Thursday, January 22, 2015

The only game in town...

The ECB QE package – a total of over €1.1tn - was much larger than initial market expectations of €500bn to €600bn. Mario Draghi also left the door open for the monthly bond purchases of €60bn to be continued beyond next September’s notional end-date.  This is, on the margin, positive for European equities and fixed income - notably the Eurozone's peripheral countries – whilst being negative for the Euro.

Yesterday’s price action confirms this with EUROSTOXX Index up 1.7%, Spanish 10Y bonds gaining 14bps and the Euro -1.9% against the USD. 

We’ve been pointedly underweight European markets for a while now, but there are 4 developing reasons – independent of yesterday’s ECB move - for being less underweight European equities:

1. ECB's accommodative monetary policy is starting to filter into the real economy via lower borrowing costs.

2. There are signs of a pick-up in the credit cycle, as a result of stronger household loan demand and a recovery in corporate lending, as well as reduced disparity in lending between countries.

3. The sharp fall in the Euro from the highs last year helps the EU's competiveness and is a tail-wind for EPS, especially when compared with the headwinds faced in the three years to ‘Q3 2014 created by a strong Euro. UBS thinks certainly thinks so, and suggests that Q1 EPS could be boosted by as much as 6% from the currency 'swing' YoY. The Germans will certainly be big beneficiaries, even if they are reluctant participants in the QE process.

4. Lower oil prices will boost real consumption decently. Markets have so far focused mainly on the negative implications of lower oil prices, but not on the positive aspects of this “global tax cut” equivalent.

Short-term, the EU economy will remain feeble, deflation fears will continue, EPS forecast revisions will remain the worst of any equity region and could eventually imply negative equity returns in '15. The political construct of the EU/Euro could also be tested by rising support for euro-sceptic parties in countries with elections this year (in Greece – this Sunday – Portugal and Spain), and in the UK as an important non-Eurozone member.
However, much of this could now be in the price, and as a consequence, European equities look like they could be a better 2015 story than was first thought – once you’ve hedged out the currency risk - provided that European politicians start following the ECB's lead and embark on long overdue reforms (something they've avoided doing). If they don't, there's not much more that the ECB can do.
However, although QE might have a limited effect in real terms, there’s no doubting that markets love it. It’s also worth noting that the ECB’s move comes in a week in which we've seen the PBOC inject around RMB400BN into China’s banking system (offsetting last week’s clumsy crackdown on margin lending by stockbrokerages), unexpected rate cuts by the Reserve Bank of India and the Canadian Central Bank and a shift in the consensus on potential Fed rate increases to 'lower for longer' (2016 anyone?). In Japan, the BOJ has also extended its QE from the original end-March end date and modestly boosted the 2 programmes it uses as part of its QE. This global wave of central bank created liquidity is equity and fixed income friendly.

Overall – the basic point is this.

If 2013 was a year of low yield for fixed income, 2014 a year of no yield, 2015 is shaping up to be a year of negative yields. By comparison, equities look like the only game worth playing.

Steve & Justin


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Tuesday, January 20, 2015

Deja Vu All Over Again...

The DJIA dropped by 5.3%, the world equity index fell by 4%, the dollar rose by 1.6%, 10 year US Treasury yields fell by 12% and commodities were generally weak.

All this happened in January 2014, and we saw that by the year end, these declines had been reversed for a generally positive year end outcome.

In January 2015 - so far, markets are down (albeit by less significant amounts), the dollar's been strong, commodity prices have fallen and US treasury prices have risen sharply. 

We accept that there are good reasons for short-term caution: downward revisions to global growth, possible deflation in Europe and Japan, a weakening Chinese economy, the Greek elections this coming weekend. 

However,  the rationale for remaining fairly sanguine about equity markets in 2015 still seems the same as last year: US growth is strong, interest rates are likely to remain low pretty much everywhere, and - unlike 2014 - the sharp fall in oil prices is producing a global cost saving equivalent (for oil consuming countries) to a significant tax cut for consumers. January 2015 has so far been all about taking on board the bad news whilst ignoring the better. At some point this dynamic will flip over.

We also get back to the basic premise which has underpinned equities as a class for some time: with interest rates low, equity markets remain the least ugly looking asset class. Damning with faint praise, perhaps, but still a valid premise.

Our stance therefore remains  much as it has been for a while: overweight equity, and within that, overweight the USA, benefiting as it does from lowish relative labour costs compared with other developed countries, and significantly lower energy costs than an even larger number of developed countries (and including China). Whilst one might want to be more focused on mid-caps (Healthcare & Technology) than less focused large caps overall (dominated as these are by energy and financial companies), the outlook is still fairly positive.

In Europe (excluding the UK) there are two big issues. The first is that, according to JP Morgan, earnings expectations for 2015 are still in low to mid double digits, whereas on a trailing basis, actual earnings results have been negative by virtually the same quantum. As JP Morgan notes: "analysts have been predicting an earnings recovery that hasn't happened yet...". 

The second is obviously that of the Euro. If the ECB rides in with its expected QE announcements this week, the outlook for the Euro is for further weakening. That would be good for export focused countries such as Germany, but much of that uplift would be offset for non-Euro based investors by a decline in the currency. As we do with Japan, therefore, it's best to hedge out that risk by investing in funds that are currency hedged.

In the UK, the dominant them in the first half of 2016 will be politics. A Conservative victors means a damaging referendum on the Euro which will cause much unease amongst businesses. A Labour victory means back tracking from structural reforms and a damaging increase in government debt. It's a moot point as to which of these two unenviable options will be less bad for the UK market and the GBP.

Asia however, looks a lot better. India particularly so as the reform programme from PM Modi gathers pace and India benefits from lower oil prices. It looks pretty simple as an investment choice. Japan is a more difficult allocation choice... expectations of PM Abe are high, but so far there has been little achieved and all the running has been made by the BOJ.

Broadly speaking therefore, we're still comfortable with being overweight equity in our portfolios even though volatility in 2015 will be higher than we've seen for a while. The jitters of January will, we think, be passes off as just jitters, and therefore it will pay to stay fully invested.



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Javelin Wealth Management supports the global microfinance philanthropy initiative, the education charity,, and the Singapore Children's Cancer Foundation, New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.