Market Bulletin - As the dust settles
One week after the Bank of England announced measures designed to stimulate the economy, commentators are beginning to digest the implications of its actions.
Whilst the tide of global policy loosening continues, the argument that central banks have exhausted their stores of ammunition continues to grow more vocal, as some market commentators have expressed concern about the diminishing returns of monetary stimulus. This may be true from an economic perspective, but history has shown that easy monetary policy is supportive for asset prices, including equities. Whilst a very short-term study, the performance of global equities last week appeared to support that case.
Equity markets broadly shrugged off any overarching economic concerns and posted gains across all but one of the major indices. In London, the FTSE 100 Index closed up 1.8% over the week. Mining stocks stuttered in Friday trading, halting progress in what had, until then, been a strong week. Despite the muted end to the week, the headline UK index clung on to finish at a 14-month high.
The fate of the EuroStoxx 600 mirrored that of its London equivalent, gaining over the first four sessions of the week – closing at its highest since June 23, the date of the UK’s referendum on EU membership - before falling back slightly on Friday. The index recorded a weekly gain of 1.4%.
Japanese markets closed on Thursday for Mountain Day – the newly-added public holiday intended to strengthen the nation’s appreciation of mountains in Japan. The enforced rest appeared to rejuvenate the Nikkei 225, which bounced 1.1% on Friday and 4.1% over the week.
Perhaps surprisingly, it was the US which trailed behind, although the weekly numbers hid a significant event not seen since 1999. The S&P 500 Index, Dow Jones Industrial Average and Nasdaq Composite simultaneously closed at record highs on Thursday. Yet by midday on Friday all three had fallen slightly from their peaks. The S&P 500 closed down fractionally – just -0.13% - over the week.
Give an inch
The Bank of England’s (BoE) interest rate cut equates to a saving of just £20 per month in the pockets of the average variable rate mortgage holder; a helpful move, but hardly likely to transform the UK economy. Many now point to the addition of fiscal stimulus as the required tonic for a sustainable, long-term recovery.
The cut to interest rates further undermines the profitability of the beleaguered banks, the lifeblood of the economy, and twists the knife into the already beaten-up saver.
Reports last week revealed that a number of banks and building societies have taken steps to preserve profit levels by slashing the rates paid on deposit accounts by more than the quarter percentage point cut. According to data from Moneyfacts, there have been 207 savings rate cuts since the start of August, and an incredible 1,281 since the start of the year. More worrying for those relying on deposit income is the suggestion that the falls could be set to continue.
With banks no longer needing to rely on savers’ deposits to fund mortgage lending, commentators are speculating that the ‘race to the bottom’ may well have some distance to go, highlighting the need for savers to seek out sustainable, alternative income solutions.
In the eurozone, Mario Draghi continues to implore political leaders to undertake structural reforms and pro-growth policies, but to little effect. However, news that the EU last week agreed to waive fines for Spain and Portugal over their excessive budget deficits was potentially viewed by some commentators as the precursor to what could become full-blown fiscal stimulus in Europe.
Both governments had breached an EU rule of ensuring budget deficits do not exceed 3% of their GDP. Spain has been given two more years to bring its deficit below the limit, while Portugal has another year to reduce its shortfall. The waivers come as anti-austerity sentiment across Europe increases. With elections looming in France and Germany, incumbent governments might decide that fiscal policy represents a decent bet to win over voters.
A further impact of the BoE’s financial stimulus package has been the acceleration in the collapse in returns on gilts. Yields on British government bonds traded in negative territory on Wednesday, increasing fears that the fall in government borrowing costs could signal a deepening funding crisis for the UK’s pension industry.
The fall in gilt yields has expanded the significant deficits that employers are having to manage. Total deficits of the UK’s 6,000 private-sector final salary pension schemes climbed by £24 billion last month, according to estimates by the Pension Protection Fund.
The Royal Mail is the latest company to report problems. More than 900,000 staff at the postal operator have been warned that the scheme may have to be closed by 2018.
That gilt yields are being artificially depressed will be a further blow to those planning to secure a guaranteed income from their pension pot. Annuity pay-outs reflect returns on gilts; when gilt yields fall, annuity rates also fall. Last week, it was reported that many of the biggest annuity providers were offering rates up to 8% lower than at the beginning of July.
Although the new fiscal stimulus package is designed to keep the economy ticking over, retirees may ask if their needs are being factored into the Bank of England’s thinking.
Commodity prices, in particular oil markets, were back in focus this week. Prices rallied on fresh hopes that OPEC could agree to a production freeze. Brent crude was up nearly 2% in Friday trading, adding to gains secured earlier in the week, closing at $46.77, but still some way short of the $50 mark reached in June.
Yet the threat of a slowdown for the broader global economy saw the International Energy Agency forecast falling demand for oil. Despite this, the agency also reported that some of the biggest producers continue to increase output to record levels. Saudi Arabia’s production (the second largest OPEC member country), reached new heights during July, just as some oil exporting countries were beginning to worry about supply once again.
Hamish Douglass of Magellan stresses that, whilst oil prices have the potential to shift the economic picture, they are less of a concern for his portfolio. “The oil price has a very limited impact for us. We don’t invest in energy stocks and so we don’t have oil-sensitive earnings. Oil has a very modest input as a commodity cost into many of the businesses we invest in, but in terms of direct earnings impact on our holdings, it’s very small.”
And whilst central banks are loosening monetary policy in a bid to reboot their respective economies, Douglass believes that oil prices are potentially more important to the broader economy, particularly as a catalyst for creating inflation. “Oil does impact overall inflation in the world. It had a large deflationary impact as it fell from under $120 to low $20s. If the oil price was to rise it may well put pressure to increase interest rates and subsequently inflation will start to increase.”
Magellan is a fund manager for St. James’s Place.
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