Market Bulletin - Playing safe
US interest rates are left unchanged as the Federal Reserve expresses ‘global’ concerns.
The most important event of the week was, in fact, a non-event – the US Federal Reserve chose not to raise interest rates. The downbeat comments which accompanied the news prompted some rotation out of equities and into bonds.
After weeks of anticipation and debate, the 0–0.25% target range for the federal funds rate stays where it is, at least for the time being. The decision of the Fed’s monetary policymaking body, the Federal Open Market Committee (FOMC), was not announced until late on Thursday. While they waited for it, US and European equity markets had rallied earlier in the week, even as Chinese stocks endured yet another sell-off. Some had expected a rate hike, but the majority opinion was that the Fed would pass, so the decision was not a huge surprise. Since July, the International Monetary Fund has urged it to wait until 2016. On Wednesday, Goldman Sachs’ CEO Lloyd Blankfein also counselled delay, saying that the economic data “isn’t compelling an interest rate rise at this point”.
What really struck markets, however, was the tone of the accompanying statement and remarks by Fed chairman Janet Yellen. “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” the statement said. For ‘global’, read ‘Chinese’. Yellen underscored the point, saying that the outlook abroad had become less certain. She referred to the lack of “deftness” shown by the authorities in handling China’s recent market turbulence, and said there was a risk of an abrupt Chinese slowdown.
The FOMC has two more meetings this year, in late October and mid-December. Though a majority of its members still expect a rate rise before the end of the year, the number of those who expect no move before 2016 doubled from two to four. The committee thought the US economy would grow 2.1% this year, slightly faster than previously expected, but downgraded its GDP growth forecasts for 2016 and 2017. It did not think the outlook for the US economy had changed significantly since its last meeting in June. However, markets reacted both to the cautious tone and to the tacit acknowledgement that the Fed is no longer master of its own destiny. The S&P 500 fell 1.6% on Friday, though it was still 0.2% up on the week.
With the Fed highlighting growth worries, commodity prices fell, and oil dropped by nearly 2%. Only gold benefited, rising almost 2% to $1,138.50 per ounce. All major developed world equity markets slid by more than 1% on Friday.
Yet, as Geoff MacDonald of EdgePoint recently reminded investors, market falls should not be feared by long-term investors. “Market turbulence often presents us with opportunities to buy a business for less than what we think its worth. It’s our job to know the value of a business and to capitalise on that volatility. Volatility is simply the bumps in the road on your journey. You can’t invest in the stock market and think for a minute that you’re going to go straight up. The lesson here is that volatility is not an ‘if’ but a ‘when’ and it’s what we do when it happens that really matters. If you don’t sell, you should equate it with opportunity and not financial loss.”
While equities fell, so did government bond yields as their prices were bid up. Ten-year German Bund yields shrank by 12 basis points to 0.66%, their biggest fall since June. The Fed’s decision makes it easier for the European Central Bank (ECB) to expand its €1.1 trillion quantitative easing (QE) programme. Since QE involves buying bonds, any expansion would support their prices.
French government bonds, however, will be hurt by the decision of credit rating agency Moody’s, announced on Saturday, to cut France’s credit rating from Aa1 to Aa2, two notches below the topmost rating of Aaa. Moody’s pointed to what it called “the continuing weakness in France’s medium-term growth outlook”, a weakness it believed would last for the rest of the decade. It added that low growth would make it difficult for the government to make a material reduction in its high debt burden.
The Organisation for Economic Co-operation and Development has raised its 2015 GDP growth forecasts for the eurozone from 1.5% to 1.6%. It warned, however, that the currency union was not reaping the full benefits of the drop in commodity prices and the depreciation of the euro, and should be growing by one extra percentage point. It blamed the inadequate strength of the banking system and insufficient progress in writing down bad loans. The FTSEurofirst 300 Index fell 1.9% on Friday to finish the week 0.25% down.
In Greece, the left-wing Syriza party won a second general election in less than nine months, seemingly vindicating the decision of its leader Alexis Tsipras to accept austerity measures in return for more bailout cash. However, the party again failed to win a majority and will form a coalition with the nationalist Independent Greeks. But the country still faces formidable challenges. In October, creditors are due to review its progress on fulfilling the terms of the bailout.
France was not the only nation to have its homework marked down by the rating agencies. Standard & Poor’s cut Japan’s rating by one notch and criticised Prime Minister Shinzo Abe’s economic strategy, noting that economic support for Japan’s sovereign creditworthiness had weakened in the past three to four years. Abenomics, it said, would not reverse this trend in the medium term. The Nikkei 225 index lost 2% on Friday, to close 1% down on the week.
Although China’s stock markets suffered another difficult week, other emerging markets fared better, with India, South Korea, Turkey and even Brazil posting solid gains. The first week of positive inflows in three months suggested investors were taking advantage of certain valuation measures which show emerging markets trading at a 35% discount to developed markets, the largest in 12 years. However, fund manager BlackRock was quick to remind investors that the emerging markets are not a homogenous area and advocated selectivity, whilst reminding investors of the need to pay attention to currency risks.
Back to zero
In the UK, the FTSE 100 Index fell 1.3% on Friday, as mining and energy stocks mirrored the Fed’s growth concerns, leaving it 0.2% down over the week. Average earnings in the three months to July rose at their fastest rate for six years. Consumer price inflation fell back to zero in August, from 0.1% the month before. This was in line with the consensus forecast and was helped by a fall in petrol prices. Core inflation, which leaves out volatile food and energy prices, also fell, from July’s 1.2% to 1%.
Economists say the Consumer Prices Index will hover close to zero for most of the rest of the year, and could even fall back into negative territory. “With productivity finally picking up and keeping unit wage costs subdued, inflation will still take a long time to return to its target,” said Vicky Redwood of Capital Economics. “Accordingly, the [Bank of England’s] Monetary Policy Committee can take its time with the first interest rate rise.” Citigroup economists pushed back their forecast for a UK rate rise from the first half of 2016 to the last three months of the year.
EdgePoint and BlackRock are fund managers for St. James’s Place.
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