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Richard Buxton: Fed inaction on rates makes investors nervous


Should anyone need reminding, we are seven years into an era of extraordinarily cheap money. The number seven, supposedly lucky for some, is not insignificant in the context of stockmarket investing.

For a short while this year, it looked as though US equities would do the unthinkable and notch up seven consecutive years of gains. Then China, already reeling from a string of weak economic data, finally decided to devalue its currency, providing the final straw for already nervous investors.

China’s painful transition from an investment-driven economy to one of reliance on domestic demand was never going to be easy. Slower growth, financial reform and a commodity bear market are painful pills to swallow. With the threat of Chinese deflation being exported to the West at a time when the European recovery is finally a reality, they are even more so.

Yet let’s not forget that much of the emerging world remains a net buyer of commodities. And for those in any doubt, the oil price is going nowhere fast. US shale production will not disappear overnight; the shale revolution is here to stay. So, oil is likely to trade in a lower, tighter range for longer, between US$45 and US$60 a barrel.

And if a halving in the oil price leads investors to conclude this is the onset of a sharp slowdown in global growth, may I remind them of Anatole Kaletsky’s work. On all recent occasions when the price of oil halved – 1982-1983, 1985-1986, 1992-1993, 1997-1998, and 2001-2002 – faster global growth ensued.

What exactly, can we conclude then, is making investors nervous?

China, until recently, has been perceived as the engine for global growth. But action over an interest rate rise, or lack of it, on the part of the US Federal Reserve is also proving unsettling. Despite clamours by emerging market central bankers, and others, to put an end to Janet Yellen’s prevarication over the future direction of monetary policy, events in China have given the US Federal Reserve chair yet another excuse to sit on her hands and do nothing.

The phrase “data-dependent” is beginning to test the hawks’ patience and yet the “will they/won’t they” conundrum has assumed a new importance. Is it better to raise rates, safe in the knowledge the US economy has not needed life support for some considerable time now? Or, given the slowdown in Chinese growth, should an interest rate rise be put on the back burner? Furthermore, as there is no inflation in the US economy, does the Federal Reserve need to raise rates at all?

And what is the lack of further downward movement in bond yields, at a time of wild equity gyrations, telling us? Textbooks tell us bond prices rise and yields fall in times of investor uncertainty as “safe-haven” assets are sought. Is it that investors are not convinced by the growth scare? Or has the bond market moved from one based on fundamentally-driven considerations to liquidity-driven ones?

Close followers of the US dollar will also be wondering why, when investors are so reluctant to take on extra risk, it did not register any further upward movements over the summer months. Answers on a postcard please.

So, to prospects for the UK equity market. I, for one, believe there is extraordinary value opening up in UK mega caps (those companies with a price tag of more than US$ 100bn). This is both in absolute terms and relative to their smaller and medium-sized brethren.

The reasons for falls in stocks in both the energy and mining sectors are well documented but unwarranted. More interestingly, perhaps, is how the indiscriminate sell-off in equities has pervaded virtually all sectors. This would appear wholly unjustifiable.

Yet one niggle remains. The earnings growth that investors so desperately seek to propel the stockmarket higher is as elusive as ever. Last year, a strong currency – the product of a fast-growing UK economy – was the key culprit cited for stemming profits growth. This year we have no such homegrown excuse. Do we have to look to the relative strength of the US dollar to start the blame game again?

As we head for the home straight in 2015, it appears that the strength of UK equities has been severely buffeted by the international winds of change. Justified? I think not. UK growth is set fair for the foreseeable future, averaging 0.5 per cent a quarter, and driven by an improving labour market. Just as important, wage and income growth is finally starting to come through. Once the dust settles, investors will come to realise the merits of UK equity investing remain firmly intact.

Richard Buxton is head of UK equities and manager of the Old Mutual UK Alpha Fund



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