US assets fuel ever-increasing investor interest
The yawning gap between economic cycles in the eurozone and the US is mirrored in the relative appeal of asset classes for both regions. The US dollar and equities, such as those in the S&P 500, are attracting ever more interest from investors.
In contrast with the other leading economies in the developed world, Japan’s economy is enjoying the benefit of liquidity being pumped into it wholesale, which is influencing both the yen and shares in Tokyo. Japan stands out on account of the influential driver affecting how assets are behaving.
Disparities in terms of economic growth argue in favour of US assets
The overriding trends dictating the behaviour of the US dollar, euro and, by extension, US and European equity markets are still being predominantly influenced by the gap between growth rates on either side of the Atlantic. The pendulum has clearly swung in the direction of assets sensitive to developments in the US economy: the US dollar has been climbing steadily against the euro while Wall Street shares have been stretching their advance over eurozone equity markets. By way of example, the total return, with dividends reinvested, from the S&P 500 worked out at 11% for the year to 31 October, almost double the 5.7% gain on the STOXX Europe 600.
The differing strengths of the rebound on the two share indices as they bounced back from their mid-October bouts of weakness highlight disparities at the level of macroeconomic fundamentals: the S&P 500 registered a clearly delineated V-shaped pattern from 16 October on, recovering to beat its previous record of 2,011 points set on 18 September; the STOXX Europe 600 rebounded too, but, at 337 points, it is still well short of its peak of 347 on the same date.
The macroeconomic cycle rather than monetary policies is the deciding factor influencing trends on both sides of the Atlantic. As for Japan though, the latest phase of expansion in the monetary base announced by the Bank of Japan (BoJ) has set up the following pecking order for the trio of main currencies, USD>EUR>JPY, in terms of their structural robustness. The yen continued to lose ground in October, sliding from 110 yen against the US dollar to 114 and from 138 yen against the euro to 142.
QE and pension fund overhaul in Japan
In early October, some discordant noises about the weak yen were coming out of Japan, with Prime Minister Shinzō Abe and BoJ Governor Haruhiko Kuroda seemingly singing from different song-sheets. Consequently, the news on 31 October that the BoJ was expanding its financial asset purchasing programme came like a bolt from the blue. The impact on the Japanese equity market was even more powerful because, on the same day, there had been an announcement about reforms to the Government Pension Investment Fund, with a significant shift in allocation weightings out of Japanese bonds towards Japanese equities for which the average weighting was doubled from 12% to 25%. In tandem, the average combined weight of foreign equities and bonds was lifted from 23% to 40%. The GPIF is the biggest public-sector pension fund in the world having $1,100bn assets under management, suggesting we may well see significant flows heading into Japanese and international equities. On the day the news broke, the TOPIX index soared by 4.3%, roughly equalling its advance for the whole of the year to date.
Pleasant surprises despite the October correction
Equities endured a severe bout of wobbles in early October, with losses of 8.9% run up on the STOXX Europe 600 and 5.4% on the S&P 500. The correction happened at the same time as a big shift, that had commenced in the second half and broadened in October, whereby allocations in equity funds were shuffled away from Europe into other markets. Wall Street recovered very swiftly from the correction to return to its all-time high, taking its total return for the year to date to 11% whereas Europe confirmed it has been falling behind since mid-June, with a gain of just 5.7% so far this year.
Tensions that built up on markets were partly eclipsed by the third-quarter reporting season. US companies, despite showing some evidence of diminishing momentum, still delivered some positive surprises in terms of turnover and profits. This was reassuring after the downgrade trend on earnings estimates in September. Europe, however, offered a surprise package, with net profits beating expectations on average by 6% overall and even by 3.5% once financials are stripped out. After seeing some 8% being shaved off earnings forecasts for 2014 since the outset of this year, reported results should go some way now towards stabilising the level of current-year earnings expectations, at a fairly meagre 4.5%, and bolster the credibility of projections for an almost 13% increase in 2015.
Dollar at a two-year high
Rumours doing the rounds to the effect that the ECB is likely to resort to even more monetary-easing measures, compounded by confirmation the Fed was terminating its asset-purchasing programme, forced the euro down to $1.25, its lowest level for two years.
There was also plenty of volatility in other exchange-rate pairings, attributable in the main to monetary policies of the relevant central banks, especially the BoJ (see ‘Currencies’ article on page 11), but also in Sweden where the Riksbank squashed the repo rate down to 0%. As a result, several developed-nation currencies are valued at their lowest ebbs since 2010.
Not all currencies ended October on the same sour note though. A number of commodity and emerging-country currencies actually gained ground against the dollar, like the Australian dollar, South African rand, Turkish lira and, topping the league table, the Chilean peso which appreciated by 3.5%.
We can detect no compelling reasons for current trends to shift into reverse, so they are likely to persist over the rest of the year. The US dollar looks set to stay strong and could even reach a level of 1.20 against the euro by end-December.
Commodities lacking any impetus
A robust US dollar and sluggish demand from China have continued to pressurise commodity prices. This state of affairs has been improving a little. Some prices have begun to edge back up, such as those for basic industrial metals like aluminium or zinc which have notched up increases of over 12% since the start of the year.
Energy prices have been in free-fall: the price of a barrel of Brent crude oil fell 10% in a month – even more good news for households, but creating more angst about the onset of deflation in some countries. Judging by today’s levels measured against cyclical macroeconomic factors, energy prices do look to have overshot on the downside. The oil price looks likely to consolidate between now and the year-end. That cannot be taken for granted though as the price of crude oil does appear to be declining as the dollar climbs, seemingly defying the usual fundamental laws of supply and demand. If the price of oil were to go on sliding, Saudi Arabia would probably be tempted to step in more forcefully as keeping its budget in balance relies on an oil price close to $100 a barrel.