Posts tagged ‘credit’
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 …
We are now comfortably over half way through 2014. After a shaky start, and despite persistent jitters, much of the year was actually quite undramatic for financial markets. For a while it looked as though asset prices were struggling to establish any direction. In some areas this has remained the case. But since the spring there have been signs of movement, and these have been mostly supportive of the pricing of risk.
Starting with assets which have prolonged their mundanity: gold, at just under $1,300 an ounce, is priced almost exactly in line with its average for the year to date. Despite some volatility over May and June it shows no sign of directional movement whatsoever. The story is the same for oil, which spiked up as news broke of the crisis in Iraq but has since fallen back again to about its average level for the year so far.
Government bonds have not been terribly exciting either, at least in general. The ten year gilt yield, for instance, has moved within a range of 2.5%-2.8% since mid-February and currently stands at 2.6%. On the other hand the ten year German bund yield hit a record low of 1.15% only this week, having tumbled from 1.94% at the end of 2013. In recent years this might be seen as a reaction to crisis fears in Europe, but this time round it would appear to have more to do with declining inflation and anticipation of the ECB’s policy response: bond spreads in the peripheral eurozone countries have, without exception, tightened over the year to date.
In fact, credit markets generally have been giving the strongest risk-on signals. High yield spreads, as measured by the Markit iTraxx Crossover index, narrowed with conviction as the year wore on. Twelve months ago they were above 4%. Now they are under 2.5% and have closed below 2.2% in the last few weeks. At that level they were almost exactly in line with the average for 2006 when the Great Recession was a mere glint in the US mortgage market’s eye. Consider also that only this month we saw a default event materialise in the banking sector of a south European country. Just imagine the effect this would have had on markets in late 2011 / early 2012. In this case spreads came off their lows but by no stretch of the imagination has there been any sign of real panic. The transformation is astounding.
Equity has found some tentative direction too. As late as mid-April, year to date returns for both the MSCI World Index of developed-world markets and the MSCI Emerging Markets Index stood at an unbeatably dull zero. But since then they have now risen to 7.3% and 9.4% respectively.
Past performance, as they so rightly say, is no guarantee of future returns. There are several “known unknowns” to contend with as the year continues. Political risk in the Middle East and Ukraine shows no sign of subsiding. Earnings growth, especially in Europe, needs to come through to support equity markets at current valuations. And the ancient phenomena of price inflation and monetary tightening could provide unsettling surprises as the quarters grind on.
While there is nothing to stop them being unwound, however, these signs of a rediscovery of market direction are cautiously encouraging. Looking forward the safest observation we might make is that the behavioural inconsistency in some asset prices should not be expected to persist indefinitely. Bears, as well as bulls, now have a little more scope to position themselves accordingly.
The latest Italian government bond auctions took place a few days ago. They were maxed out on low yields against high demand. In fact at a yield of 4.1% the Italian ten year is within sight of its spring low, and trading at around the levels seen before the Greek debacle began in 2010. Only two years ago it was looking as if the bond market might break Italy. How times change.
Looking further around the eurozone periphery there are some other points of note too. In Spain, which has not seen the same political upheaval as Italy has done of late, the ten year yield dipped below 4% on Friday – again, the lowest level since the Greek crisis started to unfold. In Greece itself, ten year paper currently yields 7.7%, down from 12% at the beginning of the year.
There is some truth in the argument that this reflects relief in the wake of the worst of the temper tantrum. It is also impossible to reject with complete certainty – as ever – the warnings that Europe could still collapse in a default hurricane, its pseudo-currency breaking into pieces round its feet, etc. Look around the rest of the global bond market, however, and it is possible we are seeing signs of something else.
Let’s start with the safe havens. Ten year US debt at 2.6% has come down from a taper tantrum high of 3%, but remains over 120bp above its 2012 low and is back within the range seen prior to the stock market crash of 2011. In Germany, by contrast, the market never sold off so much in the first place. The current ten year yield of 1.7% is about 30bp under where it got to in August but only 50bp off the bottom. It has quite some distance to go before reaching the range it saw in 2010.
In fact, if we look at the spread between the two markets over time, we see that it is normal for US yields to push much higher than German ones in times of recovery and to fall below them in periods of economic weakness and poor market sentiment. Growth and inflation are typically higher in the US, especially in the good times, and it is in the bad times that treasuries tend to have strongest investor appeal. In other words, the relationship between the two markets has been normalizing.
Turning to credit, the iTraxx Europe index stands at 84bp, meaning that on average an investment-grade 5-year corporate note should be expected to yield 84bp over LIBOR. In line with equity markets the Europe index has more than made up the ground lost in 2011, though it remains above the 50bp level seen at the end of 2007 and the 25-30bp area it was rooted to before the credit crunch earlier that year.
The equivalent high yield index, the iTraxx crossover, has followed equity more closely. Its spread of 345bp is in line with the end-’07 level and it is not far off the 200bp it averaged in the six months before the crunch. Not all high yield credit is equal, however. Emerging market sovereign spreads at about 330bp are still above the level seen prior to the 2011 crash and remain some distance away from 2007 territory.
Markets have certainly been nervous on occasion this year, and shown inconsistency in some respects. But what we have seen in bond world as elsewhere has been more generally a function of recovery and normalizing market conditions. It is arguably this “bigger picture” which allows us to judge whether episodes of volatility and incongruity present us with opportunities – and take advantage of them accordingly.
The S&P 500 index has roared through 1700 for the first time ever. US GDP for Q2, expected to come in at 1.0% annualised, hit 1.7% on the advance estimate instead. Jobless claims reached a new five-year low. It is clear in some quarters that “the US is the engine of global recovery“.
Elsewhere, enthusiasm about the growth data in particular has been tempered. After all, the number for Q1 this year – which began life estimated at 2.5% and was later cut to 1.8% – was revised down further to 1.1%. And the figure for Q4 2012 was cut to an almost flat 0.1%. In fact, in real terms the American economy expanded by a rather torpid 1.4% over the full year from Q2 2012 to Q2 2013.
Which brings us on to the stock market. The S&P 500 is 25% higher than it was a year ago but reported earnings per share for the quarter so far (393 index members) are up by only 3.6%, and have actually fallen by 2% for non-financials. So over the last twelve months the p/e ratio has jumped back to its pre-recession level – about in line with the long run average for the index. US stocks are not yet expensive by this measure but they are no longer cheap.
This is not to knock the rally. There is a bigger gap between rhetoric and reality than there is between reality and market behaviour. Confidence and activity indicators are consistent with continued, solid growth, albeit at a sub-trend pace, and that’s always better than the alternative. There was a marked correction across equity markets in May-June, which slowed the pace a little, and there will doubtless be more volatility to come. It does not look as if there should be much reason to argue with a measured, patchy uptrend in the US stock market. That’s what’s happening to growth and earnings too.
It is instructive to compare the lie of the land this year with the immediate aftermath of the credit crunch. In 2009 confidence began to improve way before the Great Recession ended. It became clear that capital losses and writedowns in the banking system had peaked in Q4 2008, and that was enough for the S&P to return 50% over the year to 31 March 2010. It was not until the Greek crisis that the scale of contagion began to be more widely understood, and market confidence has still not fully recovered from the demeaning misery of having to absorb fixed income ephemera such as what a “Fitch” is and how one might go about swapping a credit default.
So US equity has shown about half the exuberance in price terms since last summer as it did over the 12 months from Q1 2009. Again, let us stress that this does not appear unreasonable. But back in ’09 of course it was not just a select group of developed-world stock markets that embraced the transformation in morale.
Over the same 12-month period – from Q1 ’09 to Q1 ’10 – the MSCI Emerging Markets index returned 82%. The yield on the ten year Treasury rose by 1.4%. The trade-weighted dollar fell by over 8%. Investment grade credit spreads in Europe fell by 95bp. Brent crude futures were up 68%, COMEX copper futures up 93%.
Much of this seemed absurd at the time, and in hindsight seems especially so. What is useful, perhaps, is to note what a really abandoned recovery in confidence looks like, and to compare these numbers and others with the very much more tentative present upturn.
The move in Treasuries has been similar, with the ten year yield up 1.2%. Compared to ’09, therefore, bond bearishness has outpaced stock market optimism. And that optimism has been much narrower: the MSCI EM equity index has returned only 4%. Credit markets have broadly kept in step with Treasuries, tightening by most but not all of what they managed back in 2009-10 (80bp so far). On the other hand oil has gone nowhere and base metals have fallen.
There are always risks and always fundamental changes to consider. So there were four years ago. What differentiates markets today is that they are less certain – more confused – than they were back then. If the confidence felt on Wall Street is justified, and if this confusion should diminish, there are a number of dots which need to be joined before the picture across asset classes looks composed once again.
Last week it was the ECB. Yesterday – not to be outdone – it was the Federal Reserve’s turn to give markets a shot in the arm by announcing a new round of asset purchases. The Fed’s own chairman cautioned against expecting too pronounced an effect on the economy, but it didn’t matter: the numbers were large, the scope unexpected and the restatement of resolve to promote the creation of jobs most welcome.
We noted at the beginning of August that markets had seemingly rediscovered the civilized seasonal phenomenon of the “summer lull”. Through August itself that continued. This month, the change in sentiment – encouraged by the open mouth as well as the open market operations of the world’s biggest central banks – has developed into a broadly based re-rating of risk.
Equity markets have risen at a faster pace: the S&P 500 is up 4% month to date at the time or writing. And as the riskier eurozone sovereign market has continued to recover, safe haven governments have lost some of their shine. The ten year gilt price is down 3%. Credit risk has repriced significantly too: the iTraxx Crossover index of higher risk corporate credit pricing has moved from 5.9% at the end of August to 4.6% today. Commodities have bounced, with the Brent crude future up 2% and Bloomberg’s base metals index nearly 13% higher. The euro has risen 4% against the dollar and is somewhat stronger against sterling.
At the same time, economic data – some of which is significant – has continued to be mixed. While industrial production data for August was not as bad as expected in the eurozone, it disappointed in the US, where there have been mixed signals from the employment figures too. Growth in the UK has been showing some signs of recovery, while it came out slightly weaker than expected for Japan. Confidence and activity indicators around the world are similarly patchy.
It has been like this for some time now. Last year, markets were arguably too bearish about our patchy, rather chaotic recovery. If current price behaviour continues, then it might be the case before too long that sentiment could be said to have got ahead of itself.
Longer term, there are risks to consider beyond confidence too. While central banks enjoy their adulation, some may remember the “Greenspan put”. Former Fed chairman Alan Greenspan developed a reputation for cutting interest rates to prop up markets – during the stock market correction of 1998, for example, and after the dotcom / TMT collapse, when there was widespread concern over the potential “wealth effect” of falling markets on American households. Pursuit of this approach in the 2000s is now perceived to have contributed to the subprime crisis and credit crunch.
Central bank action to prop up bond markets and restore confidence in risk could end up inviting similar criticism. Much as it makes a change for markets not to be engulfed in panic and despair, it is surely no coincidence that index linked bonds issued by safe haven economies on both sides of the Atlantic have not fallen by as much as their conventional cousins.
Nonetheless, the year so far has been the first for a long time in which the volatility rollercoaster has showed signs of slowing down. The VIX index – a derivatives-based measure of volatility on the S&P 500 index – has fallen to levels not seen since the summer of 2007. Of course there could be another dip just around the corner. But while the ride has been exciting, there are many who would benefit from at least a short stop.