equity

Why Europe Is Doing The ‘Ice Bucket Challenge’ With A Glass Of Water

‘Grand’ gestures with minimal effects, Europe is doing the ‘Ice Bucket Challenge’ with a glass of water. Measures won’t measure up to much. Little movement in interest rates, not enough assets to buy and ultimately – you can put out as many cream cakes as you’d like, but if people aren’t hungry, they aren’t going to eat. The pressure is rising and more is needed. Europe has become a ‘binary trade’, and it is important to invest in those set to benefit regardless.

(Click on the image below for a quick video clip summary)

cnbc FMHR Sept 2014

2 Measures That Won’t Measure Up To Much… (more…)

5 Ways To Check You’re Not Late To The Stock Market Party

The room’s getting crowded, the party’s been going on a while but more people could arrive. Just beware fair weather friends and a sign it could be time to think about leaving…

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Can Stock Markets Continue Their Recent Rally?

Published by the Guardian

Gemma Godfrey, head of investment strategy for wealth management firm Brooks Macdonald, argues that the small drop in US economic output shows investors may have got carried away in recent weeks.

She warns that the stock market rally may prove fragile:

As investors dismiss the economic contraction to focus on the resilience of consumption, they miss the risk that this will come under pressure over the coming months as fiscal cliff measures come into play.

Market rallies have been driven by the fear of an imminent risk receding, but growth is now needed for another leg up in markets. Instead, the ‘pain trade’ is now missing out on equity upside, implying fear of underperformance may be driving investment versus conviction in the outlook for markets going forward. Exemplifying this is the recent rotation by Hedge funds into financial stocks, following the positive earnings momentum, which of course is backward over-the-shoulder looking, rather than based on confidence in the future.

Published by CityAM

After hitting multi-year highs, can the FTSE 100 continue its recent rally?

NO – The FTSE 100 has been rallying as the fear of risks, like a Eurozone exit or fiscal cliff stalemate, has receded. But growth is now needed for another leg up: there has been relief in the diagnosis, but the patient must now show signs of recovery. The concern for the UK is that it is tough to see a possible source of growth, especially after the latest economic figures showed us courting a triple dip recession. Looking overseas – as many FTSE companies do ­– the outlook for growth is more encouraging. But troubles in Europe and the US are far from over, as the former grapples with fiscal and banking union, and the latter with delayed spending cut decisions. Equities may provide value over the longer term, but you will have to encounter heightened volatility – and a likely correction – in the immediate future.

What may drive markets this week?

Inflation, hard-to-beat expectations and political stalemate provide a significant downward risk to market this week. (Quoted in the Weekend edition of the Financial Times)

Last week was dominated by disappointing manufacturing data from Europe and China, whilst markets shrugged off a less than impressive Budget. After such a substantial rally year to date, this correction is healthy.

Graph showing the correction in world equity markets over the past week (S&P 500 in white, Eurostoxx 600 in orange, FTSE 100 in yellow); put in context of the substantial upward move year to date. Source: Bloomberg

Graph showing the correction in world equity markets over the past week (S&P 500 in white, Eurostoxx 600 in orange, FTSE 100 in yellow); put in context of the substantial upward move year to date. Source: Bloomberg

This week, issues concerning Europe’s firepower, the US consumer and broader economic growth will determine the direction of markets. Inflation, hard-to-beat expectations and political stalemate provide a significant downward risk to market, although upward momentum could always drive them further.

As fuel price inflation dents sentiment in the US, the consumer may be squeezed and figures for income and spending may disappoint. Furthermore, the opportunity for upside surprises in durable goods orders and Q4 GDP growth is limited as forecasted figures are already high.

A two-day meeting of Europe’s finance ministers will be closely watched for signs of an expansion in the firepower of the rescue fund. The deadline to do so draws near and the pressure for progress grows. However, Germany remains staunchly against such a move and, even if achieved, the figure reached may still not be enough.

Why Europe’s Market Correction is a Healthy One…

As European markets suffer the longest losing streak since November, the correction is a healthy one. The index is still up over 8% this year, despite many of the region’s problems remaining unsolved. The latest disappointment, a manufacturing industry contracting more than forecast, is merely the next knock in an overall shrinking group of countries. Just this month the European Central Bank reduced the outlook for growth this year to a 0.1% contraction, keeping the region in recession. As expressed by Tim Geitner in the US, Europe is “only at beginning of a very tough, very long, hard road”.

See this as a quick video clip on CNBC 

Italy struggles to free its labour market, essential to restore confidence and ease debt

Crucial for Italy to restore confidence in their markets and bring down hefty borrowing costs is the structural reform of its labour laws. The country’s growth has lagged the euro average for more than a decade and with unemployment at the highest level since 2001 (9.2%), the fear is they will be left further and further behind. Unfortunately, talks between government and union have failed to ease firing laws, which would stop older workers being protected to the detriment of the youth (suffering from a massive 30% unemployment rate) and encourage hiring. With elections early next year, the time for progress is running out.

Portuguese auction success shows investors convinced short term but long term concerns continue

Portugal, seen as the next card to fall after Greece, succeeded in auctioning 4 month bills at the lowest yield since late 2010. Demand for these bonds reached 7 times the amount on offer, implying investors were sufficiently confident on the short term outlook for the country. Nevertheless, long term bond yields remain elevated, with investors requiring 12.5% to lend to Italy for 10 years. With a 3.3% economic contraction expected this year, unemployment at 14.8% and strikes over pay, welfare cuts and tax hikes, the long-term outlook is yet to be rosy. The deepening slump has dampened deficit reduction, with the figures almost tripling in the first two months of this year. The fear is more rescue funds will eventually be needed.

ECB passing the baton: unwinding support for banks but had better move cautiously

Interestingly, despite the potential pitfalls, the ECB seems to be scaling back certain bond purchases. Prior to the recent Long-Term Refinancing Operations (LTRO), a measure to buy €40bn of bonds was set. Since then, only €9bn has been bought and the policy expected to last until autumn may be wound down sooner. This is understandable with LTRO, injecting a whopping €1tn of liquidity having made this ‘gesture’ obsolete. Furthermore, a member of the ECB has proclaimed that it “has done its part now governments must do theirs”. A move towards letting banks stand on their own two feet is the long-term strategy for stability, but with potential for risk to re-erupt, they had better step cautiously.

Stagflation risk and what this means for stocks

As the outlook for growth continues to deteriorate, whilst the price for goods and services remain stubbornly high, the risk of stagflation returns. This would be a tough scenario, where policy options tackling one of these issues would only worsen the other. This creates substantial downside risk for stock valuations based on bullish growth forecasts, whilst making it more prudent to invest in price makers able to pass on rising input costs.

Lower growth outlook

The outlook for growth is bleak. The IMF has reduced their forecasted expansion of Europe from 2% to 1.6% and Goldman Sachs swiftly followed suit predicting France and Germany will fall into recession next year, with the EU stagnating. The data looks supportive of this view. German retail sales disappointed expectations, with a contraction of -4.3% in July vs. -0.5% expected. With Europe still our largest trading partner, the effect on the UK could be severe.

Outside the EU, countries aren’t immune. China’s Purchasing Managers Index has fallen below the 50 mark, the line separating expansion from contraction and GDP growth came in at 9.1%, falling from 9.5% and below expectations.

QE increases stagflation fears

In an effort to boost the economy, the Bank of England surprised many commentators by increasing their purchases of UK government bonds, from £200bn to £275bn.  However, this is not without its risks. It is not a guaranteed strategy to boost growth and crucially create jobs. Instead, it is more likely to increase inflation.

Taking bonds out of the market and pumping cash in their place only reduces the value and purchasing power of the currency, making goods and services more expensive. Inflation is already above the 2% target set for price stability, hitting a rate of 5.2% at the latest measure this week. In the EU the value jumped to 3% in September, the fastest increase in 3 years and potentially a reason behind their Central Bank’s decision not to cut rates.

Unemployment in stagnating economies is an issue and highlights the threat. Spain is struggling with 1 in every 5 of their people without a job, increasing to 45% of the youth population, and Portugal’s jobless level has reached highs not seen for over two decades. The US’s September figures are stuck at 9.1%, although CPI came in below expectations. Here in the UK the level might ‘only’ be 7.9% but this is still high and stubbornly so, with inflation surprising on the upside.

The stagflation quandary (where stagnation and inflation meet) is that to tackle unemployment and boost growth, interest rates would be cut, however not only are they already low, but that would boost inflation even further. Likewise, to tackle inflation, interest rates might be increased but this would only hurt growth and employment.

A lose-lose situation.

Risk of Stock Downgrades

So what has this meant for stocks? Firstly, there is downside risk to stock valuations. With many valuations based on forecasted growth, downgrades could negatively impact and seem more expensive. Analysts are 10 times more bullish on the growth outlook than economists. Although, always more optimistic, that is twice the historical average.

Secondly, it may be more prudent to invest with those that are price makers not price takers, as well as with a protected demand base, in order to be able to pass on rising costs.

Russian Investment Opportunities: The Drivers and the Hidden Gems

From the world’s best performing index in the first three months of this year, to a laggard this quarter, the Russian index has offered dramatic returns as well as downside risk. What has driven investor sentiment and what are many investors missing?

The World Leader Slips to World Laggard

Russia’s RTS Index was the world’s best performing index in the first three months of this year but has now fallen by around 11% in value so far this quarter (Source: Bloomberg). Moves in this market are often attributed to sentiment over the oil price due to the significant revenues generated by the country exporting this commodity. Therefore speculation over economic growth (read: oil demand) is highly influential. This year has been no different. Turmoil in the Middle East can be attributed as one of the main drivers of a strong rally in oil in the first quarter and concerns over economic growth has caused a reversal since that time. However, is this too simplistic a view and aren’t there other factors to which an investor in Russia should be paying attention?

Source: Bloomberg. Russian RTS Index (white) vs. MSCI World Index (orange) - all $.

Beyond Oil

It is clear to see why investors play so much emphasis on the oil price as a dictator of Russia’s financial health. Supplying some 11.4% of the world’s oil supply last year, Russia is the “biggest single source outside the opec cartel”. Although official figures calculate its contribution to Russia’s GDP at 9%, it is important to be aware that speculation over tax avoidance suggests the value may be nearer to 25%. Nevertheless, what is often overlooked is the specific oil price factored into their budget. For this year, a price above $75/barrel will produce a deficit reduction. With Brent currently standing at $115/barrel, a fall in the Russian Index in reaction to a fall in the oil price to anything above $75/barrel may be missing the point.

Boosting Ties with Iraq

With Russian oil fields maturing and production growth resting heavily on foreign investment, the country is looking externally for new sources. Iraq offers potential opportunities and TNK-BP, Russia’s 3rd largest oil producer and BP Plc’s 50-50 joint venture, isn’t holding back. The relationship between the two countries dates back many years and in 2008 Russia wrote off most of their $12.9bn debt mainly generated pre-gulf war from the Saddam Hussein government purchases of Soviet weapons. Interestingly, last October the Russian President, Dmitry Medvedev announced his country was ready to strengthen co-operation with Iraq, the same month TNK-BP gained the right to bid for 3 natural gas areas in the region.

Mediating the Exit of Qaddafi

Within the political arena, Russia has been just as active. In addition to fighting for a stronger developing market influence at the IMF, Russia has offered its services to facilitate the exit of Qaddafi from rule in Libya. This is the first time it has shown support for the NATO-led military campaign after abstaining from UN Security council vote in March which authorised the intervention and accusing NATO of violating the resolution by backing anti-Qaddafi rebels and causing civilian casualties from air raids. Due to the belief that Qaddafi has “forfeited legitimacy”, they are willing to negotiate his fate with members of his entourage. Evidence of the country’s powerful network, the value of their political clout has been highlighted.

Driving the Agriculture Market

Back to commodities but from a different angle, the Russian weather is an influencer to watch for investing in the agriculture markets. Fine weather has prompted an upward revision of Russian grain production with the Federal Hydrometerological Center reporting the warmer weather has improved the prospect for crops. This has led to speculation that Russia’s ban on grain exports may be lifted on 1 July. Wheat future prices saw double digit losses.

The Chinese Buyer

One particular potential buyer of Russia’s resources is China, state media reported last Monday. China Investment Corp (CIC), the country’s $300bn sovereign wealth fund, was set up in 2007 to invest some of the country’s massive foreign exchange reserves. With the world’s largest foreign capital resource, at $3.0tn, they are keen to find better sources of return and commodities to fuel their rapid economic growth.

G-8 Bullishness Boosting Appetite for Risk

Despite these many factors which may influence Russia’s outlook, financially, economically and politically; its index continues to exhibit a strong correlation to the oil price. This week we’ve seen oil (and Russian equities) respond positively to the declaration by the Group of Eight that the global recovery is strengthening.

Investment Insight

Nevertheless, to differentiate between short-term over-reaction and more logical fundamental moves, being aware of all the issues will equip you with the insight to navigate this volatile but potentially profitable market.