- Markets entering a scratching head period
- Globalisation has already peaked
- Remains to be seen if developments are short term reversals or more structural
- Retaining bias to cyclicals and short duration good quality corporate bonds
Anthony Rayner, manager of Miton’s multi-asset fund range, comments:
A number of multi-decade, multi-dimensional trends are currently being challenged. From an economic perspective, we have moved from a disinflationary environment, which has dominated since the 1980s, to an inflationary environment. Geopolitically, globalisation and free trade, which have been the prevailing orthodoxy for decades, are being challenged by a shift towards protectionism. At the same time, monetary policy has done a hand brake turn, away from quantitative easing, with interest rates rising from multi-decade lows.
Of course, these dynamics are not operating in isolation of each other. The Chinese economy joining the world economy back in 2001 was a major driver in pushing global consumer and wage inflation lower, while the recent inflation pick-up is one of the reasons that interest rates are on the rise.
Unsurprisingly, the combined effect of these forces is leading to a pickup in equity market volatility, reflecting a higher degree of uncertainty. This feels particularly volatile, coming as it does after a period of fairly black and white markets, characterised by an extended period of ‘lower for longer’, when interest rates and bond yields moved to multi-decade lows, before a rebound in growth and an inflation pickup signalled a ‘reflationary’ period.
The graph below sketches out this economic context and its impact on equity markets. The US ISM manufacturing survey has been a pretty good proxy for US economic growth over time, showing the latter part of the lower for longer period (anything below 50 is considered consistent with economic contraction), before giving way to a building economic growth momentum from the beginning of 2016. We’ve also plotted the FTSE World cyclicals relative to FTSE World defensives, which shows clearly how cyclicals underperformed defensives during the lower for longer period, while cyclicals have outperformed in the reflationary period.
During these two distinct periods, once the economic scene was set, equity markets and most other assets behaved in a fairly understandable way. That said, at the turning point in the first half of 2016, there was a lot ambiguity in the data which translated into a directionless period for equity sectors.
The combination of whether we’re seeing another turning point now, after a very strong run from cyclical sectors, combined with what appears to be a shift in some of the longer term dynamics, is leading to a scratching head period for markets.
It’s fair to say that there’s decent economic momentum globally, with a pickup in inflation that’s encouraging at these levels, rather than discouraging, while the path of US interest rates have been fairly clearly sign posted. As ever, there are risks to the more probable range of scenarios but an economic base case can be fairly easily constructed which, on many levels, feels like a sensible exit from an extremely unusual period in economic and financial market history.
Questions remain as to whether markets will respond to this in a disorderly manner or not and it’s unclear at this stage which part of the equity market will lead from here, if , indeed, it will be led higher.
Turning to protectionism, at this stage it’s probably fair to say we have reached ‘peak globalisation’ with global trade as a percentage of GDP falling in several consecutive years now. That doesn’t answer the question of whether we’re heading into a trade war proper, and by that we mean action severe enough to lead to materially slowing economic growth and further momentum to inflation, or stagflation.
Gauging the answer as to whether protectionism will increase materially is difficult as it involves understanding political actors, though in certain parts of the world this has got easier. The Chinese president is now “president for life”, while the Russian president looks to have at least another six years, and in many ways both have set their stall out pretty clearly. Donald Trump, where the recent protectionist measures started from, has been less easy to get a handle on, partly as he is so unconventional but also because his belief system is less clear cut.
What we can say is that he’s surrounding himself with an increasing number of economic nationalists, and short term political opportunism might be more tempting than economic rationalism.
In summary, markets are trying to get their heads around whether a number of new developments are short term reversals, or something more structural, including inflation, protectionism and interest rate rises. The market’s job is to extrapolate, ours is to construct a portfolio for the data we can see in the here and now. As a result, we retain a cyclical bias in equities and a bias for short duration good quality corporate bonds. As ever, liquidity is key for us, so that we can move quickly if the data changes.
Shares and commodities keep climbing, so do bond yields
By Marc Jones
LONDON (Reuters) – World stocks headed back towards record highs with a third day of gains and the dollar dropped to a three-year low on Thursday, after top Federal Reserve and European Central Bank officials took aim at rising bond market yields.
There was a lot to keep tabs on. A renewed retail frenzy re-ignited the likes of GameStop, bets on $70 a barrel oil and a decade high in copper prices drove a commodity currency rally [/FRX] and bond yields were still rising too. [GVD/EUR]
A near 1.9% jump in oil and gas shares ensured European markets followed Asia’s overnight gains [.T][.SS]. MSCI’s main world index, which spans 50 countries, was up 0.5%.
“There are two clear stories now” said CMC Markets senior analyst Michael Hewson. “You have the concerns about rising yields and they are continuing to move higher today, and then you have got an economic recovery story, which is helping lift the more moderately-valued parts of the market.”
Federal Reserve Chair Jerome Powell said on Wednesday that U.S. rates could remain low for years, while ECB board member Isabel Schnabel was out early on Thursday saying it would fight any big increases in inflation-adjusted market rates.
“A too-abrupt increase in real interest rates on the back of improving global growth prospects could jeopardise the economic recovery,” she said. “Therefore, we are monitoring financial market developments closely.”
But bond markets are still not playing ball. Ten-year German Bund yields climbed 3 basis points in early trading. U.S. 10-year Treasury yields were near one-year highs at 1.42% and on course for the biggest monthly rise since Donald Trump’s 2016 U.S. election victory jolted markets.
In the FX markets, the safe-haven U.S. dollar slumped near three-year lows as the Fed’s stance, ongoing progress with COVID vaccination programmes and commodity market uplift boosted riskier currencies.
The Australian and Canadian dollars both hit three-year highs of $0.7978 and C$1.2503 per U.S. dollar respectively.
The euro touched a one-month high of $1.2183. The safe-haven yen and Swiss franc both weakened.
“It is pretty clear that there is a pretty strong concentration in the commodity currencies,” said Saxo Bank’s John Hardy. “Even with emerging markets you are seeing it to a degree,” he added, pointing to how big energy importers like Turkey’s lira had faded.
MARATHON NOT A SPRINT
Crude oil climbed to 13-month highs after U.S. government data on Wednesday showed a drop in crude output as a deep freeze in Texas disrupted production last week. [O/R]
Copper prices steadied near $9,500 a tonne in London. It’s now at its highest level in almost a decade and could log its biggest monthly gains in 15 years this month.
In a possible sign of a renewed retail-driven frenzy in equity markets, GameStop’s Frankfurt-listed shares trebled as they opened on Thursday, overshooting the videogame retailer’s 100% surge on Wall Street overnight.
Other so-called “stonks” – an intentional misspelling of “stocks” – favoured by retail traders on sites such as Reddit’s WallStreetBets had also leapt again, although explanations for the moves were tenuous.
Some online stocks watchers had even pointed to a picture posted by an activist GameStop investor of a McDonald’s ice cream cone with a frog emoji as a cryptic sign.
“It’s a marathon, not a sprint. Whatever happens resist the urge to sell. The longer we hold the higher it goes,” said @catchme1fyoucan, one user in Italy of the retail trading platform eToro, in a discussion on GameStop.
(Reporting by Marc Jones, editing by Larry King)
Sterling steadies above $1.41 as risk currencies gain
By Ritvik Carvalho
LONDON (Reuters) – A rally in risk currencies on Thursday helped Britain’s pound steady near $1.41, a day after it hit its highest levels in nearly three years.
Sterling surged to $1.4295 on Wednesday, as analysts maintained a positive outlook on the currency.
Bets that Britain’s vaccine rollout will enable a quicker reopening of its economy and relief over a Brexit trade deal have pushed the pound up 3.5% against the dollar, making it the best-performing G10 currency this year.
U.S. Federal Reserve Chair Jerome Powell on Wednesday calmed fears that higher inflation would also lead to a tapering of monetary stimulus, saying the central bank would not change policy until the economy was clearly improving.
On Thursday, a broad risk-on tone in markets after Powell’s assurances spurred a rally in commodity-linked currencies such as the Canadian, Australian and New Zealand dollars and the Norwegian crown, pushing the dollar and other safe haven’s lower. [FRX/]
“Classical FX havens are weakening (CHF, JPY) and risk currencies such as GBP and NOK are performing well as U.S. rates are now rising in tandem with equities and commodities,” said Lars Sparresø Merklin, senior analyst at Danske Bank.
The pound is correlated with risk and growth and tends to gain along with risk-on plays in markets. It traded 0.1% higher at $1.4163 by 0911 GMT. It was 0.1% lower to the euro at 86.22 pence.
Issues over Brexit still simmer, although analysts maintain they won’t hurt the pound in the short to medium-term.
Northern Ireland’s first minister upped the ante on Wednesday in a dispute between the UK and the European Union over trade with the province, calling on Prime Minister Boris Johnson to “step up and protect the United Kingdom”.
Earlier, the UK and the EU held talks and agreed to press on with work to resolve the difficulties that have impeded deliveries of goods, notably food, from other parts of the United Kingdom to Northern Ireland and caused some shortages in supermarkets.
The dispute, which was heightened when the EU involved Northern Ireland in a COVID-19 vaccine ban, has cast a shadow over a post-Brexit trade deal agreed late last year and threatens to further sour future ties between the neighbours.
(Reporting by Ritvik Carvalho; editing by Larry King)
FTSE 100 climbs as recovery bets boost mining, energy stocks
(Reuters) – London’s FTSE 100 rose on Thursday, helped by mining and energy stocks that tracked higher commodity prices, while Standard Chartered dropped after its annual profit more than halved due to the impact of the COVID-19 pandemic.
The commodity-heavy FTSE 100 index was up 0.3% by 0808 GMT, with mining stocks, including Rio Tinto, Anglo American, and BHP, gaining between 1.5% and 3.6% on higher metal prices. [MET/L]
Oil heavyweights BP and Royal Dutch Shell also provided the biggest boosts, with gains of 1.2% and 0.8%, respectively. [O/R]
The domestically focused mid-cap FTSE 250 index rose 0.2%, led by industrials and consumer discretionary stocks.
Standard Chartered PLC fell 3.3% despite restoring its dividend and reaffirming its long-term profit goals.
Anglo American gained 3% as it boosted dividends after strong commodity prices helped the diversified miner recover from coronavirus disruptions suffered in its first half.
Outsourcer Serco Group Plc rose 8.3% as it reinstated dividends and raised 2021 forecasts, after posting a 20% jump in annual revenue.
(Reporting by Shivani Kumaresan in Bengaluru; editing by Uttaresh.V)
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