Market Bulletin - Clear signal?
Resilient equity markets post strong monthly gains as the US Federal Reserve leaves the door ajar to a December rise in interest rates.
“The bears are in hibernation,” quipped market strategists as a month dominated by central banks’ activity ended with global markets clawing their way back to near record highs. After a bruising August and September, the FTSE All-World Index gained 8% in October, its biggest monthly rise in four years. European equities had their best month for six years, as optimism mounted that the European Central Bank would bolster its asset-buying programme, and US stocks registered their strongest month since 2011. The FTSEurofirst 300 gained 8.3% and the S&P 500 returned 8.7%, taking both indices back into positive territory for the year.
The key event of the week came on Wednesday, when the US Federal Reserve left interest rates unchanged at the end of its October meeting. However, after weeks of mixed messages, the accompanying policy statement laid down the clearest marker yet that there is a serious possibility of a rise in short-term interest rates in December. The more hawkish tone surprised markets, which moved quickly to imply that the odds of a move on 16 December were slightly better than 50%, up from 33% before the statement. In taking the rare step of highlighting a future meeting for possible action, the Fed appeared to be following the tactic of the European Central Bank to tell the market that a policy change is coming.
Significantly, the statement also dropped any reference to risks to the US economy from global developments, suggesting that domestic economic indicators will be the key determinants of the timing of the Fed’s move.
The first indicator was Thursday’s news that US economic growth had slowed sharply in the third quarter. Gross domestic product grew at an annualised rate of 1.5% between July and September, down from 3.9% in the second quarter. The slowdown was largely attributable to companies running down warehouse stockpiles to meet demand, a factor unlikely to be repeated in the coming quarters. Strong domestic sales growth suggested the fundamentals of the economy remain strong. US consumer spending also remained robust, with household consumption rising 3.2% over the quarter.
“The falling oil price has been a big factor in the US recovery, holding back wages inflation but also boosting consumer expenditure,” commented Hamish Douglass of Magellan Asset Management. “Importantly, the savings being made by households are not yet all being spent.” Douglass also pointed towards employment indicators that suggest the US economy is growing steadily, albeit with some headwinds. “There are now more job openings in the US than ever before, and we’ve recently seen a big change in the move from part-time to full-time employment."
At the moment there is considerable disparity between the opinions of the US Federal Reserve and the markets over when interest rates will rise. There are two US payroll announcements before the Fed’s meeting in December. It is anticipated that if employment rises by about 140,000 or more in each, then market expectations of a rate rise in December will increase, narrowing the gap between the two opinions and making it easier for the Fed to tighten without creating a potentially nasty surprise for equity and bond markets.
However, the Fed’s new language by no means makes a rise in December a certainty. Capital Economics still anticipates that it will be delayed until early next year, noting that a number of Fed governors were holding out for firm signs of acceleration in wage growth and/or price inflation.
As speculation continues over the timing of monetary tightening in the US, the opposite is the case in the eurozone, as inflation and unemployment data released last week signalled that the ECB might soon have to extend its programme of quantitative easing, as suggested by bank president Mario Draghi earlier in October.
Eurozone inflation returned to zero in October, from -0.1% in September, and there were similar small improvements in the unemployment rate, which is now at its lowest since January 2012. While the numbers show the eurozone recovery remains on track, it seems increasingly likely that a shift in gear will require the ECB to ease monetary policy in December. That is something the Federal Reserve will need to weigh into its decision, as further ECB stimulus will drive up the dollar.
Japan’s equity market also reflected the more optimistic mood. The Nikkei 225 rose 1.4% over the week and 9.7% in October; the best monthly showing since 2013. The gains came despite the Bank of Japan opting to leave monetary policy unchanged, following considerable speculation that it would step up the pace of its annual asset purchases from the current level of ¥80 trillion, equivalent to 15% of GDP. Although core inflation increased to 0.8% in August, it is still well below the 2% target. It is also anticipated that Japan’s third-quarter GDP data, to be released in mid-November, will show that the economy fell back into recession, further increasing the likelihood of additional stimulus measures at some point soon.
Preliminary figures from the Office for National Statistics showed that the UK economy’s growth slowed in the third quarter to 0.5%, down from 0.7% in the second quarter. The announcement had been preceded by a CBI survey showing that manufacturing production fell in the three months to October for the first time in two years, underlining concerns about the UK economy’s over-reliance on the services sector and consumer spending.
The growth figures were weighed down by the biggest fall in construction output in three years, although Capital Economics pointed out that the measure is especially erratic and was probably hit by August’s wet weather and the financial market mayhem over the summer. Accordingly, the belief is that the slowdown should be short-lived and that annual growth for 2015 is heading for a healthy, if slightly below trend, 2.3%. Nonetheless, the news seems to reduce the chances of an interest rate rise in the near future. According to a Reuters poll, economists have pushed back their average forecast of when the Bank of England will start to raise interest rates to the second quarter of 2016.
The FTSE 100 Index ended the week down 1.29% to register a monthly gain of 4.63%.
On Tuesday, Chancellor George Osborne confirmed that the government will not announce any changes to the pension tax relief regime until next year’s Budget. Following the end of the government’s consultation on radical proposals, that included an end to the current system of upfront tax relief on pension contributions, it had been widely anticipated that changes could be announced in this month’s Autumn Statement.
The pension industry has been largely supportive of proposals to introduce a flat rate of tax relief of 30%, which would make pension saving more appealing to basic rate taxpayers but lessen the attraction for higher earners. There was widespread relief that the government has accepted the need to take its time to consider complex and challenging reforms, but recognition that significant changes are now very likely to form part of next year’s Budget.
For higher earners, the message is very clear: maximise pension contributions in the current tax year to make the most of the current tax breaks.
Hamish Douglass of Magellan Asset Management is a fund manager for St. James’s Place.
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