Our ‘normal’ monthly commentary focuses, fairly naturally, on events and market movements of the last month but this time we have decided to look at market movements over the past 12 months. Why? Regular readers will be aware that we believe the 9-year economic up-cycle to be tired and, associated as it is with excessive debt, inflated asset prices, unnaturally low interest rates and increasingly fractious and unpredictable politics it makes sense to draw a slightly longer bow when reviewing the relatively recent market ‘dance’.
Stock markets have clearly had a rocky 12 months. If they truly are a forecasting tool they aren’t providing much cause for optimism. It has always been clear that the force-feeding of markets (led by central banks) must end and with it the economic and market distortions that are an inevitable by-product. Perhaps we are now finally nearing the end of the distortions. Credit is tightening, inflation is up, unit wage costs are picking up, output gaps are closing and corporate profit margins are no longer expanding.
It is fascinating that the country that has been the chief protagonist in the trade “war”, the United States, has managed to produce a positive stock market return over the 12 months whereas almost all others are wallowing in red ink. This leaves the U.S. market at a very rich valuation. Support has mainly come through share buy-backs. S&P Dow Jones Indices reports that in the first half of 2018 buy-backs in the U.S. rose by 49.9% to U.S. $379.7 billion from U.S. $253.3 billion in the equivalent period in 2017. On the other hand, retail support for the market has been absent. Data supplied by the Investment Company Institute indicates that equity mutual funds have been subject to net withdrawals for every month but one in the past 12 months – and the positive month (March) was marginal.
Most stock market returns in Europe have been poor although it is interesting that the UK return, whilst negative, is better than many other EU members (including Germany).
The bond market backward-gaze inevitably zeros in on the U.S. where 10-year yields are sizeably up over the 12 months. With the end of Quantitative Easing and active shrinkage of the Fed’s balance sheet it would be brave to forecast a fall in U.S. yields – particularly as the burgeoning budget deficit demands sizeable issuance of new bonds.
Yields in Japan can largely be ignored as the Bank of Japan continues to target a 10-year yield of zero and pours sufficient yen into the market to ensure the yield bobs around that level.
Italian bonds are the other obvious market to attract attention – for the wrong reasons. Yields are up as questions are asked about the viability of the public-debt burdened Italian economy whilst hamstrung by the constraints of eurozone membership. The Bank of Italy (the central bank) recently reported that the country will pay an additional €9 billion a year in interest costs on its debt by 2020 if bond yields remain around current levels – threatening the government’s plans to stimulate the economy by increasing public spending. The Bank also reports that the rise in bond yields (fall in price) is largely responsible for a fall in household financial wealth by €85 billion in the first six months of this year.
UK bond yields are unchanged over the 12 months – suggesting that investors are less perturbed about the UK market than many public commentators – including Mark Carney, the Governor of the Bank of England, who has decided that his brief includes a mandate to regularly comment on Brexit and all matters relating.
Oil prices are little changed on 12 months ago but this disguises the run-up to U.S. $86 in early October and the sharp run-down since then. Global economic growth is ebbing and rampant production of non–conventional oil in the U.S. is helping to produce a glut. In fact, the U.S. is now at the top of the league-table of global producers. This emphasises the unpredictable nature of the industry. From the mid-1980s until 2008 U.S. oil production steadily declined but since then the only way has been up with annual production now far exceeding previous record levels. “Peak oil” has been consigned to the dustbin – technology has taken care of that.
Iron ore has experienced a similar cycle to oil with a run-up and a rundown, leaving it relatively unchanged over the 12 months. It is always difficult to disentangle supply and demand factors when analyzing commodity prices – what is cause and what is effect? – but in the case of iron ore the slowing industrial activity in China and the slump in steel prices is clearly having an impact. Mounting trade conflict is not helping. Of course, the same factors impact the price of many other commodities.
Gold, as always, dances to its own tune and it has danced both up and down over the year but ended November not dramatically different from the previous November – in fact over the last 5 years the price has not varied by a significant amount. Over 10 years it has generated a compound annual return of 4.3% – not too bad.
An update on Brexit
Turning to other news we must reluctantly refer to Brexit: Theresa May has negotiated an agreement with the EU that has enraged the “leaver” supporters (and even some “remainers”) as it leaves a British foot firmly planted in the Customs union – at least for a couple more years and perhaps indefinitely, as Britain will only be able to exit with EU agreement. In the meantime Britain will be obliged to observe all EU rules. Mrs May’s next task is to get the agreement through the UK parliament in mid-December which will be difficult – to say the least. Talk about a second referendum continues to bubble near the surface. We will defer further comment until we find out which way these various balls bounce.
That cryptocurrency meteorite that streaked across the firmament prompting all sorts of extravagant claims about its future price and its potential as a global medium of exchange. The meteorite has now fallen to earth. In December last year it closed a whisker short of U.S. $20,000 but now has subsided to around U.S. $4,000. All bubbles burst. Bitcoin was underpinned by clever technology (blockchain) but it was not unique to bitcoin and afforded bitcoin no intrinsic or easily measured value. It provided fodder for many dinner party conversations with ‘expert’ after ‘expert’ emerging – bringing back memories of the technology bubble at the end of the 1990s. All bubbles run to a similar pattern and are based on misinformation, unbridled optimism and, most importantly, great lashings of greed. There will be many more.