Market Bulletin - Ornament and safeguard?
After a troubled opening to the year on markets, a calmer week saw the focus shift to central banks.
After several weeks of frenzied stock movements claiming newspaper headlines, it came as a relief last week to find attention turning instead to those most ponderous of market makers, the central banks.
The S&P 500 and FTSEurofirst 300 both enjoyed steady if unspectacular rises over the five-day period; the US index climbed 0.83% while its European counterpart was up 1.18%.
Much was made of the fact that correlation between stocks and oil reached a 26-year high this month; oil’s mild recovery to $35 coincided with a 3.11% rise in the oil-sensitive FTSE 100 last week. Moreover, stocks were unusually insensitive to the latest round of quarterly corporate earnings; data compiled by Bank of America showed that stock price reactions had been the lowest in 14 years.
The most important news of the week, however, came not from trading floors but from central banks. As expected, the Federal Reserve declined to move rates in its January meeting, having raised them in December for the first time in nine years. (Mark Carney, chair of the Bank of England, said last week that the Fed’s December rate rise had contributed to market volatility. If he is right, it is yet more evidence of markets acting irrationally in the short term; the December rate rise was one of the best-signalled rate hikes in history.)
In its press release, the Federal Reserve said that, in keeping to its currency policy rate, “the stance of monetary policy remains accommodative”. While it acknowledged the positive employment and labour capacity utilisation trends, it highlighted low inflation as giving cause to pause.
If the Fed’s optimism sounds muted, it merely reflects the wider mood. There are few predictions of stellar global growth in the year ahead and those low expectations will continue to influence stock markets, although the falls of recent weeks look excessive. Blithely investing evenly across an index is unlikely to be a productive strategy.
“In a low growth, low inflation world it’ll be hard yards going forward, but that’s an environment in which truly active managers rather than index surfers should do better,” says Richard Colwell at Columbia Threadneedle.
Janet Yellen was keen to emphasise that the Fed remains accommodative, but inevitably she was not expected to compete with the European Central Bank or Bank of Japan. Mario Draghi said last week that monetary stimulus would receive serious consideration at the European Central Bank’s March rate meeting. On Thursday, Haruhiko Kuroda actually delivered, moving the Bank of Japan’s benchmark rate (which is applied to additional surplus deposits held at the central bank) into negative territory at -0.1%, and even refusing to rule out further cuts in coming months. The Nikkei 225 ended the week up 3.3%.
“The impact on bank earnings will probably be small in the short term, but may affect lending in the long term,” said Richard Oldfield of Oldfield Partners. “Although negative at first sight, it will probably lead to an acceleration of restructuring at the banks, and other actions to improve balance sheet efficiency.
“The resulting weakening of the yen should also help those companies which depend on exports or inbound tourism. Moreover, as last week saw the start of wage negotiations for large companies in the coming fiscal year, the weaker currency and message of continuing stimulus by the BOJ [Bank of Japan] may give firms comfort that they can afford to be more generous with wage increases, a key plank of Prime Minister Abe’s policy to boost the domestic economy. The move should benefit the majority of our Japanese holdings,” said Oldfield.
Markets were surprised by the decision, although Kuroda gave some indication of his belief in the current need for central bank activism when he used a stage at Davos to recommend that China introduce currency controls to support the renminbi.
The reality is that, while markets need reliable global growth to keep up confidence, they have also become used to receiving boosters from central banks, especially when growth is struggling. Sometimes viewed as ornamental in the years leading up the crisis, central banks have been critical in supporting the world economy after 2008. On the side of some British pound coins are the words ‘Ornament and safeguard’ (albeit in Latin); last week, central banks confirmed that they were not done with safeguarding just yet.
“Quantitative easing purists may say that the [Japanese] move to -0.1% on additional surplus deposits held at the central bank is largely symbolic and will affect very small sums,” said Mark Holman of TwentyFour Asset Management. “However, we think it is the direction of travel and intent that should not be overlooked here.”
If stocks settled in first-world markets, it did not stop the ongoing speculation about whether Chinese growth is in dangerous decline and what contagion the world might suffer as a result.
Last week came the news that Chinese steel production and power generation contracted in 2015, their first annual downturn in 25 years. Recent figures compiled separately by Capital Economics and Lombard Street Research both estimate that recent Chinese growth has been at least a couple of percentage points below the official figures. Ratings agencies announced last week that there is a risk of increased Chinese bond defaults in 2016.
Meanwhile, Chinese state media announced that several officials in the country’s north-eastern manufacturing hub, known as China’s ‘rust belt’, had been fiddling local growth figures. Perhaps more significantly, Wang Bao’an, head of China’s National Bureau of Statistics, is currently being investigated by the government’s anti-corruption commission.
What troubled markets, most, however, was that funds flowing out of China in 2015 reached $735 billion, up from $111 billion in 2014. It is this trend that persuaded Kuroda (and several economists) to recommend fresh currency controls; already, there is some evidence Beijing has taken his advice. Moreover, on Tuesday last week China’s central bank pumped an extra $67 billion into the economy.
All these problems are already known, but that did not stop the Shanghai Composite index from falling 6.1% last week, thereby continuing its multi-month slide. The chief difference was that the major first-world indices were largely unaffected. Perhaps even short-term investors are realising that Chinese stock market movements have only the most distant of relationships with Chinese growth.
In reality, neither the Chinese stock market nor the latest statistics-induced panic is a reliable guide to the direction of Chinese growth or the earnings outlook for Chinese companies. More broadly, however, the Chinese story is very far from turning sour.
On foreign indices, lower growth is already priced into stocks with exposure to China. Last week a Capital Economics report found that the worst of China’s slowdown is already past. It also pointed out that low to middle single-digit growth (which typifies a services- and consumption-based economy) was ultimately not just inevitable but desirable. Thus markets may be misreading appropriate development as a pernicious slowdown.
They are also misreading oil, the company argues. When oil was expensive, markets feared it would harm global growth. Now it is cheap, they apparently fear the same outcome. Cheap oil has thus far harmed producers more than it has benefited consumers, but once volatility tails off, a low price should help both inflation and consumption.
Recent months have made clear that oil is not a proxy for global growth, any more than the Shanghai stockmarket is a proxy for the Chinese economy. Investors looking for growth should remember that cheap oil and continued Chinese growth will provide tailwinds in the long run. Last week global stock investors may just have shown their first, hesitant signs of having learnt the same lessons.
Columbia Threadneedle, Oldfield Partners and TwentyFour Asset Management are fund managers for St. James’s Place.
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