next year in a positive state of mind,” said Chris Ralph, chief investment officer at St. James’s Place.
Meanwhile, the UK Boardroom Bellwether Survey published last week showed that just 28% of the 57 FTSE-350 company secretaries surveyed expected an improvement in the global economy in 2016.
But the greatest risk is the possibility of Brexit; the same survey found that 70% expected Brexit to do damage to their business. Last week David Cameron returned from Brussels with a deal looking likely, if far less generous than he had initially aimed for. At the weekend a senior Tory warned that more than half of Conservative MPs are ready to vote for Brexit.
Debt and democracy
Leading indicators in the eurozone remain mildly positive. Manufacturing activity rose at its fastest pace for 18 months, inflation was up slightly at 0.2% and employment growth hit a four-year high. An election in Spain returned no majority – Spanish stocks and bonds dipped in response.
The Federal Reserve decision, coming swift on the heels of easing measures at the European Central Bank, helped to buoy stocks and the FTSEurofirst 300 finished the week up 1.56%. Sovereign debt remains a problem in Greece, Spain and, most importantly, Italy. The ECB is not supposed to print money as a cure for indebtedness but, having found other reasons to do so, it will doubtless be glad of what easing does to the debt profiles of over-leveraged eurozone countries.
The most contentious debt dispute in Europe, however, is not in the eurozone, but in Ukraine, which last week decided not to pay its full outstanding $3 billion in bond payments owed to Russia. Ukraine has a ten-day grace period before it has technically defaulted on the debt. Meanwhile, EU sanctions on Russia have been extended.
We hope all our clients enjoy a more amicable Christmas break.
AXA Framlington and Oldfield Partners are fund managers for St. James’ Place.
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