In this week’s bulletin:
- Global markets wait for US foreign and monetary policy developments
- The crisis in Syria has increased demand for safe haven assets
- Reviving the Japanese economy is crucial for wider Asian equity markets
- Middle Eastern tensions bring some shine back to gold
For all the talk of a 21st century new world order, recent days are a reminder that the US remains unrivalled, if more reluctant, on the international stage. While American military action looms against the Assad regime in Syria, a tightening of US central bank policy is awaited across the world’s economies. Markets and investors are moving to the drum beat of US financial and foreign policy and anticipating what next step this will require for the world’s largest economy and the rest of the globe.
Investors and markets oscillated in the dying days of August to the unfolding response of the US and the international community to Syria’s use of chemical weapons. Global equities dipped over the week amid the uncertainty surrounding the US-led military action and the waiting game on Fed monetary policy. The threat of military strikes also pushed up the price of Brent crude mid-week to a six-month high of more than $117 a barrel, although this fell back to $114 at close on Friday as supply concerns eased.
Although Syria is a minnow among the world’s energy producers, a conflagration of its conflict would have repercussions across the Middle East, potentially disrupting supplies from oil-producer neighbours Iran and Iraq and the wider region, and through the Strait of Hormuz as well as the Suez Canal. An oil-price spike is likely to be offset, however, by increased production from Saudi Arabia, which would help minimise any short-term turbulence for stock markets and the world economy.
US Federal Reserve chairman Ben Bernanke, however, may well have a more lasting influence on world fortunes than President Barack Obama and his response to Syria’s gas attacks. The world’s policymakers and investors are waiting for a decision on 17–18 September from the Fed on whether or not it will start to trim the US’s $85 billion-a-month asset-purchase scheme. An anticipation of this retreat from the quantitative easing (QE) programme, however gradual when it comes, has shaped emerging and advanced markets and economies since Bernanke set out on 22 May the economic criteria required to start the tapering.
Last week an upward revision of US second-quarter annualised growth figures to 2.5% from an initial 1.7% estimate brought divided opinion on which way it would influence the Fed’s decision. August employment figures – which are expected to keep the overall unemployment rate at 7.4% – are due this week, as well as trade and purchasing manager survey data. Markets will also anticipate the European Central Bank president Mario Draghi’s interest rate statement on Thursday, and news from the Bank of Japan’s policy board meeting. Eurozone retail sales and German industrial production data this week will give further detail of how the region is building on its recent pull-back from recession.
The S&P 500 index fell 0.3% to 1,633 on Friday which was a loss of 1.8% over the five days and 3% for the month – its biggest monthly decline for more than a year. Across the Atlantic, the FTSEurofirst 300 fell 1% to 1,195 on the last trading day in August, which was a weekly fall of 2.3% and its biggest five-day decline since June. The FTSE 100 also ended the week at 6,413, down 1% on the day and 3% over the month. In Tokyo, the Nikkei 225 Stock Average fell 0.5% to 13,389 on Friday, leaving it down 2% over both the week and the month.
The old nexus
If there is a world order that has been on view in recent weeks it is the familiar late 20th century nexus of ever-closer globalisation with America at its centre. Since Bernanke raised the prospect in May of ending US easy money, investors have been bracing themselves, which has hit stocks, bonds and currencies in developing countries. The Fed’s ultra-loose monetary policy since late 2008 has kept domestic yields low and investors with billions of dollars of easy money made their way to the corners of the world for higher returns.
Low interest rates and QE were the cause of dollar liquidity moving into the emerging nation economies; the reverse of QE will not be easy. Nations that are dependent on cheap foreign financing, such as Brazil, India, Indonesia, South Africa and Turkey, are suffering the most as the tide draws out. Some are raising interest rates, such as Indonesia, but this risks curbing growth. Others are struggling to keep their economies from stalling as China slows. Emerging market currencies continue to suffer with the Indian rupee last week recording its worst one-day decline since 1995, despite the government unveiling a ten-point plan to reduce India’s current-account deficit.
Comparisons with the 1997 Asia crisis are, however, wide of the mark, with many of the emerging economies in a very different condition two decades on. The underlying fundamentals of many are healthy, with manageable public debt and minimal solvency risks. Many of these nations, including India and Indonesia, have built up improved reserve holdings. Many in the longer term offer growth of consumption based on urbanisation and the rise of the middle-classes.
The message from central bankers in Jackson Hole, Wyoming the other week was that the difficulties are not the Fed’s (although they are concerned that tapering could create a rush for dollars). However, the summit in Russia of the group of 20 leading economies this week is expected to discuss the recent emerging market volatility. The tapering of the Fed’s QE programme may have had the unintended consequence of pain for developing nations. It may also encourage countries looking for future investment to make themselves more attractive to private investors.
Return of bonds?
Heightened international tension last week over Syria and the ensuing geopolitical concerns for the Middle East also increased demand for less risky assets, including bonds, the Japanese yen and gold. Investors’ renewed appetite for safe-haven investments comes after some difficult months for these asset classes in the wake of the Fed indicating an impending wind down of QE and strong performances by equities. The yield on ten-year US Treasury bonds was up 2 basis points (bp) on Friday to 2.78%, although this was 4bp lower on the week. German Bunds held at 1.86%, although they were 6bp down over the five-day period.
PIMCO chief operating officer Douglas Hodge believes that net inflows of bonds will return over the long term after the recent outflows since Bernanke’s comments in May on the future of QE. PIMCO, which manages the Multi Asset fund for St. James’s Place, has taken issue with the financial media coverage of bond outflows in the months following the Fed’s decision to raise the prospect of a tapering of QE. “Their message that bonds are riskier than stocks remains untenable,” says Hodge.
US institutional investors are again buying long-dated bonds, observes Hodge in a recent PIMCO paper. Individuals can be expected to follow suit, he adds, with fund managers sorting through a broader global bond ‘supermarket’ to identify value even as rates rise. Hodge believes that bond markets are at an investment inflection point that will draw investors back towards fixed-income assets.
Investors, of course, will hold differing views on what the future holds for fixed-income investments. As we have stated several times recently, the days of double-digit returns are clearly over. There remain pockets of value, however, and these continue to play a moderating role in all but the most aggressive investor portfolios.
As the Fed moves towards tapering, Japan’s government and central bank have taken some bold steps this year to stimulate the country’s moribund economy that have spurred market and investor confidence. Last week also saw investors favour the yen as a safe-haven currency, with the Japanese currency at over 96 yen against the dollar. The Nikkei 225, although down 2% in August, is 30% up in 2013 and 55% over the last year.
Prime Minister Shinzo Abe’s election victory in July has given him the working majority he needed to pursue the next stage of his ‘Abenomics’ programme: his mix of reflation, government spending and strategic growth to jolt the economy out of its slumber over the last two decades. China overtook Japan as the world’s second-largest economy in 2010, which, among other things, stung Japan into debate about its future. The Abe government is not only showing urgency on the state of the economy, it is also matching a more assertive China, whose growth along with the rest of Asia is vital for Japanese wealth too.
Aberdeen Asset Management Asia’s managing director Hugh Young believes Japanese and Asian equities look good for the longer term. “The great driver for growth is coming from within the region itself – as populations become richer, we’re seeing increased domestic demand.”
The success of Abe’s project to revitalise the Japanese economy is one of the paramount developments for the wider Asia region and its equity markets, says Young, as are China’s growth slowdown and the ripple effect of Fed policy. Young says Japan desperately needs the wide package of Abenomics reforms. “We find some fantastic companies and values particularly in the smaller-cap end of Japan,” adds Young. “It is a very broad market and a very bountiful fishing ground for managers such as us.” Global investors have remained reticent, however, about Japan, following its prolonged economic depression. And uncertainty over whether the Abenomics programme will work is still keeping some investors shy of Asia’s leading developed market.
Gold has had a difficult summer, reflecting a return of confidence for the developed world’s economies and equity markets. However, Middle Eastern tensions have started to bring some shine back to the precious metal, if not quite enough to enthrone it again at its all-time high price of $1,923 in September 2011. Last week the yellow metal hit a three-month high of $1,433 an ounce, although it closed at $1,394 on Friday.
The price of gold fell in the first half of the year, dropping to $1,200 on 27 June. The metal draws its appeal from uncertainty, which has returned in galleon loads in recent weeks amid the impending conflagration of Syria’s civil war. (Gold and crude oil prices are also correlated historically and rise during rumblings in the Middle East region.) Gold-bugs will be some of the few to draw strength from the news that the US next month will reach its $16.7 trillion government debt ceiling. The need for Capitol Hill to negotiate a new limit to avoid default before mid-October will, for these gold enthusiasts, highlight the investment’s perceived safe-haven status.
Problems in the emerging markets, including India’s currency crisis, have also boosted the lure of gold as a safe haven to protect wealth, particularly for these countries’ burgeoning middle-classes. With markets expecting an announcement of the start of tapering of QE if not later this month then at some time quite soon, gold investors will have to contend with a potentially strengthening dollar as monetary policy tightens and bond yields rise. Gold for many, it is well acknowledged, can be as much a faith as an investment, and these holders may remain undeterred.