Market Commentary - 2013 Quarter 4 January 2014

Market Commentary - 2013 Quarter 4

The main topic of debate this quarter has been that of determining the real level of economic growth in each of the leading economies. In the US this debate has centred on the likelihood of QE tapering, and in China on the concerns over a hard or soft landing as the growth rate of the economy slows. In Europe the focus remains on the peripheral nations and their ability to stabilise debt and deliver on austerity measures.
As is generally the case over the summer, the markets have generally fluctuated around the same sort of levels as politicians and senior investors are on holiday. In the US most of the issues have revolved around the variability of economic data and of course the likelihood of the Federal Reserve switching off the monetary tap of Quantitative Easing. In Europe, the German elections were a distraction as progression of anything meaningful awaited the result.
As we head into the fourth quarter of the year investors need to decide whether the strong performance recorded in most equity markets so far in 2013 is likely to continue. There are three issues that are likely to determine the performance of equity markets over the remainder of the year.
The first of these is how dependent the US and global markets are on the accommodative monetary policy of the US Federal Reserve. In other words, if quantitative easing (QE) is moderated through tapering can equity markets continue to deliver gains to investors?
The second issue is whether the European crisis could re-surface in some form after the German elections. For the peripheral economies there has only been marginal improvement with unemployment, especially amongst the young, remaining exceptionally high. For most of the peripheral European countries there is no meaningful economic recovery and debt ratios remain high as support for austerity is waning both amongst politicians and the electorate.
The third issue for investors is whether China can smoothly adjust to a slower rate of growth, as it tackles an unhealthy level of credit expansion and looks to rebalance its economy away from fixed asset investment (FAI) to a more consumption led economy. This will have implications for the global economy as well as emerging markets and commodity producers.
Much of the activity in the quarter has been influenced by the views on Quantitative Easing and the position of the Federal Reserve. In May and June of this year when Fed Chairman Bernanke first suggested the prospect of potentially moderating the bond buying programme (commonly referred to as tapering) markets suffered a bout of volatility. Even though this was a change to domestic US monetary conditions, its impact on global markets was far reaching. Riskier assets in fixed interest markets initially suffered a sharp selloff and whilst the high yield markets have recovered to some degree, until recently, emerging market debt has continued to suffer as outflows from the region have weakened local currencies. Emerging market equities also suffered a selloff, although prospects for individual countries and regions are now quite differentiated.
Some investors argue equities have only risen due to Fed largess on monetary policy. In other words equities have risen higher on a tide of Fed generated liquidity and so any withdrawal of this will be bad news for stock markets. While in the short term it would be foolish to argue volatility is unlikely to occur, more important over the medium term is whether Fed tapering has any impact on economic or market fundamentals.

The difficulty for the monetary authorities was seen when tapering was first suggested - whilst seen as an action that was inevitable, markets still seemed to over react. In September we then saw the central bank surprise everybody by announcing tapering was still some way off, which reversed some of the movements in markets and lowered bond yields once again.
We remain cautious on this issue as an orderly withdrawal of QE looks difficult given the economic fragility that still exists despite growth figures improving in a number of economies around the world. It is likely that whenever it does come it will create volatility and cause issues in fixed income markets as yields start to rise again.
Overall, however, there are a lot of positives in company information flows as well as in employment, and economic confidence has returned in a number of developed economies, including the UK. This growth level is expected to be muted given the severity of the financial crisis that preceded it but it shows the global economy is in a stronger position now to improve growth and fight off the deflationary pressures that still exist. 

Market commentary provided by Rayner Spencer Mills – Quarter 3 2013


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