Western-developed equity and bond markets have been surprisingly stable this year, though the index numbers hide significant stock divergences.
This stability has been in spite of heightened geopolitical risk, most notably the annexation of Crimea by the Russian army, consolidating control of the strategically vital warm water port of Sevastopol
for its navy.
Supportive data indicating continuing economic growth in western developed countries reassured investors, as did the expected reduction by the US Federal Reserve of its monthly purchase of bonds from $65bn to $55bn.
In North America, spring does indeed appear to be thawing economic activity after an unusually cold winter. Five years into the US economic recovery, industrial and construction expenditure rose, fuelled by corporate cash balances that remain close to all-time highs. US commercial and industrial lending also showed a marked increase in March.
The flow of money in an economy acts like oil to an engine; it is also a vital ingredient for corporate expansion. We are optimistic about the outlook for US economic growth, which should help US companies increase their earnings and share prices.
Meanwhile, the UK economy continues to positively surprise and Europe, while coming from a much lower base, is also enjoying improved macro-economic news and investor sentiment. In contrast, the emerging markets suffered a poor first quarter. Capital continues to be withdrawn from the region’s debt and equity markets and repatriated to developed markets.
Weak emerging market currencies were joined, from the middle of February, by the slightly weaker Chinese renminbi, which has fallen against the US dollar, a reversal in the longer trend that has endured since 1994.
Some investors have been enticed by the cheaper valuations and have bought these markets. However, we remain concerned about China’s slowing economic growth and its banking sector, which dampens our enthusiasm.
In developed markets, Japan is the clear exception, having had a particularly weak start to the year in stock market terms as overseas buyers, who often dictate market direction, became impatient and took profits.
One of the Jupiter Independent Funds team spent a week in Tokyo in February, accompanying managers at company meetings and attending a regional conference. It was quite apparent that the 3 per cent increase in sales tax (VAT equivalent) in April has prompted consumers to accelerate their retail purchases and that the public resent tax rises when their wages are lower (in real terms). This tax hike may reduce consumer demand significantly.
While the jobs market in Japan indicates a more reassuring picture, and current levels of stimulus are ongoing, investors question whether the ‘third arrow’ of deregulation is dying a slow death in Japan’s labyrinthine and somewhat dysfunctional political system. Furthermore, net exports have yet to expand, despite a weaker Yen.
There was much talk before the financial crisis that the emerging markets had decoupled from the developed world and ,looking at markets now, that would appear to be the case, but not in the way that a forecaster in 2007 would have expected.
The markets in the western world appear to be in rude health, the US and UK markets, for example, being close to all-time highs. When looking at these markets in isolation and taking account of some of the IPO activity that has gone on this year, one would think that euphoric times were upon us.
Pricing new age opportunities for world domination has been seen before and it can go on for some time, but the trend has historically proved to be transitory.
In the coming months the US intends to continue to reduce its monthly purchase of bonds, as confirmed by Janet Yellen, the chairwoman of the Federal Reserve. If economic activity recovers further from the Arctic winter that crippled large parts of North America, financial markets may bring forward their expectation of interest rate rises in the US.
Typically, companies that are more sensitive to economic growth perform well in this environment, with a particular emphasis on those in developed markets. In the fixed interest sphere, generating absolute returns is likely to be more challenging as we move into a rising interest rate environment.
John Chatfeild-Roberts is chief investment officer of Jupiter Asset Management