Market Bulletin - Smooth running
Equity and bond market volatility struck new lows, as sterling and the FTSE both surged, and earnings season got underway.
Volatility on equity markets last week struck a 60-year low while, in the US, Treasury market volatility slipped to a 50-year low, despite yields recently creeping upwards. The S&P 500 rose by 1.37%, while the FTSE 100 and Eurofirst 300 rose by 0.7% and 0.35% respectively. The US and UK indices posted record highs; the Eurofirst 300 struck a six-month peak.
One reason for the rises was buoyant corporate earnings. The first US bank earnings to come through did not offer quite the unalloyed good news some had hoped for, but were still broadly positive. Wells Fargo said profits were up $3.4 billion in the fourth quarter, thanks to a tax-cuts package that reduced its liabilities – although it also reported $3.3 billion in legal costs following a consumer deposit scandal. JPMorgan Chase suffered a 37% drop in annualised fourth-quarter earnings due to costs on deferred taxes and foreign earnings relating to the new tax-cuts package; but its CEO said the cuts would benefit the bank by around $3.5 billion in 2018. The dip in the tax take spurred Walmart, the world’s largest company by revenue, to raise its minimum wage by more than 20%, and Fiat Chrysler to pledge a $2,000 bonus to its 60,000 US staff.
Historic lows for stock volatility served to highlight the fact that Bitcoin was experiencing its most volatile period in three years. Between mid-November and mid-December, the price of the cryptocurrency trebled before losing 25% of its value in five days. The pricing zigzags did not end there, but at time of writing it is priced at around $13,700 – a year ago it was not much above $820. That’s a gain of more than 1,500%.
“Whilst the underlying blockchain technology is probably here to stay, it can’t be long before the global regulators intervene into this world of cryptocurrencies and prevent investors, who would ordinarily be more sanguine, from taking investment decisions which could harm their long-term wealth creation,” said Chris Ralph, Chief Investment Officer at St. James’s Place, in December. “When there is finite supply and seemingly infinite demand, even my long-buried economics training informs me that the price is likely to move up – until the rules are changed and the demand collapses.”
As if on cue, a number of Asian governments took (or countenanced) remedial action last week. China announced a crackdown on its extensive domestic Bitcoin ‘mining’ operations; it emerged that South Korea – currency Bitcoin hub – is planning a bill to ban cryptocurrency trading; and the central bank chief in Singapore – a centre for ‘fintech’ – expressed his own wariness about cryptocurrencies. Bitcoin is currently 18 times more volatile than the US dollar.
Just because Bitcoin shows that you can have too much volatility doesn’t mean volatility itself is a bad thing. For long-term investors, the market distortions that volatility generates provide opportunities: sometimes to buy, sometimes to sell. As the current equity bull market approaches its ninth birthday, an increasing number of investors are arguing that markets look expensive – and are forecasting a spike in volatility.
Yet the stock market is hardly alone in gaining altitude. Global growth is now more broadly based than it has been at any time since the financial crisis, and corporate earnings are on a tear. Retail sales figures in the US lifted consumer stocks last week and earnings for the fourth quarter in the US are expected to rise 10.9% (annualised), according to FactSet Research Systems. Wall Street analysts are forecasting that every one of the 11 major sectors of the economy will show an uptick. Donald Trump’s tax-cuts package certainly hasn’t hurt sentiment – nor have Fed rate rises.
For all the talk about equity valuations, it was bonds that drew much of the market’s attention last week. Bill Gross, the billionaire investor and PIMCO founder once dubbed the ‘Bond King’, warned that bonds had entered a bear market for the first time in almost three decades. (“Bonds, like men, are in a bear market,” was the high-risk analogy he actually employed.) The comments came amid a rise in the yield on the 10-year US Treasury – the world’s most important bond yield. (Yields move inversely to prices.) Last week it edged towards 2.6% for the first time since July 2016.
In part, the rise in the yield reflected concerns over the gradual withdrawal of quantitative easing and the raising of interest rates. The US Fed began to reduce its bond holdings in December, and has already signalled further interest rate rises to come in the year ahead, having made three hikes last year. The rise also reflects concerns over the cost of the new tax-cuts package. Steve Mnuchin, the treasury secretary, said that US taxpayers would see the tax cuts in their February pay cheques. A further cause for concern came in the form of a government report in China which concluded that Chinese purchases of US Treasuries should probably slow. The US’s deficit shortfall could be as large as $1 trillion this year, making a bond sell-off hurt all the more. It was unclear, however, whether China was merely using the report to warn the US against introducing protectionist measures on trade.
Investors still bought plenty of US debt last week, both 10-year and 30-year notes, and there were signs of other major central banks slowly shadowing the Fed too. Last Thursday, December minutes published by the European Central Bank were interpreted as hawkish, since they expressed confidence in economic growth, hinting at the possibility of gradual rate hikes in the not-too-distant future. The euro rose to its highest level against the dollar since 2015, although it was also aided by Angela Merkel’s success in agreeing a preliminary coalition deal with the Social Democratic Party of Germany.
Prospects for increased US–UK trade after Brexit were not helped last week – at least on the surface – when Donald Trump cancelled his forthcoming visit to the UK. He blamed what he said had been a “bad deal” on the new US embassy under Obama (although the new embassy, which formally opens this week, was actually announced under George W. Bush). But the promise of extensive anti-Trump demonstrations may also have held him back.
Theresa May had rejections to worry about at home too. Not for the first time, an opportunity for the prime minister to show strength descended into quite the reverse. Her attempted New Year reshuffle received short shrift from several of those on the receiving end – and the prime minister quickly reversed many of her plans. Nevertheless, sterling surged to its highest level against the dollar since the EU exit referendum, courtesy of reports that Spain and the Netherlands were ready to back a soft Brexit deal.
But the chancellor returned home from a visit to Germany to find a mixed economic picture. While UK manufacturing rose for the seventh consecutive month in November, high-street spending during Christmas season had apparently been less liberal than usual. Visa said that retail expenditure had fallen for the fourth consecutive month in December, ending the weakest year for UK consumer spending since 2012. M&S shares fell 7% after it announced disappointing results. Tesco, Mothercare and House of Fraser all missed analyst expectations. John Lewis bucked the trend, but in part because it refrained from raising prices.
In Japan, the rapid stock surge that marked early January lost momentum and the Nikkei 225 ended down 0.25%. However, this may have reflected a rise in the yen against the dollar. The currency shift came in response to the Bank of Japan reducing its holdings in long-term bonds, which was interpreted as a move towards normalisation.
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