‘Safe haven’ government bond yields hit new lows

In this week’s bulletin:

  • Global concerns direct investors’ attention away from Europe
  • ‘Safe haven’ government bond yields hit new lows
  • JPMorgan Chase announces losses far in excess of the expected $2 billion
  • Shares in the bank rose as investors focused on future profits rather than losses already incurred
  • China’s economic growth slowed to around 7.6%, triggering speculation about the impact on the global economy
  • To reduce the risk of investing directly into Chinese stocks, some fund managers prefer to invest indirectly through companies in surrounding areas

 

Equities struggle for traction

  • Global concerns direct investors’ attention away from Europe
  • ‘Safe haven’ government bond yields hit new lows

Europe is not alone on investors’ lists of concerns. Worries over growth in China and the US recovery saw another week of increased demand for US and UK government debt. Some of these concerns were soothed last week as second-quarter data from China pointed to growth that was not as weak as many had feared, but still soft enough to keep speculation alive about further monetary stimulus. Policymakers in Beijing could be pressured into more decisive easing actions in the coming months to reverse the slowdown in growth, with falling inflation offering an opportunity for action. Central banks continued to take steps to encourage growth, with an interest rate cut in Brazil and the first rate cut in three years in South Korea adding to the much-publicised actions of the European Central Bank and the Bank of England. However, the Bank of Japan only made minimal changes to its asset-purchase programme and the US Federal Reserve said that a further round of quantitative easing will be dependent on economic conditions deteriorating further.

These overriding issues saw equity markets struggle for traction and volatility continue; after the second-quarter earnings season in the US started poorly and following particular shocks from the technology sector. Despite the S&P 500 recording six consecutive days of negative trading before Friday’s rally, the US index fell only 0.1% for the week. In the UK, the week saw thin trading and a small increase of 0.1%, closing at 5,666.13.

In government bond markets, the start of the week saw a brief respite as eurozone finance ministers sanctioned further support for Spanish banks and Madrid unveiled a further €65 billion of austerity measures. However, markets remain unimpressed, with the steps being taken viewed as too small and too slow. There was a muted reaction to Moody’s two-notch downgrade to Italian debt and the country successfully auctioned €5.25 billion of long-term bonds. Investors seemingly preferred to focus on Moody’s comments on Mario Monti, which were in praise of his attempts to overhaul state finances.

As investors continued the search for perceived safety, German Bunds sank to a yield of 1.26%, US ten-year Treasuries fell to 1.49% and ten-year UK Gilts reached 1.53%.

 

JPMorgan Chase losses reach $5.8 billion

  • JPMorgan Chase announces losses far in excess of the expected $2 billion
  • Shares in the bank rose as investors focused on future profits rather than losses already incurred

JPMorgan Chase has revealed that trading losses from the first-quarter swelled to $5.8 billion, opening fresh questions over disclosure to investors. The bank said it had “clawed back millions of dollars of bonuses” from traders, as fears grew over whether they had been reporting their positions too positively. When the story broke two months ago, Jamie Dimon, chief executive, promised that losses would be contained to $2 billion but is now warning that losses could reach $7.5 billion. The Federal Bureau of Investigation and regulators continue to investigate JPMorgan Chase and the losses linked to Bruno Iksil, nicknamed the ‘London Whale’, the credit derivatives trader who has now left the bank but whose disastrous trades have now been fully disclosed. The executive leading the internal enquiry at the firm, Michael Cavendish, said his team had made mistakes in its attempts to reduce risk exposure, saying that the portfolio of positions of credit derivatives indices had grown to a size with “numerous embedded risks that the team didn’t understand and were not equipped to manage”. Mr Dimon is expected to repay a large proportion of his pay of the previous two years as the Wall Street giant seeks to make an example that will satisfy the general public. Bonuses for 2012 and potential clawbacks are expected to be based on the mistakes for which he would be held directly responsible after the internal investigation. The situation is particularly embarrassing for Dimon after he originally dismissed speculation as a “tempest in a teapot” in April.

None of these losses seem to shock investors. The price of JPMorgan Chase stock rose on Friday by more than 6% as investors preferred to focus on the 14% rise in mortgage lending compared to the same period in 2011; a figure which could result in a significant increase in future earnings. Jamie Dimon told analysts in a conference call, “If interest rates increase by 100 basis points, our earnings would go up by $2.4 billion. If it stays like this for a while, earnings will remain the same, but it’s virtually impossible for rates to reduce year on year from here.” Shares across the banking sector in the US were boosted as Wells Fargo also announced increased lending. Both banks were helped by the government programme aimed at helping those with negative equity, the Home Affordable Refinance Program, which allows banks to earn fees from refinancing.

Reporting season continues this week with Goldman Sachs expected to report a fall in profits. Analysts believe the second-quarter delivered $839 million, following on from $1.09 billion for the same period in 2011. It will also be considerably less than the $2.11 billion banked during the first three months of the year when a raft of measures by the European Central Bank encouraged more trading activity. The fading impact of these actions is likely to have hit trading volumes and the appetite for risk that drives profits at the investment bank.

 

China

  • China’s economic growth slowed to around 7.6%, triggering speculation about the impact on the global economy
  • To reduce the risk of investing directly into Chinese stocks, some fund managers prefer to invest indirectly through companies in surrounding areas

The release of second-quarter GDP figures confirmed expectations of weakening growth in the Chinese economy and confirmed the challenges faced in avoiding a hard landing.  There is a threat of deflation, import and export growth has slowed and the outlook for domestic consumption has worsened. The figures will pile greater pressure on the Communist Party to introduce stimulus measures to get growth moving again. Recently, Wen Jiabao, China’s premier, spoke of “huge downward pressure on the economy” and said that the government was ready to fine-tune monetary policy further.

Future Chinese demand is a huge factor in determining commodity prices. Experts have long expressed anxiety over the impact of slowing demand on mining companies around the world. Around 30% of the FTSE 100 Index is represented by mining and energy companies. Countries such as Australia and Brazil are even more commodity-dependent, with 40% of Brazil’s main index made up of two companies: Petrobras, the energy company; and Vale, the second-largest mining company in the world.

It remains to be seen whether a hard landing for the economy is already priced into the Chinese market. Chinese equity funds have only delivered an average of 2% year to date (source: Daily Telegraph, 14 July 2012). However, returns in previous years have been far higher, perhaps justifying the undoubted risk in investing directly in such a relatively immature market. Hugh Young of Aberdeen Asset Management Asia, manager of the St. James’s Place Far East fund, prefers to access Chinese growth prospects in a more risk-averse way. He focuses on stocks listed in the Hong Kong and Singapore markets, home to some of the best-managed companies in Asia. “These companies are not just regional: in some cases they are global. It is not particularly for exposure to the economies of Hong Kong and Singapore, but for exposure to broader Asia.”

Hugh acknowledges that the consumer demand story is a valid macroeconomic argument but stresses that picking companies to exploit it is not a straightforward process. “Retailers in China can be very difficult. Li Ming [the Chinese equivalent of Nike or Adidas] opened hundreds of stores but mismanaged the growth and didn’t come through on the earnings front. People can make a serious mistake if they jump for any stock exposed to the consumer demand story.”

Overall though, in spite of the pressures facing the economy, he does not expect China to suffer a hard landing from growth to stagnation or recession.

“Given the way China works, I am more inclined to think there will be a soft landing. It won’t be an out-and-out disaster.”

Hugh Young, manager of the St. James’s Place Far East fund

Jonathan Asante of First State Investments, manager of the St. James’s Place Global Emerging Markets fund, agrees that indirect investment can reduce risk in his portfolio, but is changing his view about the merits of direct investment in Chinese stocks. He has been successfully taking advantage of Chinese growth for a number of years by investing in Taiwan and Hong Kong, but feels this may change throughout time.

“The issue with China is not the opportunity because I’m a great believer that the Chinese government has done a much better job than most governments, and a very difficult job at that. The issue is how can my fund benefit? The problem that you have in China directly is that the government influences many of the aspects of the corporate world. It is still a centrally planned economy. Some of the biggest banks in the world, and in emerging markets, are Chinese state-owned banks. It is very difficult for me to fund them when I know that part of their job is actually to take my capital and wipe it out by lending to uneconomic projects. I am much more optimistic about my ability to find good stocks in China in the future because of the shift in focus to the quality of growth rather than the absolute amount. This will lead to an immediate improvement in the quality of the companies.”

“There are going to be some very good investments to make in China, as long as the government is focusing on the quality of growth rather than just trying to hit a number, which it previously has been doing.”  

Jonathan Asante, manager of the St. James’s Place Global Emerging Markets fund

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