• Central Bank easing in Europe and Japan has improved the outlook for global growth.
• Stock markets are hitting new highs in response to this stimulative environment.
• We have a full weight in equities, though we are wary of upcoming events in Europe.
• Bond markets remain volatile as expectations for inflation are fluctuating sharply.
Central Banks Fuel Equity Markets
Quantitative easing (“QE”) in Europe and Japan in the first
two months of this year has provided renewed stimulus to
these previously faltering economies. In the US and the
UK, the economic news has been positive, if not exciting.
This has been a favourable environment for equities, which
have been the best performing asset class in the first two
months of the year, as can be seen in the table opposite.
The UK stock market has hit a new all time high but it is
Europe that has seen the highest returns so far this year.
The introduction of QE has driven the euro down against
all other currencies, thereby improving the prospects for
export driven growth at the same time as bank lending is
starting to pick up. The European Central Bank (“ECB”)
has thus been leaning on an open door. From a UK
investor’s perspective however, the fall in the euro has
reduced returns from European markets, leaving them
only modestly better than the return from UK equities over
the first two months. UK bonds have seen yields yo-yoing
so far this year as expectations for the path of inflation
and interest rates have changed monthly. We have a full
exposure to equity markets and are underweight bonds, so
we have captured the full equity market gains year to date.
Global Growth is Supported by the US
The key questions now are how much further can equity
markets rise and when will interest rates start to move up in
the US and UK. The US stock market, having risen by 200%
since the low point in March 2009, now looks expensive
on most valuation measures. For the moment though, US
company earnings growth is supported by an improving
outlook for consumer demand. Employment is rising and
with inflation close to zero, personal income is growing at
around 5%. This, combined with low oil prices and falling
import prices as the dollar appreciates, is a potent mix for
the consumer. It is not surprising, therefore, that confidence
indicators are rising sharply. This mix of positive influences
would almost certainly lead to a rise in US interest rates in
June were it not for the strength of the dollar. Although
the US is not a highly export orientated economy, a strong
dollar still dampens growth and keeps a lid on inflation.
For now, we see further upside for the US stock market, but
market valuations are becoming stretched and ultimately a
stronger dollar and rising interest rates are likely to cause
a material setback.
Total Returns in Local Currency
Last Two Months and Last 12 Months
Total Return for Market
Currencies v £
Rate
US dollar
Euro
Yen
1.54
1.38
184
Cash (3m)
Yield %
UK
USA
Euro
Japan
0.63
0.38
0.03
-0.10
Bonds (10yr)
Yield %
UK
USA
Germany
Japan
1.8
2.0
0.32
0.34
Equities
Index
UK
USA
Germany
France
Spain
Italy
Japan
Australia
Hong Kong
FTSE 100
S&P Comp
DAX
CAC
SMSI
BCI Gen
Topix
All Ord
Hang Seng
Alternatives
Index
Property
Commodities
Hedge Funds
IPD
DJ UBS
HFR
2 months
to 27 Feb
12 months
to 27 Feb
%
%
0.9
-6.6
1.1
8.5
-12.0
-7.6
0.1
0.0
0.0
-0.0
0.5
0.2
0.2
0.1
-0.1
1.9
2.2
-0.0
11.1
8.6
14.4
3.0
6.3
2.6
16.7
16.4
9.7
17.0
8.5
10.4
5.7
5.6
15.6
20.5
15.6
12.7
12.3
27.5
14.5
12.2
1.7
-0.8
1.9
18.6
-22.8
4.8
Source: Reuters
March 2015
Sterling is Now 24% Overvalued Against The Euro
2.0
1.9
1.8
Euro / £
1.7
1.6
1.5
Sterling expensive
1.4
1.3
1.2
Sterling cheap
1.1
1.0
Jan85
Jan89
Jan93
Spot Rate Euro / Sterling
Jan97
Jan01
Jan05
Jan09
the oil price is supporting consumer spending, though with
unemployment still at 11.5% on average across Europe,
exports rather than consumer demand will be the driving
force behind recovery. Stock markets have responded
positively and now look expensive based on past company
earnings (see the chart below), but there is considerable
scope for future earnings growth to accelerate given low
interest rates, an undervalued currency and rising bank
lending. Structural economic reform in the Mediterranean
countries, albeit slow, should also support growth as these
economies become more competitive.
Jan13
Purchasing Power Parity Euro / Sterling
Source: Valu-Trac
Economic Imbalances Growing
The UK economy is behaving similarly to that of the US,
with growth being driven by consumer demand as high
employment, rising wages and the low oil price put money
into consumers’ pockets. However, personal debt remains
high at 140% of gross domestic product (it is only 100% in
the US) so the Bank of England must be wary of putting
up interest rates. We now do not expect UK interest rates
to rise until next year even though the economy should
continue to grow at around the trend rate of 2.5%. Net
trade will be a drag on growth as exports to Europe will
be hampered by the 12% depreciation of the euro against
sterling, which has left sterling 24% overvalued against the
euro, as the chart above shows. The UK stock market is on
the expensive side of fair value at the moment, but with
global growth picking up we believe there is more upside
to come.
These positive signs are seductive but there remain huge
uncertainties in Europe which make equity investment
there a high risk proposition. The standoff between Greece
and Germany over how to resolve Greek indebtedness has
yet to be resolved and will come to the fore again in a
month’s time. This highlights the underlying tension at
the heart of Europe between German refusal to support
growth through spending and debt and the Mediterranean
countries’ refusal to commit to more restructuring and
fiscal discipline. Whilst European stocks may well have
further upside potential, the recent rally has left the market
vulnerable to a setback on disappointing political news.
We are a little underweight in Europe at present but would
add exposure on a significant setback.
Matthew Hunt
European Equity Markets Now Look Expensive
Equity Cash Flow Yield - Europe Ex UK
European and Japanese policy is moving in the opposite
direction to that of the US and UK, with bond yields being
forced down by QE and growth being driven up by exports
through currency depreciation. Ultimately, the imbalances
created by the large currency swings we have seen are
unsustainable and will lead to painful corrections. For now
though, the trends appear to have further to run.
16%
In Europe, growth forecasts for this year have been revised
up to a healthy 1.5% as exports, in particular from Germany,
are booming and bank lending is starting to rise. The fall in
2%
to 28 February 2015
14%
12%
10%
Cheap
8%
Average: 6.9%
6%
4%
0%
Jan75
Expensive
Jan79
Jan83
Jan87
Jan91
Jan95
Jan99
Jan03
Jan07
Jan11
Jan15
Source: Valu-Trac
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changes in rates of exchange may cause the value of the investment, and the income from it, to go up
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