Posts tagged ‘uncertainty’
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 …
In these uncertain times, let us refresh ourselves by beginning with what was again proved this week to be an indisputable fact: Mario Draghi is the most significant and successful central banker in the world.
The announcement three years ago that the ECB was assuming the power to intervene in bond markets, when he was not even 12 months into the job, put the sovereign debt crisis to bed, restored market confidence across the world and helped turn the creaking hull of the eurozone supertanker away from recession. Two years later his €400bn bank liquidity programme and adoption of a negative policy rate had analysts calling him a rock star. Another €700bn splurge and surprise rate cut followed. And at the beginning of this year Mr Draghi announced a €1.1trn programme of quantitative easing.
So yesterday’s announcement that the ECB was ready to modify the “size, composition and duration” of its QE exercise was part of a pattern. Draghi and team are being seen to do whatever it takes to re-normalise the eurozone economy. Indeed, as he put it at a speech he gave in London on 26 July 2012:
The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
Everybody believes you now, Mr Draghi.
Market reaction yesterday and overnight was, in a word, electric. The euro plunged by 1% against the dollar in the space of half an hour to close the day 2% weaker overall. (That is a more significant one day fall than the planned devaluation of the Chinese yuan that caused such consternation back in August.) The Euro Stoxx 50, which had been trading flat throughout the morning, rocketed up in the afternoon to post a +2.5% close. European bond yields hit new record lows: the 2-year bund was pricing at -0.35% in the opening hours of this morning while the 2-year Italian buono hit negative yield territory for the first time.
There is a good, detailed overview of the global impact of Mr Draghi’s latest star performance from Reuters here: Global Stocks Hit Two-Month High On Dovish Dragi Message. But it is the quotes from market observers which we will focus on before leaving this subject:
“Investors and traders are buying the idea of expected action out of the Bank of Japan and the ECB,” said Ben Le Brun, market analyst at trading platform provider optionsXpress.
The Chinese central bank’s injection of 105.5 billion yuan into 11 banks via its medium-term lending facility this week, combined with possible additional stimulus from the ECB, “may give the Fed more reason to raise rates by year end,” said Chris Brankin, chief executive officer of online trading platform TR Ameritrade Asia in Singapore.
“Draghi has come out and kitchen-sinked the whole thing, everything is now on the table,” said Gavin Friend, a strategist at National Australia Bank in London. “You combine what the ECB is now saying with (the fact) that the Fed is not going to be going aggressively and that the Bank of Japan is going to want to get involved, then you say ‘Blimey!'”
Mr Draghi has played his role exceptionally well, but the dominance of central bank rhetoric and activity over market behaviour is unhealthy. When the People’s Bank of China devalued over the summer for example it was treated as a disaster – a desperate act to prop up a seriously weak economy. The falling stock market in China had helped unsettle the world and the markets’ interpretation of events took place against a background of gloom. This week, however – thanks to the ECB – we inhabit an era of sunshine and optimism. So when the PBOC announced further monetary loosening today it was seen not as desperate but as a sign of “the government’s determination” which has now lit “a fire under global stocks” as “US equity futures jump”, to quote some of this afternoon’s commentary. Markets hated Chinese policy over the summer and loosening by the PBOC was taken badly; today it’s just what was needed to cement the rally in place.
If there is a cloud to go with this week’s silver lining, therefore, it is the now familiar truth that reliance on central banks has become a major source of volatility. “Money Markets Primed for Draghi as Bets Jump on Deposit-Rate Cut”, says Bloomberg’s headline today. And what if there is no cut on 3 December? Or if there is, but this is seen as bowing to market pressure – the kind of pressure which appears now to govern decision-making at the Fed? One day markets are given a boost by “Super Mario”, the next, they start looking for more – and pricing it in.
Volatility is the textbook definition of financial market risk. Mario Draghi is, to say the least, an impressive figure. He has given investors much to be very grateful for. But he and his confreres around the world, counter-intuitive though it might seem, have actually helped to make investing today a riskier proposition. To put it another way, we have become used to looking to central banks to underpin market stability; and by relying on them to the extent that we now do, ensured the exact opposite.
Political risk is a familiar concept to investors in certain contexts. Unrest in the Middle East which has an impact on oil, arbitrary rule in Latin America, and more recently excitement in Europe and strife in Ukraine are well-worn talking points which have had material impact on price behaviour from time to time.
Less familiar, though now certainly being talked about more and more, is the political risk associated with the forthcoming general election in the UK. The association of election results with movements in the London stock market seemed to have gone out with flared trousers and the FT 30. But this week, high-profile business leaders have added public weight to the private concerns of an increasing number of market participants that a Labour, or Labour-led government under Prime Minister Miliband would see a return to the kind of soak-the-rich, wage-and-price control maladies which made Britain the sick man of Europe forty long years ago.
We can return to those fears shortly.
Another reason for concern in the minds of some is the level of uncertainty associated with May’s result. The standard methodology for forecasting election outcomes is the “uniform swing projection”, under which the change in vote share since the last election as indicated by opinion polls is applied to each individual constituency. At present, this would give a hung parliament with Labour short of an outright majority by one seat.
As anyone who follows the news will be aware, however, uniform swing projection is shaping up to be a particularly poor guide to the new parliamentary makeup due to hit us in 2015. Taking the most obvious example, the national vote share of the SNP is minimal at around 5%, but within Scotland – which will return 59 out of 650 MPs – they are about bang on the 45% they polled in the secession referendum. With the unionist vote split three ways and more this puts them in their strongest ever position and they are expected to take most of Scotland’s seats. On the other hand, while the strength shown by UKIP over the last couple of years has received a lot of coverage, they do not possess the regional strength necessary to translate a national share of 15% into seats won under first past the post beyond a handful.
Betting markets are a great place to look for how this might translate into outcomes. At the time of writing, Paddy Power odds for Conservative and Labour seats put both parties on about 280, well short of the 326 required for even the most slender and unsustainable of majorities. Money is on the SNP to hold the next largest number of seats, though at only 40 this would still leave them short of being able to form the very weakest of two-party coalitions. Next come the rather emaciated Liberal Democrats at 26 (down from 57 won in 2010), with the other parties all in single figures. Try to translate this into outcomes for government of the country and markets are all over the place: shortest odds are for a Labour minority administration or a continued Con-Lib coalition, though even those manage only 4/1. There are then ten less likely scenarios before one gets to the “Grand Coalition” outcome – a Tory / Labour love-in – offered at a princely 50/1.
The current market, then, is for chaos, and if history is any guide this will mean bickering stagnation for a few months and a fresh election thereafter. Now stagnation is the opposite of uncertainty. The postponement of real change to the country, therefore, would deliver no fundamental grounds for a shift in financial markets relative to where they are today.
Back to the “nightmare scenario” of a Labour victory, in whatever sense. They recently committed by way of a Commons vote to keeping deficit reduction plans in place, simultaneously stating that this was absolutely in line with their own budgetary goals, while distancing themselves from specific Tory policies. The Conservatives, meanwhile, claimed that although Labour had walked through the lobbies promising to reduce the deficit on exactly the same trajectory as themselves, they couldn’t be trusted; and even if they could, would fail to deliver through politically-driven changes to basic concepts of arithmetic which were understandably difficult to clarify.
In other words, on the key issue of the sovereign balance sheet, both parties are in lock step: we would take exactly the same course, but the other guys would do it with a sillier walk. This is the edifying situation in which the mother of modern democracy now finds itself.
Let’s look at some of Labour’s “frightening” policies. They have made noises to the surviving disciples of the late Eric Hobsbawm about re-nationalising things but EU competition law extends to so many areas of the economy nowadays – including the railways – that it is not clear how this might be constitutional and such efforts would certainly meet with legal challenge as a result. 50% top tax is no innovation, and the Tories’ own home purchase duty changes from their most recent budget are in absolute philosophical step with Mr Miliband’s “mansion tax” in this area, and over time would have a similar effect on those perennially plunderable plutocrats at the top of the mythical money tree.
There is much more that could be said along these lines, but to refocus attention to market behaviour let us end with two observations.
Firstly, some of the mouthier rich always protest publicly at the prospect of Labour administrations. Lord Lloyd Webber, for example, famously suggested in 1992 that he would emigrate should Labour win the election of that year. Perhaps it was because of his contribution to the ensuing Conservative victory that he thankfully chose, in the aftermath of the 1997 Labour landslide, not to do so. (In the instance of this year’s contest, one of the higher-profile mouthpieces has taken the sensible precaution of neither being born nor dwelling here to begin with.) In any event such protestations bear even less relation to the economic outcome for the country than they do to election results.
Secondly, there really was the prospect of serious political change in the United Kingdom recently when the referendum on Scottish secession threatened to reduce it to the more traditional “Union of Crowns”. There was even one especially interesting weekend over which the SNP looked to be winning.
It looks certain that May of this year will bring forth a black swan to exercise temporary notional control over the government of Britain. As readers will know, it is otiose to try to plan for black swan events. It is equally otiose to expect a stagnant quagmire to yield volcanic change, or for parties wedded to near-identical policy platforms on key matters to make too much of a difference to (say) the earnings of Vodafone, the path of the RPI index or the yield on the ten-year gilt.
This year’s general election will be exciting for those whose emotional perspectives allow for that reaction. But anybody who thinks it will be anywhere near as exciting, or dangerous, for financial markets should consider calming down.