Note October 3,2019: Market Gravitas- For the last quarter of 2019, three streams appear for investors. In capital market performance, the last twelve months should be seen beyond a currently popular day- to-day perspective. Global fixed income yields have declined substantially, even into negative yields for several European sovereign bonds. Still, market behavior appears changing. Rotation has not had junk bond yields nor equities moving in lockstep with lower sovereign bond yields which instead have spawned volatility.
In a second stream, central banks appear to be targeting more quantitative ease to boost growth prospects but the impact remains uncertain. Third and not least, political uncertainty seems elevating well beyond the Middle East, not least in the United States, in Europe and for that matter in Asia. In a summer of discord, domestic politics have reared for three of the largest financial centers, New York, London and Hong Kong.
Exchange rates between the major advanced countries appear relatively stable, potentially ephemerally so. In aggregate, emerging country fixed income yields appear also closer to 12 month lows but currency and fixed income crises have appeared especially in Latin America. It suggests systemic risk to be global. We espouse higher than benchmark weightings in precious metals and cash.
Over 12 months, equity markets like the S&P 500 and others seem in a sideways correction. With corporate reporting imminent, valuation notwithstanding and unlike some geographic assessments, global equities have yet to break from U.S. developments. Amid volatility, value appears to be doing better than concept. In equities amid selective credit stress, financials remain globally critical. For defensiveness and value, we prefer stronger Information Technology over the traditional but currently hard pressed Consumer Staples. It also means that despite valuation and due to its heavy weight in Consumer Staples, Europe is unlikely to wrest market leadership from the United States.
Prior Note September 5,2019: Not Time for Heroics.
Global growth in GDP appears slowed into the 3% annual level according to some estimates such as those from the OECD and with the IMF widely expected to further reflect on its summer view of slowed growth. In the late summer of 2019, central banks appear espousing more quantitative easing but interestingly not including the Bank of Japan. The leading edge of further quantitative ease appears to be from the European Central Bank that includes newer rounds of bond purchases as well as administered rate cuts. From tightening into late 2018 to vacillation expanding in mid-2019, the Federal Reserve has cut its Fed Funds rate by 25 basis points to 2%, not expanded securities purchases but has now expounded upon a watch and see approach. Its latest FOMC statements have also reflected that a divergence of views within has expanded. Interestingly, while administered rates in the United States remain noticeably positive (as is the case in Canada and Australia among others) and while those in Japan and Europe are noticeably negative, the exchange rates between the major advanced countries appear relatively stable. Still, systemic risk needs monitoring.
Two studies have drawn our attention. The BIS Quarterly Review, September 2019 released on September 22 points to systemically significant financial institutions as having been meaningfully strengthened but still having exposure to non-banking financial institutions where much lending has occurred. Even while current derivatives link to CLOs (collateralized loan obligations), it further points to similarities to the credit issues of 2006-7 which were different in appearing most acute in derivatives and mortgage origination. Further released on September 30, 2019 has been an IMF Working Paper No. 19/211 : Financial Repression is Knocking at the Door, Again. Using data from 90 countries over 45 years, authors E. Jafaroy, R. Maino and M. Pani conclude that financial repression could pose a significant drag on growth, perhaps of 0.4 to 0.7 %. These aspects pose to us that the risks could be significant were financial conditions to become even slightly in variance from the current.
In its continued discord through 2019, political uncertainty seems elevating well. In the war ravaged Middle East, elections in Israel have been inconclusive. Egypt has experienced renewed demonstrations. In the Gulf region, the war in Yemen seems elevated in terms of targets, both human and oil assets. On both nuclear arrangements and sanctions, Iranian issues remain unresolved. In the eastern Levant and into South Asia, much tension and war continues. The 70th anniversary celebrations of China have also been accompanied by increasingly violent demonstrations in Hong Kong that raise risks of a crackdown. In an already fractious election period, threats of impeachment overshadow in the United States. In Europe, there has not only been discord about Brexit in Britain but the second election in Spain was inconclusive, Italy appears reverting to chronically unstable coalitions and violent street demonstrations have greeted structural change in France. In this summer of discord, domestic politics have reared for three of the largest financial centers, New York, London and Hong Kong.
In capital market performance, the last twelve months should be seen from beyond a day- to- day perspective. Global fixed income yields have declined substantially. It has included globally record negative yield territory for several European sovereign bonds, surpassing Japan at its height of fighting deflation and Switzerland attempting to tame currency strength in order to protect its domestic industry. Still, market behavior does appear changing. Despite lower sovereign bond yields, rotation has not had junk bond yields nor equities moving in lockstep with lower rates nor has it protected weaker 100 year bonds or concept initial public offerings of equities. Instead, bouts of volatility have ensued.
Exchange rates between the major advanced countries appear relatively stable but could potentially be ephemerally so. In aggregate, emerging country fixed income yields also appear closer to 12 month lows but currency and fixed income crises have appeared especially in Latin America such as in Argentina and Brazil as well as further afield in Turkey. It suggests systemic risk to be global. We espouse higher than benchmark weightings in precious metals and cash.
Equity markets like the S&P 500 and others have essentially been flat over the last twelve months and appear in a sideways correction. Amid slowing global growth, there looms another period of reporting of bifurcated and low corporate results. Valuation notwithstanding, global equities have yet to break from U.S. developments. Amid bouts of volatility, Value appears to be doing better. Concept equities appear under pressure in both existing and new issue markets. In equities in most areas globally, financials are critical. Some financials such as in Europe and Asia appear under more pressure to improve loan credit quality. For defensiveness and value, we prefer stronger Information Technology over the traditional but currently hard pressed Consumer Staples. The seasoned Information Technology companies have both business line diversification and financial statement strength in their favor. Consumer Staples companies appear under sustained pressure to restructure business lines but also already have elevated valuation as a result of the penchant for yield amid suppressed fixed income yields. It means that despite widely perceived valuation advantages and due to its heavy weight in Consumer Staples, Europe is unlikely to be able to wrest market leadership from the United States. It makes geographical rotation more dependent on sector weightings than seems generally recognized.