Market Bulletin - Plain sailing?
February ended with stock markets advancing at a steady clip and moving clear of the turbulence that marked the start of 2015.
February closed with global stock markets advancing at a steady clip and moving clear of the turbulence that marked the start of the year – as the FTSE 100 index also sailed to a 15-year high. Global investors have been buoyed by the European Central Bank’s (ECB) decision to launch its €1.1 trillion or more bond-purchase scheme, as well as Athens’ temporary deal with its creditors and, for now, the receding threat of a Greek exit from the euro. World equity indices were up over the month as global investors sought out stocks that reflect renewed growth potential across the global economy – not just in the US but also in Europe too. And the continued slide of yields on government bonds to near-record lows has further encouraged investors towards equity markets.
There has been a flurry of positive news for America’s economy too. More than one million jobs have been created in the world’s premier economy over the past three months, which is the strongest employment growth since 1997. A further 240,000 new jobs are expected in February. US unemployment is one of the lowest among the developed nations; while its growth rate is one of the fastest. Although the recovery is at half the growth rate of the 1990s, the US economy is, by the month, displaying more of the momentum sought this decade. Deflation is a concern; but consumers are benefiting from lower prices and increased expendable income – and should, crucially, spend more.
As the US economy gathers speed, Janet Yellen, the chair of the US Federal Reserve, continues to prepare the decks for a possible interest rate rise later this year. In her appearance on Capitol Hill last week, Yellen stated that the economic recovery is solid and there are signs that wages have started to pick up. However, she is faced with a fine balancing act: the Fed wants to increase rates but fears a further strengthening of the dollar that could make exports less competitive, imports cheaper, risk deflation and threaten to halt the recovery. Consequently, Yellen gave more of her nuanced signals to markets – the message is that she is inclined to raise interest rates, but not until the summer.
Financial markets reacted positively last week to the Fed’s steady-as-she-goes message and the prospect of present monetary conditions persisting to the second half of the year. Although the S&P 500 hit a record high earlier in the week, the benchmark US index was slightly down at the end of the week to 2,104 points amid continued uncertainty for the energy sector over the direction of oil prices. However, the S&P 500 has gained 6% over February as the strong dollar, the deepening recovery and growing business earnings attract investors. One sign of the confidence is the advance of cyclical stocks, particularly from the consumer, technology and industrial sectors. Meanwhile, utility stocks – last year’s favourite – were the S&P 500’s worst performers in February and dipped to a two-year low.
In Asia, news that Japan’s civil service pension fund – which has ¥7.6 trillion of assets under management – is to treble its exposure to domestic equities nudged the Nikkei 225 Stock Average to a 15-year high of 18,865 points. The benchmark Japanese index advanced 6.4% in February – its best month since November. Japanese equities are also reflecting the growing confidence in the Japanese economy, which has been supported by loose monetary policy, a weaker yen and the fall in oil prices. Schroders’ chief economist Keith Wade is upbeat for Japan’s economy and stock market. Lower oil prices are a big boost for Japan’s energy import-oriented economy, says Wade, while Japanese business looks “very competitive” as increased exports look set to support economic growth this year.
European stock markets have also drawn strength from the ECB’s quantitative easing programme, signs of improvement in the eurozone economy and stronger corporate earnings. The German parliament’s support of an extension of the Athens bailout also boosted European equities. The FTSEurofirst 300 index advanced 2.5% last week to close on Friday at a seven-year high of 1,565 points. The index has gained 14% his year, as investors seek the value offered by the region’s corporates (as consistently highlighted by fund manager S. W. Mitchell Capital). The ECB this week is expected to hold near-zero interest rates as it fleshes out the detail of its bond-buying programme. In this environment, government bond yields continue to fall, with the 10-year German debt at a record low last week.
The UK stock market has also emerged from February with confidence. The FTSE 100 index breached the 6,950-point mark last reached on the final trading day of 1999 and, on Friday, touched another high before closing at 6,947 points. The ‘Footsie’ is up 6% since the start of 2015, as it benefits from low interest rates, central bank stimulus and the UK recovery. The FTSE 100 last year underperformed other leading indices – despite the UK recovery and partly due to its international horizon – but many believe that the conditions are in place to pass the 7,000 line soon.
The Footsie’s resurgence seemed to have been greeted with rumination rather than a fanfare. Certainly, there has been plenty of change to reflect on in corporate Britain over the last decade and a half – and only half of the index’s members have survived the intervening years. Since 1999, there has been the dotcom bubble; the optimism for global growth in the years to 2007; the crisis of 2008–09, and the hit taken by Britain’s banking stalwarts; recession and austerity; and the recent fall in commodity prices. One big change has been the demise of telecoms and technology and the rise of energy and mining stocks – a shift that has made the Footsie more a bellwether of the global economy.
The FTSE 100 is almost double the 3,512 points low it hit in March 2009. Investors have become accustomed to low bond yields and near-zero returns on deposits and have looked to equities for returns – the dividend yield on the index is 3.4% compared with the 1.8% from 10-year government bonds. One of the casualties of the financial crisis, Lloyds, also announced it would pay dividends for the first time since 2009. (Lloyds was one of the Footsie’s major dividend payers in 2008.) Nick Kirrage of Schroders sees the move as very positive. “A dividend needs to be a flag of something sustainably improving,” he says. “Banks will be a massive theme for income funds in the next three years.”
The long voyage
While the FTSE 100 surpassed its 1999 peak, Barclays also published its 60th annual study of long-term investment patterns. Barclays charts the course of stock markets since 1899, with events such as world wars mere features on the long voyage for equities. For example, £100 invested in 1990 would have returned £750 now, including dividends. And it is dividends that are crucial in this story – and that have risen each year since 1945. Returns on shares, for short periods, may have fallen behind government bonds and cash – and the returns on these assets are dwindling – but it is equities that have rewarded investors who invest steadily through economic cycles and events (an approach exemplarily pursued by Warren Buffett, who wrote his 50th and last annual shareholder letter at the weekend).
The Footsie’s high will be welcomed by the government as a sign of investor confidence ahead of May’s election, amid falling inflation and unemployment. But there are political uncertainties – beyond the election’s outcome – that could spell stock market turbulence. A nationalist landslide in Scotland could bring another referendum on the Union. And, if David Cameron holds power, a referendum on membership of the European Union (EU) looms in 2017. William Hill offers 3:1 odds on Britain’s exit of the EU; think tank Open Europe puts this at a one-in-six chance. Business leaders such as Martin Temple, of the manufacturers’ lobbyists EEF, are talking of a “sleepwalk out of Europe”.
Meanwhile, the once-sleepy world of pensions has become an election battleground, with Labour unveiling plans to take £2.7 billion from pension savers to fund lower university fees. The proposals hinge on a cut in the annual pension allowance to £30,000 from £40,000, a reduction of the lifetime allowance to £1 million from £1.25 million, and a decrease in tax relief to the 20% rate for those earning over £150,000. Although the finer details are lacking, the proposals have been widely received as a political raid on middle-income savers. As John Cridland, director-general of the Confederation of British Industry, – concludes, they would make it “very difficult for people who are trying to save for the long term”. One practical conclusion is clear: if you can, make the most of current rules while they are in place.
S. W. Mitchell Capital and Schroders are fund managers for St. James’s Place.
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