In this week’s bulletin:
- August has brought further good news for the world’s leading equity markets
- Central bankers in Jackson Hole debate monetary policy and the emerging markets
- The UK and eurozone show further signs of economic recovery and confidence
- Europe offers investors top quality corporates that remain competitively valued
Guns of August
The rumble of events through August is often a precursor to momentous things. The holiday month this year has brought a steady parade of signs of where the world might go as it heads towards 2014. While the unfolding tragedy of civil war in Syria threatens to draw in a Western military response, for investors, at least, the news, if mixed, is certainly not all bad. Emerging markets are floundering, but the advanced nations’ economies are making steadier steps towards recovery. The world’s main equity markets remain near historic highs, while bond yields begin to climb from record lows. The end of summer 2013 is not quite aglow with optimism, but there is plenty to encourage investors six years on from the world’s financial crisis.
Investors have had to be resilient and patient in recent years for the slow and gradual recovery of the global economy. The previous few months have established that prospects for the US-led global economic recovery are looking brighter. Purchasing managers’ data for August have offered further evidence that the eurozone is on a road to recovery, and China’s growth slowdown has stabilised. Second-quarter UK growth figures were upgraded last week on improved export and business investment levels.
With these portents of positive things to come, global central bankers gathered in Jackson Hole, Wyoming last week to discuss monetary policy, although US Federal Reserve chairman Ben Bernanke chose to stay away. Markets continue to clutch at clues as to when the US will begin to taper its $85 billion asset-purchase scheme. Investors remain uncertain as to the pace of the reduction, and how long monetary conditions will stay loose and interest rates will be kept low.
The risk that the Fed’s trimming of bond buying, a further exodus of cash and a rise in borrowing costs will further hurt emerging markets economies was a dominant theme in Wyoming. International Monetary Fund managing director Christine Lagarde pledged “lines of defence” against any deepening of problems for the emerging markets. However, one clear message from policymakers at Jackson Hole is that stormy conditions are expected to continue for the emerging markets as the US makes its transition to more normal monetary policy. But, in the longer term, central bankers and economists expect both developing and developed nations to weather these latest economic difficulties.
Amid the emerging markets sell-off, the main global equity markets remain near their record-high levels, reflecting the mix of good news for the global economy. The S&P 500 index gained 0.2% last week and closed on Friday at 1,664, lifted by the further signs of recovery for the US and the developed nation economies. The S&P is now up around 19% from the start of the year.
Across the Atlantic, the FTSE 100 index closed last week for the Bank Holiday long weekend at 6,447, slightly down by 0.1% over the five-day period but up by almost 14% since the beginning of 2013. The positive news for the UK economy was offset by speculation over US monetary policy and the effect this has had on international and emerging markets. The FTSEurofirst 300 index rose 0.4% on Friday but took a weekly decline of 0.3% as the troubles in the emerging markets dampened sentiment in Europe. In Tokyo, the Nikkei 225 saw sharp swings over the week, culminating in a 2.2% jump on Friday – leaving it just 0.1% higher over the five-day period, helped by the improved outlook for the global economy.
Global markets over the coming weeks will continue to anticipate the start to tapering from Bernanke, prior to the next meeting of the Federal Open Market Committee on 22 September. There is also growing speculation over who will replace the Fed chairman next year. And there are potentially more fiscal battles when US Congress returns from its summer recess.
The old order
Back at the start of the year, there was little concern about the emerging markets. As summer draws in, the problems facing the emerging markets have included further loss of value for the Indian rupee, trouble for Indonesian markets and interest rate rises in Turkey. Investors over the recent years of easy money have piled into developing markets for higher returns amid low interest rates in the advanced economies. Those conditions are changing and the money is moving back to the developed markets.
The recovery of the US economy and anticipation of a tapering of US Fed asset purchases has meant a retreat of money from the emerging markets. But the consensus among policymakers in Jackson Hole last week was that the effects of US policy on emerging markets was not a crisis – and certainly not on a par with the Asian financial problems of 1997. The US Fed will pursue a gradual taper of its bond-buying programme, whatever the market reactions this summer. However painful the transition might be, the world is returning to the old order of more normal monetary policy conditions and healthy developed economies.
There is a strong argument that the problems that have beset emerging markets over the last month reflect previously overambitious expectations rather than fundamental weaknesses for these markets and economies. Richard Jerram, chief economist at Bank of Singapore, for example, believes that emerging markets in Asia, at least, still offer a good structural story based on underlying domestic demand. In the longer term, with the US, Japan and Europe in various degrees of recovery, the developing world can expect some economic pull from the advanced nations finally rediscovering some confidence and momentum.
Emerging markets face uncertainty over the coming months. The tapering of the Fed’s programme will drive up US yields and borrowing costs, which will particularly hit countries with funding deficits. But investors could see plenty of value return to the emerging markets. And, as we have consistently argued, the long-term growth potential offered by exposure to emerging markets is an important aspect of a well-diversified portfolio.
The dying days of August in Britain are as good a time as any to reflect on the recent past, and the pessimism that hung over much of the talk about the British economy in the early part of the year already seems like it was about another country. The UK by the week – as we have chronicled in recent months – is slowly turning a corner; nothing spectacular, a little dull for some, but as sure enough an economic recovery, and not even of sorts.
Last week’s Office for National Statistics figures for the UK were upbeat, with growth in the second quarter revised up to 0.7% from 0.6% and the expansion balanced between exports, consumer spending and investments. Meanwhile, purchasing manager indices continue to show growing business confidence. And a new governor at the Bank of England has injected some transatlantic optimism.
There are negatives. Cash returns remain parlous, a situation not helped by government initiatives such as the Funding for Lending Scheme. Individuals looking to invest wealth face a major challenge amid volatility in all assets. However, there are plenty of positives to mull over as autumn closes in. Britain is saving more than was thought, there is a housing recovery, inflation is falling, and the labour market is holding up better than previously anticipated.
For investors, UK equities are reflecting, in part, the improved conditions for Britain’s economy. UK companies continue to offer dividend yield potential, as we reported earlier in the month. Valuations on UK equities are attractive by historical standards. Mid- and small-cap sectors are doing well. The increasingly international element of the FTSE 100 has given investors more exposure to the global economy, with all the potential growth benefits, as well as the risks, which that entails.
What is good for the eurozone is good for the UK economy and investors. And the news coming out of Europe in August has been, for once, promising rather than ominous. The periphery may continue to struggle, but the centre – the German economy and, as we highlighted last week, even France – is holding.
German growth in the second quarter was 0.7%, compared to negligible expansion at the start of the year. However, problems persist in Greece with high-level talk emerging of a third bailout. Greek finance minister Yannis Stournaras has indicated that, if another bailout is required, it would be in the order of €10 billion, which would make it considerably smaller than the previous two that amounted to €240 billion. Germany’s chancellor Angela Merkel has separately said that there should be no further write-downs on Greek debt – a message she is likely to reiterate as she approaches the German elections on 22 September.
The European paradox for investors is that despite the economic ill-health of its subsidised margins and the rickety state of their public finances and economies, they are home to some of the world’s top-quality corporates which have remained, among other things, good value. Fund managers have consistently pointed out that European stock valuations are favourable to those across the Atlantic.
Fund manager Stuart Mitchell of S. W. Mitchell Capital has maintained that, despite the lingering European debt crisis since 2010, investors can find quality and value in equities across the region.
Mitchell identifies plenty of positive recent developments in Europe. The corporate sector is in good health with cash on balance sheets and low debt-to-equity ratios, and many companies are still trading at around a 50% discount to their US counterparts, although the gap has recently begun to narrow.
Moreover, Mitchell remains sanguine about the political and financial challenges facing a number of the European Union member states. Reflecting on the overall threat to the stability of the eurozone, Mitchell believes that there is a tendency to overestimate the size of the problem in the periphery relative to the fundamental strength of other parts of the region, particularly Germany and northern Italy.
European equity funds are also benefiting from the recent pull-out from emerging markets. Figures from fund data provider EPFR last week showed $1.6 billion flowed into European equity funds in the period between 15 and 21 August, which brought to almost $12 billion the total inflows since the start of July. The previous longest run of inflows was in the first quarter of 2007.
Investor interest in European equities reflects its improved economic conditions over the last few months and concerns over emerging markets. With the eurozone officially out of recession, the FTSEurofirst 300 index has risen almost 10% since late June. Despite the crisis that engulfs Syria and the Middle East, the economic auguries of August are looking better, at least, for the eurozone and Britain, and the developed world.