A fortnightly look at global financial markets – 18 Jan 2016
The following is a detailed commentary and analysis from deVere Group’s International Investment Strategist, Tom Elliot regarding the world’s financial markets as we kick off 2016.
Q1 asset allocation preferences (updated at start of quarter): neutral equities vs. fixed income. Within equities overweight euro zone and Japan, underweight U.S., UK and emerging markets. Within fixed income, a preference for core government bonds with no duration bias.
This week: RBS and common sense remind us why we buy boring bonds and multi-asset funds, China opaque data and bank debt, UK house prices – focus on interest rates, not falls in Chelsea prices.
RBS and common sense remind us why we buy boring bonds and multi-asset funds
- Investor risk appetite is weak at present. Global stock markets have had a poor start to the year, the MSCI World index is down 8.5% in USD terms, 8.4% in local terms, since 1stJanuary, while the sell-off in credit has contributed to a fall in the Barclays High Yield index of 2.4% in USD terms. Credit’s fall reflects long-held concerns over liquidity issues and the same investor dis-enchantment with risk that is spooking stock markets.
- An unseemly brew of China worries (see below), a twelve-year low for the oil price, and some weak US economic data, drove the New Year sell-off. Perhaps, some say, the US Fed should not have raised rates in December after all? Furthermore, the still-expensive S&P500 is about to endure what analysts warn could be a bad corporate earnings seasons thanks to a substantial build-up in inventories in recent months.
- What should investors do? RBS warned last week that investors should sell everything but the highest quality bonds. No one can dispute a liking for core government bonds at present, with US Treasuries and UK gilts perhaps the most attractive from a yield perspective. Too often we shy away from these portfolio staples because they are…boring. It is moments like this that show the value of having boring investments in our portfolio. The Barclays Global Treasuries index is up 1.4% in USD since 1stJanuary.
- The other part of the RBS advice, however, is not a realistic suggestion since no one has a crystal ball and RBS may be wrong. What if this is just the start of a bear market, rather than half way through a 10% correction on global markets? In which case selling now with a view to cunningly buying back at a cheaper price (and taking into account transaction costs with both trades) looks risky. Indeed, the RBS advice ignore central bank policy response – what is to stop the US Fed reversing its recent hike if weaker US growth and the risk of deflation from China suggests that is the right course to take?
- Far easier, however, is for the long term investor (with around 10 years or more before they need their money back) to follow the following basic investment strategy. Buy an off-the-shelf multi-asset fund that will ensure a consistently diversified portfolio of high quality equities and bonds, that rebalances quarterly. Then let markets do as they will. Keep some cash in reserve with which to top up positions during bear markets, and a small position in gold for diversification purposes.
China opaque data and bank debt
- A key reason for investor unease over events in China is distrust over the reliability of official economic data. In the absence of reliable numbers, investors try to check the pulse of the economy through looking at domestic share price movements and the exchange rate. The fact that both of these are falling, despite being partially managed by the authorities, is being construed by some investors as a signal that Beijing is preparing the world for a hard landing.
- As a taste of what we might be in for, last week London-based Fathom Consulting estimated that the Chinese economy – now the largest economy in the world by some measures – is growing at only 2.4%, a far cry from the official third quarter (annualised) rate of 7%.
- A bad debt crisis may be looming, potentially crippling the county’s banks. The chief source of bad debt comes from construction work, which is slowing down as the government attempts to shift the driver of growth towards services. With less work to be had, and the withdrawal of cheap, politically-favoured loans, many development and construction companies will face problems rolling over loans. As demand for Chinese exports softens, and bank loans for stock market investing turn sour, loans to exporters and brokers may also become bad.
- Independent research house Autonomous has suggested that Chinese banks could require up to $7.7 trillion of new capital and new funding over the next three years, sending China’s debt to GDP ratio up from the current 22% to 122%. This would raise borrowing costs substantially for the Chinese government and the private sector.
- An officially sanctioned slide in the yuan against the dollar looks possible. Sure, by boosting exports and raising the cost of consumer imports the government will hinder its attempt to shift the economy away from a reliance on exports and construction. But the currency has appreciated by 20% on a trade weighted basis since 2012, thanks rising domestic wages and the peg to the resurgent dollar. Beijing may increasingly be tempted to export its problems of over-capacity and weak growth.
UK house prices – focus on interest rates, not falls in Chelsea prices
- A headline in the Daily Telegraph last week told us: ‘UK house prices to crash as global asset prices unravel’. They might, but without a rise in interest rates from the Bank of England, I suspect not. At its meeting on 13 January the Monetary Policy Committee (MPC) of the Bank again voted 8-1 to keep the key bank rate at 0.5%.
- I see only a slight rise in UK rates this year, if at all. There is no inflation pressure in the UK, with wage growth of around 2.4% on October failing to translate into inflation with the CPI headline figure at 0.1% in November. Certainly sterling is weakening against the dollar, suggesting that imported inflation may be a threat, but the falling dollar price of oil imports will go a long way to compensate.
- The Telegraph cited the death of buy-to-let (BTL) through tax changes as a possible trigger. This point is much exaggerated –why would someone holding a BTL as a pension sell, when other forms of long term pension saving are so restrictive? Certainly some marginal holders of property will be forced to sell if interest rates go up, but that takes us to the Bank of England interest rate policy question.
- Rich foreigners in selected parts of London may sell their UK houses to raise funds, as the value of investments elsewhere fall perhaps because of weaker Chinese growth. Saville’s report that house prices in Chelsea fell in calendar 2015, the only district of London to see a fall in prices. Certainly tightened tax legislation will deter some holders and potential buyers of the luxury market, and the disproportionately large value of these transactions will impact on London data. But I am sceptical that, say, a 20% fall in the asking price of a Chelsea penthouse will have much impact on the asking price of a one bad flat in more modest Hounslow.
- Of course, mortgage rates could rise if lenders take fright and restrict mortgage availability. But why would they do this while wages are growing and the cost of their funding (as measured by the UK long dated gilt) is falling?
- UK house prices are only vulnerable if the MPC announces a decision to normalise interest rates, to 3% or more. This may happen in future years, but is unlikely in 2016.