Market Bulletin - Signs of spring
Despite political and policy risks, markets struck a positive note last week, putting aside the year’s uncertain start.
The benefit of hindsight is meant to be educational, but it can also provide some satisfaction. In mid-February, the MSCI World Index hit its lowest point since 2013, as fear spread and volatility spiked.
Last week, it finally ended above where it had started the year. The S&P 500 rose a further 1.7% over the week, taking its gain so far in 2016 to 3.5%. The FTSE 100 rose 2.3% over the five-day period and has climbed more than 4% this year. There may be more volatility ahead, but returns year-to-date are just reward for investors who held their nerve in mid-February; at that point, the S&P 500 was 10% below where it began the year.
The recovery in the oil price has been perhaps the most important driver of a change in sentiment and last week it reached a four-month high. Despite a dip late on Friday, the cost of a barrel of Brent crude ended the week above $40, a far cry from the 12-year low of $30.34 it dipped to in January. Nevertheless, rumours of a deal on production cuts have yet to prove well-founded. Moreover, last week it emerged that World Bank lending to commodity exporters this year is at its highest level since the immediate aftermath of the financial crisis.
If oil is less cheap than it has been, it is still far below the price levels on which many energy companies had until recently been basing their forecasts and investment decisions. Last week, the IMF cited weak commodity prices and China’s slowdown when cutting its forecast for global growth in 2016.
Despite the continued move into positive territory, markets still found plenty to worry about. Few investors are holding their breath for good news during corporate earnings season; Thomson Reuters is forecasting that S&P 500 companies will announce a 7.9% drop in earnings for the first quarter, the steepest dip since the financial crisis. Not all of the downward shift can be blamed on a strong dollar or cheap oil – corporate profit growth remains a concern. Nevertheless, consumer companies could take heart that US inflation ticked up a notch last week.
In fact, many of the fears preying on markets concern politics and policy, rather than the economic and corporate outlook. Last week five out of eight US banks classified ‘systemically important’ were warned by the regulator that their ‘living wills’ (which are supposed to provide details of a bank’s orderly liquidation process) were inadequate. Central bankers are playing their part in driving markets, too. A more dovish Fed has placated investors in recent weeks and helped to cut the value of the dollar after its strong rally earlier in the year.
Policy decisions are proving critical in emerging markets too. At the weekend, Brazil’s lower house voted to start impeachment proceedings against President Dilma Rousseff. Polls show support for her impeachment is high. Neighbouring Argentina finds itself the beneficiary of the reforms initiated under its president of four months, Mauricio Macri. Last week Macri toured the US and UK to encourage investors to take him up on Argentina’s first sovereign bond offering since 2000. Initial signs are that the offering, which may be as much as $15 billion, is garnering plenty of interest.
In China, figures published last week showed first-quarter growth slowing only marginally to an annualised 6.7%, while trade took an unexpected turn for the better, as exports jumped 18.7% (in local currency terms) in March. Nevertheless, China’s sapping effect on global commodities prices showed no signs of abating – the government confirmed last week that, even allowing for restructuring plans, it will retain excess steel capacity.
If commodities dominated worries at the start of 2016, the focus has since shifted somewhat to the decisions of politicians and central bankers. In a report published last week, Bank of America Merrill Lynch said that the greatest ‘tail-risk’ in the world economy at the moment was not Chinese growth or commodities prices but ‘quantitative failure’ – the risk that central banks might fail in their attempts to boost growth and prevent deflation via quantitative easing (QE).
Last week, the Bank of England chose to leave interest rates unchanged, even though figures released last Tuesday showed inflation at a healthier 0.5%. Meanwhile, as the dovish policy of the European Central Bank continued to frustrate politicians in Germany, both the French government and the chair of Germany’s Bundesbank chose last week to rebuke critical German politicians for placing too much political pressure on the ECB, saying that it undermined the bank’s independence.
In southern Europe, where dovish central bank policy is welcomed, Italy pressed ahead with plans to create a bailout fund for its major banks, while the Greek prime minister used an article in the Financial Times to reassure investors that Greece was introducing reforms and paying off debt – and to warn the IMF against being too draconian in its policy prescriptions for the country. The potential for political discord in Europe remains high, as reflected in the rising popularity of less moderate political parties across Europe. Nevertheless, European markets performed well midweek, helped by mining and banking stocks, as well as Chinese export data; the FTSEurofirst 300 ended the period up 3.5%.
Yet the second-greatest risk (after QE failure) cited by Bank of America Merrill Lynch in its April report was neither trouble in the eurozone nor debt in Europe’s banking sector – instead, it was ‘Brexit’. Despite its 11% drop in value this year, the cost of insuring against a further fall in sterling is now at its highest level since the financial crisis. One of the major banks to voice its opposition to Brexit last week was UBS, which warned that sterling could lose almost a third of its value if the UK leaves the EU. Last week Vote Leave, the more moderate pro-exit group, was designated as the official pro-exit campaign representative, rather than Grassroots Out, which is led by Nigel Farage. Polls show the pro-remain campaign marginally in the lead, but bookmakers forecast a clearer vote in favour of remaining in the EU.
Markets in Japan remained focused on politics and policy last week, too. A slight drop in the value of the yen helped the Nikkei 225 to clock up a 6.5% rise over the five-day period, although the index remains significantly down since the start of the year. The combination of pro-business government policy and radical central bank easing in Japan has so far failed to deliver the growth and inflation numbers the country’s leaders had hoped for.
Perhaps above all, it has failed to move the yen downwards and last week Japan’s currency struck a 17-month high against the dollar, before retreating slightly. In a meeting in Washington last week, Japan was warned not to devalue its currency, but Tokyo may feel its options are running low. Even since the central bank introduced negative interest rates on 29 January, the yen is up some 12% against the dollar.
While votes and policy remain such a preoccupation for markets, the risk of volatility is never far away. But after the turnaround of the first quarter, long-term investors should know the value of sitting tight.
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