Archive for May, 2014
Towards the end of last year this blog noted that growth would be a key theme for 2014: “A gathering of momentum … should see gloom continue to recede from markets which have had to trudge through a bruising and tedious few years.”
And then we had news out yesterday that the US economy shrank a little in Q1, contrary to the advance estimate that it was ever so slightly up. Two weeks previously, the eurozone economy was reported to have grown by 0.2% in the same period – half the forecast rate.
So is growth falling away again? And if so, will we see gloom return?
The answer to the second question, so far, is a clear “no”. The last time we had a negative quarter for US GDP was Q1 2011. When reported in the summer of that year it triggered an almighty panic; this week’s news hardly caused a ripple. Of course the market backdrop is different now, with the sovereign debt crisis not as raw and the credit crunch more distant a memory. But the evidence on the first question suggests that markets are behaving rationally rather than over-exuberantly in taking Q1 data in their stride.
Weakness in the US was widely expected in the first quarter. We know that the very harsh winter had a role to play and there seems to have been some contraction due to inventory building in 2013. Both these may fall away – and other data strongly suggests that they will do so, with durable goods orders, retail sales, manufacturing output and consumer confidence all rebounding from winter lows, real estate activity stabilising with mortgage rates and unemployment measures declining convincingly.
The European picture is a little more equivocal, with much of the shock being due to unexpected stagnation in France (a risk I highlighted back in January). And we wait to see just how negative the effect of last month’s sales tax hike will have been in Japan. At the same time, however, GDP growth here in the UK has held its ground admirably, activity indicators suggest it will continue to do so and only this morning, the consumer confidence index from GfK reached its highest level for over nine years. In Europe too, the broad economic sentiment indicator for the eurozone as a whole has kept on climbing even as French business sentiment has weakened a little.
It is always disappointing to see economies shrink of course, and a blemish on recent quarters for the developed world. Up until the US data revision this week the American, eurozone, Japanese and UK economies had all been growing for four consecutive quarters, the longest unbroken stretch since the early days of recovery from the Great Recession in mid-2009 to 2010. But looking at the bigger picture it seems very unlikely that we are about to experience another round of sclerosis a la 2012.
Altogether, then, the growth picture is consistent with the conclusion drawn last week regarding corporate activity: that we are witnessing an unwelcome hiatus rather than a more serious trend reversal. Again, this is not an especially exciting position for the world to be in; but given the form which excitement has tended to take in recent years, we should not perhaps feel overly glum about this.
A little over a year ago we looked at nascent signs of a revival in merger and acquisition activity, noting that a continued pickup last year would be both a symptom and cause of improving sentiment in equity markets. So it proved: global deal count, transaction value and average premium paid all increased on 2012, and we know what a great year for the major equity markets it turned out to be.
This year the takeover pattern is much stronger. Much attention has been given to the huge offer made by Pfizer for AstraZeneca; despite its recent rejection by the target’s board, major shareholders have understandably been calling for the arm-wrestling to continue. Including this deal the total volume of transactions announced so far this year would reach well over $1.6trn – but even putting it aside, other deals have reached $1.5trn, which compares to $1.2trn for the first two quarters of last year (and remember, we’re just over half way through Q2). In fact the Q1 number of $835bn was the highest recorded over any quarter since the middle of 2008.
Inevitably it is not just the mega-cap deals which go to make up this number. There has been a lot of activity in the mid-cap space too, across a range of regions and sectors. The Dixons-Carphone merger is a good UK example; there have been some similar-sized private equity acquisitions; and perhaps most interestingly, the pace of sizeable outright purchases from corporates has picked up too. In the $3-5bn area there has been predictable buying from giants such as Apple and Google, but also from such diverse enterprises as Sun Pharma, Fiat and Rolls Royce.
There is a lot of sideways profit making from this activity. The investment banking fees for the Pfizer-AstraZeneca deal were estimated at about $300m. And inevitably, there are legal fees and the occasional bitter lawsuit to throw into the mix too. This tends to put some extra zing in the step of those at the institutions which benefit from the flow, and in itself certainly does sentiment in the financial world no harm.
But this blog’s bigger interest is in the broader market picture. We know that equity markets got 2014 off to a choppy start, though returns to many asset classes have been unspectacular in either direction over the whole year to date. Continued strength in M&A activity, however, suggests that corporate confidence has not been affected. And it is good to see some of that fabled “cash sitting on balance sheets” being put to work. Again, this cuts two ways: business investment can stimulate growth, and increasing growth gives businesses the confidence to invest.
This is not to say that markets should have been more aggressively positive this year. But it would surely be foolish to dismiss the flow and value of M&A deals as irrelevant. What we should perhaps draw from this information is that in considering the various ways forward for the pricing of risk, increased corporate activity is a constructive signal; and with all appropriate guardedness, this could mean that the current stagnation will turn out in due course to have been a pause in certain trends rather than a drawn out reversal.
As this week showed, markets remain jittery. The FTSE 100 had edged up to a new high of 6878 on Wednesday, only a handful points short of its all-time closing peak of 6930 in 1999, only to give up its gains yesterday in the biggest daily fall for a month. At the same time, the ten year gilt yield – which had been stuck in a range of between 2.6% and 2.8% for three months – broke lower in the biggest one day fall since January to reach its lowest point since last July. And continued euro weakness saw the pound reach a new high of 0.814 (or 1.23 for those of us who prefer our sterling exchange rates the right way round), its strongest level against the euro since January 2013.
In fact, listen to some fund managers and 2014 has been a shocker. Technology shares, which were supposed to keep going up, have underperformed, with the NASDAQ down in absolute terms and 4% behind the S&P 500 for the year to date. Indeed, some of the big internet names in particular have taken a major bath: Amazon is down 26% and LinkedIn down 33%. Last year’s massive bull trend in Japan is nowhere to be seen with the Nikkei 225 down 13%, comfortably the worst performer of any major market. Emerging markets have been outperforming (by 5% over the last three months). Duncan’s horses have turned wild in nature and gone for a picnic. For many participants it has been a bruising time.
And yet in truth, things have not been as exciting as it has sometimes felt. Equity market volatility has not been anything like as high as it was when the taper tantrum kicked off just under a year ago. Indeed, some swift linear regression to the FTSE 100 over the last 12 months shows that its line of best fit has risen 4.5% in price terms over the period. Coupled with a dividend yield of about 4% and CPI inflation of an average 2.3% over the same period and you’re looking at a real return of 6.2%, which is so near to the textbook number for expected long run returns to equity as makes no difference. Putting it another way: the equity market, despite patches of volatility and some sector fireworks, has in aggregate been quite boring – and that was always the consensus view for the major markets going in to 2014.
The economic data has been unspectacular too. Eurozone GDP for Q1 out yesterday was a little weaker than expected, but there was nothing to derail the expectation of dull and sluggish – but positive – growth this year. Employment data has continued to show measured strengthening at home and in the US, while in both countries, activity indicators have stayed healthy though below recent peaks. There have been no signs of further deterioration in EM, nor any evidence of anything beyond a gradual uptick where numbers have been positive. On the political front the Ukrainian situation remains worrying, but there has not yet been anything to match the annexation of the Crimea and there have been no more big surprises elsewhere.
In fact wherever you look – eurozone bond markets, precious metals, credit spreads, oil and gas – there have been occasional episodes of excitement, but nowhere near enough to keep the casual viewer watching. It has been a dull old time. (Unsurprisingly this will have benefited dull old portfolios. Income investors, both within equity markets and as holders of bonds, will have done pretty well.)
So these jittery markets have not really been as dangerous as they seem. But since nothing lasts forever, the question is: how worried should we be about what comes after the boredom? Will “risk on” be unharnessed as recovery continues? Or will there be another shock, or disappointment, which will make the last few months seem like the calm before the storm?
Perhaps the most sensible approach for investors to take in these circumstances is to resist the temptation to actually do very much. There has been little change in fundamental data to challenge whatever positions they may be taking, and in many markets, rarely enough volatility to suit those waiting either for a buying opportunity or to take profits. Best to stick to one’s views, save some trading costs, and see what happens next …