Market Bulletin - Add and divide
Oil and stocks enjoyed a positive week, but a UK referendum has split political opinion, contributing one more uncertainty to the global outlook.
On Friday last week David Cameron secured a compromise deal with the European Union that enabled him to announce a referendum on Britain’s membership of the European Union, to be held on 23 June.
This was the cue for a familiar sight in British politics: the Conservative Party dividing over Europe. Boris Johnson and Michael Gove were perhaps the two most significant political figures to announce their support for the exit campaign after the deal was announced. Meanwhile, the bosses of around half of the UK’s biggest 100 companies agreed to sign a letter backing the prime minister in his campaign to keep the UK in the European Union.
The stage is set for four months of debate, analysis and campaigning, amounting to a period of uncertainty that will inevitably be felt on financial markets. An exit would have implications for the UK’s economic, financial and corporate outlook. Inevitably, not all these implications can be fully known in advance. The pound was down 1.5% in early trading on Monday.
Last week HSBC’s chairman announced the bank’s decision to remain headquartered in London, but in the same statement warned that a UK departure from the EU would lead to the relocation of 1,000 investment banking jobs from London to Paris. HSBC is expected to sign the pro-EU letter of support for David Cameron that is due to be published on Tuesday. The letter will argue that the UK is “stronger, safer and better off” in a reformed EU.
In fact, the FTSE 100 enjoyed a strong week, rising 4.3% over the five-day period, thanks in great part to improved sentiment towards both banks and oil & gas majors. This was in line with global stocks more broadly, which enjoyed an exceptionally positive week. The S&P 500 ended the week up 2.7%, while the FTSEurofirst 300 rose 4.3%. But the star performer was the Nikkei 225, which finished up 6.8%, despite news last week that the Japanese economy had shrunk at an annualised rate of 1.4% in the fourth quarter of 2015.
Such single-week rallies are heartening, of course, but they can as easily be reversed in the short term, which is why long-term investors shouldn’t pay too much attention to weekly gyrations. Nevertheless, on this occasion the reasons behind the buoyant mood were more than incidental.
One of the chief drivers of stock market trajectories in 2016 has been the price of oil. Brent crude rose sharply to reach a midweek peak of $35 a barrel, as negotiations over cuts looked to be bearing fruit, before settling to around $33 by the end of the week. Despite the retail boost offered by cheap oil, low prices and high volatility create significant headwinds for oil companies and their lenders alike.
Last week Ben van Beurden, CEO of Shell, predicted that oil prices would rebound later this year. His comments came in the context of Shell completing the £35 billion purchase of BG last week.
Cheap commodities also create a problem for central banks, because they are currently the major check on inflation. Inflation in major developed economies around the world remains very far below central bank targets, which cluster around 2%. Figures released last week showed that the Producer Price Index in the US had risen by a mere 0.1% in January but the core Consumer Price Index in the US showed a 0.3% gain, its largest since August 2011.
Adding to the concerns of central banks are low commodity prices, instability in the financial sector, poor corporate earnings and politics – from the success of non-centrist presidential candidates in the US to the possibility of a UK exit from the EU. The strength of global growth is a particularly pressing concern: on Wednesday last week, the Organisation for Economic Co-operation and Development (OECD) warned that governments in advanced economies need to act “urgently” and “collectively” to prevent a slide in the growth rate.
It is significant that the OECD called on governments rather than central banks – the latter are already proving themselves willing to take even the most radical measures to aid growth. For some central banks, that will mean pushing interest rates still further into negative territory. A relatively new abbreviation has thus gained considerable currency in recent weeks: NIRP (negative interest rate policy). Already, a fifth of the world’s economy is overseen by central banks that have joined the NIRP club, and the group is widely expected to expand its membership in the coming months.
Other easing measures are expected to follow, but central bankers’ comments can be useful in quelling panic too. Minutes of the ECB’s January meeting, released last week, show the eurozone’s central bank is poised to take more radical action in March. Meanwhile, the chair of China’s central bank told domestic media that there was no basis for a devaluation of the renminbi.
For investors, the determination of central banks to aid growth and spending remains important; while global growth remains fragile and inflation elusive, a bedrock of monetary support should help to buoy stocks and bonds alike, as well as ultimately boosting retail spending.
Nevertheless, there are concerns that central banks have already done a great deal to boost growth and spending – without yet achieving significant outcomes. Central banks around the world have cut rates 637 times since March 2008; and they have bought a combined $12.3 trillion in assets, largely their own bonds. Yet bank lending remains low, in part because governments have often pursued austerity programmes and set lending limits on banks, even as they tried to revive growth.
That is why more extreme measures are now being discussed, such as introducing ‘helicopter money’, whereby a central bank finances government spending or tax cuts directly, bypassing both banks and markets. This creates new uncertainties, of course, not just over what policies central banks will choose to pursue (or when), but also over the differing extents that the major central banks will go to in boosting growth and spending. Moreover, a number of touted policy directions have not been tried before. Given ongoing debates about the impact of quantitative easing – very much a tried-and-tested approach – it is hard to predict how these new policies will play out in markets.
In such an environment, long-term investors would be unwise to limit themselves to just a few companies, sectors or even countries. This year the Chinese currency, for example, has been particularly susceptible to rapid global inflows and outflows and to the vagaries of central bank policy – last week the renminbi saw its biggest single-day rise (of 1.2%) in a decade.
Such global swings and roundabouts are not easy to foresee even when monetary policy is predictable; today, it is anything but predictable. The wisest course of action for investors in such an environment is to diversify their holdings across sectors, regions and asset classes. That not only saves them from the risks of playing soothsayer – it should also help enable them to ride out the volatility.
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