Market Bulletin - On the brink
Global equity markets stall as the lack of progress in negotiations between Greece and its foreign creditors weighs on investor sentiment.
In a week of eye-catching headlines, disappointing data and further uncertainty, there was very little movement for the major global equity markets. The leading benchmark indices for the US, UK, Europe and Japan traded within an extremely narrow band – none of them gaining or falling by more than 2%.
For the US, UK and Europe, continuing concern over the progress – or lack of it – in negotiations between Greece and its foreign creditors weighed on investor sentiment and saw the three indices fall slightly over the week. Despite the upbeat rhetoric of Greek officials earlier in the week, the normally guarded Christine Lagarde, managing director of the International Monetary Fund (IMF), admitted that a Greek exit from the eurozone was now a “possibility” after four months of tortuous bailout talks have so far failed to get both sides closer to a deal to release aid to the country.
Athens has warned for some time that it will be unable to fulfil a €300 million loan obligation to the IMF, which falls due this coming Friday, without further financial support from its creditors. Yet both the IMF and European Central Bank have ruled out providing any emergency cash without a comprehensive deal being agreed with the left-wing Syriza government and its creditors. The main reason for this stalemate is the leftist regime’s failure to back down over promises to raise pensions and undertake labour reforms. If this Friday’s payment is missed then Greece will slip into a “silent arrears process” which could last a further couple of months before an official default is declared. Yet even if the payment is made this week, the situation is far from resolved; the Greek government will still face another three payments totalling €1.3 billion in mid-June.
For now, markets remain acutely aware of the situation. This week is shaping up to be the most pivotal in the course of this unfolding drama.
Despite this, it was China that provided the market’s biggest talking point as investors considered whether the rally witnessed in Shanghai over the past year might be turning on its head. The Shanghai Stock Exchange Composite Index dropped 6.5% on Thursday and suffered a further fall of 4.1% in early trading on Friday before rallying to end just 0.2% lower. Commentators suggested a range of possible reasons for the unexpected drop, including tighter liquidity conditions, increasingly tough disciplinary action by regulators and significant disposals by major shareholders such as China’s sovereign wealth fund.
Yet it isn’t all doom and gloom in the Far East. A gain of less than 1.5% over the week is perhaps not a significant indicator that Japan has turned the corner and that two ‘lost’ decades should be consigned to history. But looking a little closer there are signs that, perhaps, the outlook is more positive than for many years.
Friday’s small rise was the eleventh consecutive trading session in which the Nikkei 225 had posted a gain – its longest run since early 1988. The benchmark index now stands tantalisingly close to a 15-year high and has gone up almost 18% since the beginning of the year.
Japan sceptics may say it is a bubble but it seems that corporate Japan is in good shape. Total corporate taxable income is higher today than when the Nikkei was peaking near 40,000 at the end of the 1980s. Recurring profit margins are at a record high and wages have started to rise for the first time in 20 years, which should start improving private consumption.
So what is the catalyst for this change? “Corporate Japan has transformed its business model from a market share-driven exporter to a more profitability-orientated value creator. Many Japanese manufacturers have shifted their focus from end products to higher-value-added devices and new materials. Even if consumers don’t see Japanese names on the products, Japanese technologies play essential roles inside them,” notes Chisako Hardie of AXA Framlington.
Yet this shift has been a gradual one, and investors have carried the burden during the revolution. “While the transformation of the business model was underway, employees and shareholders were the lowest priorities for a long time. This is clearly changing now,” Hardie adds.
The launch of a new Japanese equity index at the start of the year could claim some of the credit for a new-found focus on shareholder value. A crucial part of the calculation of the JPX-Nikkei Index 400 is a three-year record of return on equity (ROE), a metric which expresses how much profit a company generates from the money shareholders have invested.
And, according to Richard Oldfield of Oldfield Partners, this demonstrates that the boardrooms of Tokyo are starting to take the importance of shareholders seriously. “We have been really impressed by the seriousness of this new emphasis. It comes both from the top and from the bottom; from the government and the authorities on the one hand, and from shareholders on the other.”
Some companies excluded from the new index have reacted by immediately announcing share buyback programmes. Last year, share buybacks for Japanese businesses amounted to ¥4 trillion, roughly double the record in any previous year, and already this year about ¥1.8 trillion has been announced. Yet, as Oldfield points out, there is one significant difference between Japan and other markets in which share buybacks have been prevalent this year. “Share buybacks in the US have been immense and one might be slightly sceptical about this piece of financial engineering when it is done with borrowed money. Yet in Japan it is all from the huge cash piles which so many Japanese companies have as a consequence of the sloppy balance sheet management of which many of us in the West have been critical for years.”
A world of income opportunities
The European Central Bank began its programme of quantitative easing in January, the consequences of which have seen bond yields fall to their lowest-ever levels and the euro currency weaken versus its peers. Furthermore, government bond yields remain low against equities in relative terms – making shares, rather than bonds, a more attractive option for income investors.
Yet looking beyond the UK, traditionally one of the highest-yielding markets, there are plenty of opportunities for equity income investors. In the US, pay-outs from S&P 500 companies reached $93 billion in the fourth quarter of 2014; and this figure was eclipsed in the first three months of this year, which saw some $99.4 billion paid out in dividends. This trend looks set to continue, according to Stephen Thornber of Columbia Threadneedle: “We expect global dividends to keep growing in 2015. Although a stronger dollar is likely to be a challenge for some US multinationals, we expect shareholder-friendly activity to continue.”
The global dividend story is not just about the UK and US, though. Thornber cites a “slow but discernible change in Japanese corporate behaviour, with many companies committing to making or raising dividend payments”. Thornber’s team believes the potential is significant and calculates that Japanese businesses return just 42% of profits to shareholders – equivalent figures in Europe and the US are around 60% and 80% respectively.
In an environment where some of the traditional asset classes favoured by income investors are looking less attractive – in historic terms – Thornber believes that equities represent the best value and should continue to offer an attractive and growing income when compared to bonds, even if bond yields start to rise. However, he points out that diversification remains an important watchword. “The long-term opportunity in Japan is very meaningful and underlines the importance of not being constrained to investing in only one country or region.”
AXA Framlington, Columbia Threadneedle and Oldfield Partners are fund managers for St. James’s Place.
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