Market Bulletin - Eurozone laboratory
Central bank action in the UK and US has supported financial markets and economic recovery, now the eurozone has introduced quantitative easing.
Almost six years ago to the day after the Bank of England launched quantitative easing (QE), the European Central Bank (ECB) has started its version of extraordinary monetary policy. In the intervening years, the extraordinary has become almost ordinary – or, at least, large-scale asset purchase programmes to support financial markets and economies are a fixture of the post-financial crisis world. Certainly, central bank action in Britain and America – the two early exponents of QE – has successfully buoyed financial markets and economic recovery. But as the UK and US look to return to more normal monetary policy, Japan and the eurozone have adopted QE. Now only time will tell if the ECB’s €60 billion a month of government debt and asset purchase programme can work the same magic.
Anticipation of the eurozone QE programme, however, has already fired European markets. The German DAX last week closed at 11,551 points after hitting a record high of 11,600 points earlier on Friday. Other indices in the region – including France’s CAC 40 and Spain’s Ibex – also made strong gains over the week and so far this year. The pan-European FTSEurofirst 300 index rose to its highest level since November 2007 on Friday and ended the week at 1,571 points. German government bond yields fell lower, as prices climbed, while 10-year sovereign yields in Italy, Spain and Portugal fell to near record lows. Investor optimism for Athens’ ability to resolve its differences with its creditors has helped push Greek government bonds lower after their peak following the Greek election in January.
Mario Draghi, the president of the ECB, believes QE can help defeat the threat of deflation and expects growth across the eurozone of almost 2% in 2016, as well as this year’s zero rate of inflation to rise to 1.5% next year. Alongside signs of improvement for the eurozone economy and the stimulus that the anticipation of QE has brought to the region’s financial markets, European corporate earnings are also recovering. Fund manager Stuart Mitchell of S. W. Mitchell Capital says European equity valuations are “stunning”, particularly domestic-oriented stock, and attractive compared to other asset classes and regions. Fund manager Schroders believes that improved conditions should benefit stocks such as autos, media and construction – as well as the region’s higher quality banks.
Central bankers also took action last week in China, where benchmark interest rates were cut for the second time in three months amid concerns over slowing growth and deflation. Beijing’s move gave a lift to Japan’s Nikkei 225 Stock Average, which last week exceeded the 18,700 point level it last reached in 2000 (although it remains around 50% below its 39,000 record in 1989). The Nikkei closed on Friday up 0.9% over the week at a 15-year high of 18,979 points. The Bank of Japan’s QE programme has continued to weaken the yen and strengthen Japanese exporters. Overall conditions for the Japanese economy look positive, with annualised growth now at 2.2%, corporate profits at record levels and signs of much-needed wage increases that should help spur consumption and curb deflation.
The week also brought good news for America’s economy, although there remains some disquiet that the recovery is short of policymakers’ forecasts. However, 295,000 US jobs were created in February, which is the 12th consecutive month that the economy has added more than 200,000 employees. The unemployment rate fell to 5.5% from 5.7%. The positive development further strengthened the value of the dollar. Markets are now speculating that the US Federal Reserve could raise interest rates this summer. Fund manager Payden & Rygel believes that the Fed is on track for an interest rate hike this year, with a rise in June “on the table”.
Shares in New York were down on Friday, while the dollar further strengthened and Treasury yields rose, as the robust job figures heightened expectations of a US rate increase. The S&P 500 index lost 1.1% over the week and closed at 2,071 points, although it had earlier, on the first trading day of March, reached a record high of 2,117 points as technology stocks, led by the world’s largest company Apple, gained amid strong earnings growth. A series of big corporate deals also stirred Wall Street, including a $21 billion move by AbbVie on Pharmacyclics to boost its cancer drug business. Hewlett-Packard also made a $3 billion swoop on Wi-Fi networks maker Aruba – its biggest deal since the troubled $11 billion purchase of UK group Autonomy in 2011.
The ECB’s adoption of QE has also boosted the UK stock market. The FTSE 100 last Monday hit a record 6,974 points, however, it had settled back by Friday to 6,912 points. Although international mining stocks continue to weigh on the market, gains in the financial sector helped lift the FTSE 100. Life insurers Aviva and its £6 billion takeover target Friends Life also announced they would increase their dividends amid strong results. Other strong performers last week included house builder Taylor Wimpey, which doubled its dividend payout amid rising demand for new homes, while Asian-oriented bank Standard Chartered and broadcaster ITV also made noticeable advances. Drug giant GlaxoSmithKline gained after the completion of its $20 billion asset swap deal with Swiss group Novaritis.
The FTSE 100 so far this year has advanced around 5%, after last month breaching the record high set at the end of the last century. While the 1999 peak at the height of the dotcom boom was driven by unrealistic valuations, accommodative central bank policy is now helping to power the UK stock market and economy. Although energy-related stocks have been hit by falling oil prices, a broad range of industries – together with UK households – have benefited from the downward pressure on already low levels of inflation. As the UK economy continues to improve, conditions look positive for businesses and consumers. Households’ inflation expectations are at the lowest for 13 years, according to the Bank; and UK consumer price inflation in January was at its lowest recorded level of 0.3%.
Last week also marked the sixth birthday of near-zero interest rates. In March 2009, the Bank announced its move to cut rates to the lowest levels since 1694. With the financial crisis in full swing and the economy in dire straits, there was good reason for the emergency measures. But six years on and savers are still waiting for an increase – in fact, the last time there was a rise was July 2007 to 5.75%. The bleak news for savers is that, despite all the market speculation about when a rate rise will occur on this side of the Atlantic – probably after the Americans have increased theirs – the Bank has made it quite clear that we are in for a prolonged period of low interest rates and only gradual rises.
Then and now
Britain’s businesses and individuals have become accustomed to these conditions. Borrowers are benefiting from record low mortgage repayments, and readily available consumer debt. Meanwhile, savers faced with near-zero returns on cash have had to pursue other ways to generate returns, with many for the first time turning to stocks and shares. Certainly, as a recent Barclays Capital study underlines, stocks and shares offer long-term returns that can beat inflation. Whether the Bank sets it first rise in the autumn or early in 2016, ultra-low rates look likely to be here for some time – which will underline the need for investors to consider what the stock market can offer.
The stark reality for savers is that near-zero rates have also meant that steady inflation, although relatively low, has eroded the real value of cash – with AXA Group estimating a 13% fall over the last six years. Yet, as a BlackRock survey identifies, Britons continue to favour savings in cash, despite being aware that the money would offer better returns elsewhere. For example, the FTSE All Share index since its low in March 2009 has generated a total return for investors of 139%.
Stock markets in the UK and US are at record highs, and at recent peaks in Europe and Japan. Certainly, investor caution is understandable – the financial crisis still casts a shadow. But central bank action and the global economic recovery – although patchier than many had hoped for – together with strong corporate earnings are reasons to be upbeat. Although global equity growth may have slowed, equities still beat cash. Crucially, as the tax year-end approaches, there is still an opportunity to review plans in light of the realities of financial markets and the wider economy in early 2015.
AXA Framlington, BlackRock, S. W. Mitchell Capital, Payden & Rygel and Schroders are fund managers for St. James’s Place.
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