Nothing emerges from Jackson Hole

In this week’s bulletin:

  • Ben Bernanke’s speech at the annual Jackson Hole meeting fails to provide a specific commitment to further large-scale asset purchases and leaves markets guessing.
  • Attention turns to this week’s meeting of the European Central Bank and hopes of news a bond-buying programme to ease the pressure on Madrid and Rome. Meanwhile, the Bundesbank  expresses German concerns about the inflation dangers of an open-ended deal, raising the prospect of further delays in decisive action.
  • Latest unemployment and inflation figures confirm the plight of the Eurozone’s peripheral countries.
  • After making quiet progress over the summer months, markets may resume a more volatile path as September’s calendar of events unfolds.
  • Against that backdrop, investors await the return to a focus on fundamentals rather than sentiment.


Nothing emerges from Jackson Hole

  • Federal Reserve keeps everyone guessing over QE3

It was another week when, in the absence of any decisive news or announcements, investors continued to mull over economic or political soundbites and markets meandered in much the same way as global policymakers appear to be doing. On Friday it was the turn of Federal Reserve chairman Ben Bernanke to be in the spotlight. His long-awaited speech at the yearly symposium of central bankers in Jackson Hole failed to provide the hoped-for specifics about whether and when the Fed would commit to further large-scale asset purchases, or ‘QE3’. However, in painting a relatively downbeat picture of the world’s largest economy, Bernanke made it very clear that he believes more action is needed, stating “the economic situation is obviously far from satisfactory” and “the stagnation of the labour market in particular is a grave concern”. The payrolls situation appears to be Bernanke’s key concern and further US jobs data this week will provide some more clues to the Fed’s likely next move. Together with the dovish minutes of the previous Federal Open Market Committee (FOMC) meeting, the speech was a clear sign that the Fed is ready to provide more policy stimulus. Whilst Bernanke acknowledged the potential costs of a further expansion to the Fed’s balance sheet, QE3 and an extension to the Bank’s zero-interest-rate pledge (to sometime in 2015 from “late 2014”) are the tools most likely to be used.

Bernanke’s fence-sitting act disappointed the stock-market bulls, with the result that equity markets across Europe and the US trimmed earlier gains to end the week in marginally negative territory. The S&P 500 Index finished down -0.47% and the FTSE 100 shifted -1.13%.


Wait and see

  • ECB plans come under fire by Germany
  • Eurozone unemployment and inflation gives more cause for concern

In his speech, Bernanke also offered his thoughts on the eurozone and its consequences for global trade and markets.

“Some recent policy proposals in Europe have been quite constructive in my view, and I urge our European colleagues to press ahead with policy initiatives to resolve the crisis.”

Ben Bernanke, Federal Reserve chairman

Like many others, Bernanke is waiting for news and signs of action elsewhere. September sees a raft of further political events, with the speculation and (potential) disappointment over their outcome likely to signal the direction of markets in the coming weeks. Equity markets quickly turned their attention to this Thursday’s policy meeting of the European Central Bank and hopes that its president, Mario Draghi, will unveil a bond-buying programme to ease pressure on Spanish and Italian sovereign yields. A week later, Germany’s constitutional court will rule on Europe’s new bailout fund, the European Stability Mechanism (ESM). While the court is unlikely to block the ESM’s launch, it could insist on greater safeguards for German sovereignty. Assuming the German court deems the ESM legal, the new bailout fund must then be ratified, which won’t happen until at least the end of the month, and only then if all the eurozone governments agree.

Persuading Germany, with its inflation-scarred psyche, to toe the line on the ECB’s open-ended commitment to buy bonds appears to be one of the major challenges for Draghi. Reports emerged that the chief of the Bundesbank, Jens Weidmann, had threatened to resign in protest at the plans to prop up Spain and Italy.

“Such a policy is, for me, too close to a public finance by the printing press. We should not underestimate the risk that central-bank financing can be addictive like a drug.”

Jens Weidmann, Bundesbank

With the Bundesbank such a revered institution in Germany, this latest development piled even more pressure on the chancellor, Angela Merkel. If the bond-buying plans end up being watered down to appease the doubters then the danger is that yields will not come down as far as Spain and Italy would like (and need). Ultimately, the decision on whether ECB bond-buying goes beyond the €50 billion of Greek bonds purchased so far and extends to the much bigger requirements of Spain and Italy rests with Madrid and Rome. They must apply for the bailout assistance, with all the pre-conditions and political humiliation that will come with it; something their excitable electorates are unlikely to accept quietly.

The dispute took centre stage as details of Spain’s “bad bank” were announced, intended to come to the aid of the country’s beleaguered banking sector. Minister Luis de Guidos said the “bad bank” – intended to house distressed assets of Spain’s banking sector – necessary “to have the banks lending again”, would begin operating this year and is expected to make a profit within 15 years. The plan is the key to unlocking €100 billion of EU loans to recapitalise Spanish banks.

In a possible sign that some of the worst fears have receded for the eurozone’s under-pressure bond markets, Italy sold €7.3 billion of debt on Thursday at some of the lowest yields in months; the first such sale of long-dated debt since late July when Mario Draghi made his pledge to defend the euro. However, such news came in the same week as unemployment in the eurozone hit a new high of 18 million in July, or 11.3%, across the 17-country area. Spain was worst hit, with 25.1% of its workers out of a job and a depressing 52.9% unemployment rate amongst the under-25s. Greece was next on the list with 23.1%, whilst German figures remained steady at 5.5%, lower than a year ago; and highlighting once again the north–south divide. Coupled with higher-than-expected inflation figures across the eurozone – 2.6% compared with 2.4% a month earlier – the unemployment figures compound the problems policymakers face in taking decisive measures to restore business confidence and boost economic growth.


Seeing through the sentiment

  • Market volatility set to continue as September’s events unfold
  • Patience and diversification will be rewarded

After a summer which has seen a powerful rally in equities, corporate bonds and commodities, the aforementioned diary of events in September coincides with the period that traditionally marks the return of many financiers from holiday; a combination which could lead to heightened volatility as more investors jump onto the sentiment pendulum. There is no doubt that stock-market investors have had to get used to greater, potentially unsettling, volatility in recent years. Research by HSBC reveals that the FTSE 100 Index was five times more volatile over the last decade than in the 10 years before. During the nineties, the index rose or fell by more than 3% in a day on 22 occasions, but there were 106 such swings in the last 10 years. The same trend is repeated across the globe and, given the headwinds faced by the world’s economies, there is little likelihood of anything changing soon.

Faced with that reality, what is the answer for investors? The important thing is to remember that our investment goals are not achieved today or tomorrow, but over the longer term. Whilst the temptation might be to run for cover as prices fluctuate, finding the bottom of the market and perfectly timing a re-entry into risk assets is a feat rarely achieved. Difficult though it may sometimes feel, sitting tight is invariably the best course of action, coupled with the additional comfort that can be gained by ensuring that your portfolio combines assets that are diversified and not closely correlated. Finally, techniques to drip-feed money into the markets can provide additional peace of mind in the face of higher volatility, either through regular savings or phased investment.

The key is to have patience and faith that the markets will eventually turn their focus onto company fundamentals rather than sentiment. In 1999, equities in the FTSE 100 Index were twice as expensive, relative to earnings, as they are now. The dividend-paying capability of those companies also remains an important factor, either for those seeking income or investors looking for total return. That said, the highest dividend-yielding stocks will not necessarily deliver the greatest returns, as they could signify their companies are distressed. The focus for income-seeking investors should be on quality companies with the scope for dividend growth as the best counter to the effects of inflation.

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