When good news became bad news
It was all looking good at the start of the second quarter – stock markets were reaching historical highs and sentiment was buoyant – and then the US Federal Reserve ruined the party by drip-feeding the market with comments about the possibility of it beginning to withdraw liquidity support.
It took a few times before the reality dawned on investors. Then in May, Bernanke finally spooked the market by indicating the Fed could start “tapering off” its $85bn a month bond buying programme as early as September. This had the following results:
Stock markets in the developed world tumbled off their highs
Sentiment towards emerging markets soured
Volatility, as measured by the Volatility Index, jumped
US treasury yields spiked
The rand’s depreciation accelerated
After that point, any news that showed the US economy was on the road to recovery was taken as bad news for the market, particularly when it came to the three statistics we have been watching to gauge whether the US recovery is on track: jobs growth, the housing market and private sector credit extension (see below). So during June and July any time a better-than-expected figure was released, the market reacted negatively.
What this means for equities:
When it comes to equities, from a long-term perspective we believe the SA stock market is now trading slightly above fair intrinsic value. The performance of indices on the JSE continued to diverge considerably, with the Industrial Index still gaining ground, the Financial Index effectively flat and the Resources Index losing significant ground again during the second quarter.
As we saw during the second quarter, this means you should be cautious about investing your capital in sectors where future cash flows are highly uncertain, such as the SA gold miners, which were especially hard hit during the quarter. As pragmatic value investors, we prefer to take positions where the risk-return equation is in our favour and too often investors forget that the permanent loss of capital is the biggest mistake an investor can make.
What this means for bonds:
Within the fixed interest asset class, the spell that policy makers have had over the bond market may stretch wider than monetary policy – and so could remain in force. While this is not to say that the level of bond yields will not fluctuate, the cold shower that investors have had to endure with the significant spike in global and bond yields recently may present value-orientated investors with good opportunities to buy bonds. After all, at 8% the SA 10-year bond yields offered at least 2% more than SA’s long-term – and more recent – inflation experience, which appears reasonable in a historical context (see graph below).
THE BOTTOM LINE
For the economy, it is clear central bank balance sheet expansion in developed markets has failed to ignite a strong recovery in real economic activity. Global real GDP growth has continued to disappoint in the aftermath of the Great Recession.
Ultimately, we do not believe the current environment of a high level of government claims on available savings; restraint of financial sector activity and weakened productivity growth are conducive to a robust global economic upswing.
Meanwhile, with investors now concerned that the Fed and other central banks may remove stimulus from the global economy at too fast a pace, the era of excess liquidity and low funding rates is indeed coming to an end and this could provide another headwind to company earnings growth.
In addition, the Chinese economy is showing signs of sputtering, which is negative for commodity demand. Markets will remain rocked by emotions – whether it’s the Fed’s tapering or a demonstration in Tahrir or Taksim Square. Against this backdrop, our job is to make sure that we profit from these opportunities by not losing our cool when others lose theirs!
The post A tricky global macro-economic operation appeared first on Sanlam Intelligence.