Posts tagged ‘cash’
Well so much for 2015. It was a curious year for the major asset classes and a frustrating one for many investors, including those in the UK. Still, now it has passed we can look at the numbers, identify the winners and losers and remind ourselves that the only reliably immovable feature of the financial landscape is uncertainty.
Starting with UK equity an initially record-breaking year unwound to deliver a disappointing total return of -1% to the FTSE 100 Index. It was a very different story for the mid- and small-cap indices, however, which are less exposed to energy price and currency effects and posted numbers of +11.4% and +9.5% respectively.
On the fixed income front it was a tough year for gilts. Markets which might have been expected to benefit from “risk off” nervousness struggled in the face of the anticipated gradual unwinding of emergency monetary conditions both here and across the Atlantic. The Bank of America Merrill Lynch conventional gilt index managed to return only +0.5% last year with the index-linked index actually losing 1.2%.
Corporate bonds did a little better, with the BoA ML sterling non-gilt benchmark delivering +0.7%. The sterling high yield bond market is tiny (with a face value of £48bn, about the size of Diageo’s market cap), but for what it is worth returned a creditable 5.4%. High yield returns in Europe (+0.8%) and the US (-4.6%) give a more representative idea of what might have been secured by UK-based investors in this asset class, however, and the combined $1.7trn market here was dented by the collapse of borrowers in the US energy sector.
Away from smaller-cap equity and high yield the really bright spot was the property market. Commercial property continued its strong recovery, with price growth underpinning a 19.1% return to the IPD All Property Index (over the year to November, the most recent month for which data is available). And though the residential market lost a little heat last year it was up by 9% on the year to November in price terms using the smoothed HBOS house price series.
Cash rates hardly moved in 2015 as one would expect with the Bank rate frozen at 0.5%: the NS&I Income Bond rate stood at 1.25% with term fixes from the banking sector available a few bp higher. Key exchange rate moves were (as one would also expect) rather more exciting: the pound fell by 5.4% against the dollar, 5.0% against the yen and 4.9% against the Swiss franc while managing to put on 5.4% against the euro.
The most significant market move of all came from commodities with the price of oil down by more than 31% in sterling terms over the course of the year. Gold also fell, the GBP price losing 5.3%.
Finally a brief look at some of the other key international markets (all in local currency terms).
- It was a disappointing year for US equity with the S&P 500 returning only 1.4%.
- Europe did better, paying investors 7.4%, while Japan was best of the major markets with a total return of just over 12%.
- Major government bond markets did very slightly better than gilts with the BoA ML US Treasury Index returning 0.8% and the Euro Government Index 1.6%.
- More interestingly, the top performers in the eurozone were the weaker peripheral countries with the Italy index returning nearly 5% and Greece – recovering from price depression into the start of the year – delivering over 20%.
- During the year Greek politics were usurped by the Chinese stock market as the financial world’s bête noire. So it is interesting that the Shanghai Composite Index, despite all its intra-year turmoil, posted a return of +11.2% across 2015 as a whole.
It was a year of turbulence and surprises, though one or two of these numbers did turn out roughly as the consensus had expected at the start of the year. How the consensus, along with the rest of us, will do during 2016 we will all discover in due course …
Goodbye – all right, perhaps a little prematurely, but goodbye anyway – to you, 2012. While you brought your own mix of shocks and surprises, at least financial markets were less excitable as a rule than they had learned to become over the course of your immediate predecessors. Let’s take a look at some of your highlights …
Fears over Eurogeddon and global slump had their share of the limelight over the year and produced some familiar episodes of funk. As in prior years, however, the sky did not fall in and almost all markets had a good 2012 overall. In price terms, the FTSE 100 is 6.6% up YTD, the S&P 500 up 8.7%, the Euro Stoxx 50 up 11.6% and the Nikkei 225 up 5.9% (all on a sterling basis). Currency made some big differences: in yen for instance, the Nikkei is 22.9% up on the year.
It wasn’t all gung-ho risk repricing, however; there was still too much chaos around for that. In Europe, for instance, safe-as-houses Germany comfortably outshone the wider eurozone with a 26.6% GBP price return to the DAX, while Milan couldn’t match the large cap index with a return of just over 6%. Then again, Germany wasn’t the zone’s top performer .. Step forward new entrant Estonia, with a 35.6% rise. Amazingly, the Athens Stock Exchange is up almost 31% too.
At a whole-world level too, the numbers show there was more going on than simple bullishness, or shared damage repair from the crash of 2011. In GBP terms, the MSCI World Index of developed market equity stands 12.3% above where it began the year, while the equivalent Emerging Market index has moved practically in lock step (+13.7%) – i.e. has still underperformed since H1 last year.
Fixed income markets offered greater clarity and greater confusion at the same time. Greater clarity, because the behaviour of government and credit markets followed a similar pattern of “risk on”: the spreads of weaker eurozone government bond yields over those of Germany came in as a rule, spreads on emerging market debt were also tighter, and credit spreads have tightened significantly for both investment grade and high yield corporate bonds.
At the same time, yields on “safe haven” governments drifted lower over the year as a whole; despite the recovery of sentiment, 10-year German debt yields 0.5% less than it did a year ago. This could be explained by relief over slack growth (leading to contained inflation and continued low policy rates) – but that is hardly consistent with strong returns to equity, where slower economic growth means lower growth in company earnings. Similarly, equity market revaluation arising from stronger confidence over tail risks should have been expected to go hand in hand with a sell-off in safe haven assets, which didn’t happen.
The commodity story is similarly varied. Oil trickled higher, with the Brent crude future about 3% above where it began the year. Or perhaps it fell – the American WTI index is lower by almost twice as much. So the gap between oil futures contracts in London and New York has widened to $20 per barrel; before 2011 it was reasonably firmly pinned to an average of zero. This is attributable to the relative pace of shale development in the US and European economies.
In metals, gold continued its strong run overall across a year in which it failed to beat its 2011 high – it’s about 6% up YTD. Amazingly, the gold price (in nominal dollar terms) has now not fallen over any calendar year since 2000. Silver has done a little better (+7.9%), though of course it’s had a rougher ride over the longer term and is much further below its 2011 top. For those interested, the ratio between the two prices (gold:silver) is roughly in line with the 40-year average now at 55.3x.
UK commercial property across all types and locations (as measured by the IPD index) is heading to be about 4% lower in terms of capital value over the 2012. Offices did better than industrial buildings, with retail property coming in last, though there has not been much to choose between them at the nationwide aggregate level. Overall, commercial property prices are about where they stood at the end of 2008 (following the lion’s share of the post-boom shock).
Land registry data on the residential property market is published with a longer than usual delay, but currently available figures suggest anything from flat growth overall to a modest sub-2% rise. Nationally, housing is still more affordable – or at least, cheaper in price terms – on average than it was at the 2007-8 market peak. Interestingly, the national figures conceal a safe haven effect which is visible at the more local level. The government data shows that prices in London have risen at about 4%, having held steadily above the peak since the second half of last year. While there is no official data on the subject the inferior reservoirs of anecdote and common sense suggest that the preference of international investment flows for the capital are behind this.
The year saw very little change here. OK, so the ECB slashed its main refinancing rate from 1.00% to 0.75%, but the other big developed world banks had little scope beyond sticking to their existing near-zero policies (0.5%, 0.25% and 0.1% in the UK, US and Japan respectively).
Let’s look at the negatives first:
- In a low-growth year, equity market recovery has pushed earnings valuations out of cheap territory. Should forecast increases fail to materialise – for whatever reason – this should make those markets more vulnerable to a setback.
- Stronger safe-haven bond markets could reflect a greater general level of comfort with the concept of government debt – and respect for the willingness of central banks to increase their influence over longer-term interest rates. But they do conflict with stock market optimism and it’s impossible to say with certainty which market is right.
And to end with the positive notes:
- During 2012 markets flirted with the idea of renewed global catastrophe, which made a pleasant change from assuming it was absolutely, definitely just around the corner.
- If this increase in confidence persists – in the bond markets most importantly – it will encourage confidence in the real economy to continue to trickle back as well.
Perhaps the most positive sign for those of us who try to behave like the fabled Rational Investor of the financial textbooks was this: differences in price movements within asset classes reflected discernible variations in fundamental behaviour. It was logical for Italian bond spreads to narrow by twice as much as those of Spain. At the same time, it was reasonable for Italian stocks to underperform German ones.
There was much that is difficult to explain, and the broad outlook for the world remains enigmatic. But 2012 gave us a little more stability in the financial world, a little more sensitivity to fundamentals and valuations and altogether less downright hysteria. If that background for 2013 stays in place then investors could well find themselves looking back on the past twelve months with some gratitude.
As Greece flirts with economic suicide and JP Morgan loses $2bn under the carpet, it is worth revisiting the subject of safe havens – those assets that receive attention from time to time as possible ports in a storm. We last looked at this back in July 2011, covering various government bonds, currencies, commodities – and cash. Events since the summer give us the opportunity to see how safe these havens really proved.
Starting with government bonds: lots of these went up. 10 year US Treasuries yielded 2.74% at the end of July; they now yield 1.86%. The equivalent German yield has fallen from 2.45% to 1.51% and ten year gilt yields from 2.80% to 1.95%. As well as coupon income over the period, therefore, investors in these kinds of bonds would have seen capital appreciation of the order of 7-8%.
Of the major currencies, the strongest was the dollar, which has risen 6.5% since last July as measured by the Bank of England’s trade weighted index. Sterling almost managed to keep pace, rising 5.9% on the same basis, and the yen drifted a bit higher too. The Scandinavian currencies softened slightly (-0.4% to -1.8%), dollar zone rates fell by a bit more (-3.6% to -5.4%), the euro lost 5.7% and the biggest faller was the Swiss franc (-7.9%).
The major commodities for which haven status is claimed are of course precious metals. Gold shot up during the stock market crash in August, reaching a peak of over $1,900 before falling back again to $1,580 today – about 2.4% lower over the period as a whole. Silver has performed dismally, losing over a quarter of its value at the same time.
Cash of course would not have lost its value. Banks have continued to fail since July (e.g. Dexia), but there have been no losses to retail deposit holders.
It would be unwise to draw anything axiomatic from this information, but tentative lessons might include the following:
- If the banking system does not implode and one’s appetite for volatility is low, then cash is an obvious choice in a crisis. (Nonetheless, the UK Retail Price Index was 2.6% higher in March than it was eight months previously. This annualised inflation rate of 3.9% would have been impossible to match with a cash deposit rate.)
- Currency views are genuinely speculative and exchange rate movements over a length of time such as 8-9 months are completely unpredictable.
- The claims made for precious metals are exaggerated.
- The most effective hedge against panic is government bonds (though only those seen as safe).
Of course every situation is different and the next crisis is unlikely to look much like the last. Perhaps the most robust conclusion remains the one we reached in July: that caution needs to be exercised. What looks like a hedge at first can sometimes be the edge of a cliff.
For most of the last few weeks it was the Eurozone crisis. Now it’s the crisis in the US (debt or growth, take your pick). Whatever the reason, risk assets have been through panic after panic. And at the same time, certain assets, regarded as safe havens, have shot up.
The question is: how safe would these havens really prove in the face of a true financial catastrophe?
Government bonds are the classic escape for the risk averse. But in a world where the source of much of our panic is uncontrolled government debt – in other words, an embarrassment of such bonds – which ones to buy? The US has traditionally played the role of safest bond haven in the world, but a failure to raise the debt ceiling in a few days’ time, which would present the real prospect of an event of default, challenges this view. Likewise, the performance of the gilt market looks out of tune with an indebted, low-growth economy battling a deficit of 10% of GDP; and would those euro-denominated bunds really give investors such a smooth ride if the single currency were to collapse?
On the currency front, market behaviour is if anything more perplexing. One of the most notable beneficiaries of weak sentiment over the US has been the Japanese yen. The yen! Japan’s economy is contracting, its debt burden as a percentage of output is the highest in the world (it overtook Lebanon in 2008), it has terrible demographics and it has also experienced the worst nuclear accident for a generation and one of the worst earthquakes in living memory. Then there’s the Swiss franc – Switzerland’s fundamentals are enviable and it certainly has the benefit of a defensive location, but it would be far from immune to the effects of another financial crisis. Looking at the other top performers, Norway and Australia would surely be affected should a new recession provoke another slump in commodities – which leaves those economic superpowers, Canada and New Zealand.
We can write off equities while disaster has the upper hand; ditto, property.
Commodities too should suffer in a crisis, with the notable exception of gold and silver. Though even then, with precious metals prices where they are (in the case of gold, not much more than $200 off its all-time real terms high) and volatility high, the risk of sudden and painful capital loss should Armageddon fail to materialise takes the shine off them rather.
Which leaves cash. And with interest rates at record lows throughout the developed world, and inflation having picked up steam, investing in cash guarantees the erosion of your wealth in real terms.
In short, while there is the odd bond market, currency or commodity that might be expected to offer some upside in the event of another major crisis, investors need to tread carefully. What looks like a hedge at first can sometimes be the edge of a cliff.