Plus c’est la même chose?

Finance | Thu 29 May | Author – Business & Finance
2014 stock pic

The year so far has turned out to be a real rollercoaster ride for most investment markets with a lot of huffing and puffing but not much going very far, writes Aidan Donnelly.

If you had been marooned on a desert island on January 1st only to be found today, looking at the various global asset class returns to date you could be excused for thinking that not a lot has really happened in your absence; but there you would be well wrong.

What has also been interesting to see has been how many consensus views from the start of the year have struggled to gain momentum. These consensus trades as we entered 2014 included things like being positive on developed market equities, the US dollar and the Japanese equity market, and being negative on the oil price, developed market government and corporate bonds and emerging market equities – well at least that one has borne fruit to some degree.

Lest we be too critical, it is worth remembering that there have been many cross-currents pulling markets to and fro. Much of the economic data has been – and remains – heavily influenced by the particularly severe weather seen in the US, and therefore any assessment of the strength of that economy is open to debate. Coupled with that, there has been a new form of ‘water torture’ with the near constant flow of disappointing economic data coming out of China. Throw into the mix a geopolitical crisis with the situation in the Ukraine and one could be excused for wondering how it is that investment markets aren’t considerably lower over this period.

But baby it’s cold outside …

There are few inhabitants of the north-east of the US that would disagree that this has been the coldest winter for quite some time. Temperatures plunged, and remained that way for long periods, along with most people’s desire to brave the elements and leave the comfort of their homes. The knock-on effect has been widespread ranging from muted employment activity, poor retail sales, reduced housing market activity and generally slower economic growth overall. At first markets readily accepted the weather excuse to explain the series of weaker economic data released in the US, but as the year has progressed a more insidious doubt has crept in, wondering if there was some fundamental weakness in the economy as well.

In the run-up to the March US employment data report known as the Non-Farm Payrolls (NFP), there were hopes that the data would experience a strong bounce-back after the winter stresses. In the 12 readings before last December, on average 205,000 jobs were added in the economy. In the three months from December to February, they averaged +129,000, a three-month average level last seen in the summer of 2012. So, either the economy was truly underperforming or there would be some real payback to come on the payroll numbers.

In the end, the numbers proved to be a slight disappointment, with less of a weather-induced bounce than hoped for.

It’s not just the economy, stupid

Needless to say, the economic data hasn’t been the only thing affected – company profit forecasts have also slipped. As we entered the year, analysts were forecasting growth rates of 10% and 15% for US and European companies respectively for 2014. These rates have now been pared back by 3-5%.

As would be expected with reduced activity levels, US companies have seen their sales forecasts pared back, but what is of more interest has been the pick-up in the costs associated with doing this business − be it higher heating costs in factories and offices, or higher transportation and distribution costs as companies alter supply chains to meet orders in non-affected regions. As we moved through late March and April the number of companies reducing their guidance for profit almost reached a level not seen since records began in 2006.

In the case of Europe, some of the decline has been blamed on the strength of the euro which, notwithstanding some recent weakness, still remains higher than a year ago. There has been a long list of large European companies bemoaning the recent euro strength and its impact on profitability. Only time will tell if the sanctions recently imposed on Russia in the wake of the Ukrainian debacle, will have further knock-on effects to European growth rates.

More Yellen than sotto voce

While global central banks can have no sway over the weather, what they can control is their own actions and in the last few months we have seen monetary authorities, particularly in the US and Europe, influence market behaviour to a growing degree.

It seems that the message from the US Federal Reserve has increasingly been that barring a significant negative shock to the economy which would lead them to notably lower their outlook for employment and inflation, the tapering of their Quantitative Easing (QE) programme, announced late last year, is set to continue. Some thought they might pay more attention to sluggish global growth, low current inflation and any possible issues in the emerging markets but it seems that their sensitivity to these issues is lower.

At the March two-day meeting of the US Federal Reserve – the first meeting under Janet Yellen, who also held her first post-meeting press conference at that time – the Fed continued with its $10bn/month QE taper and shifted away from its quantitative forward guidance. What was less expected, however, was the Fed’s hawkish turn in the form of its upward bias in interest rate expectations and lack of emphasis on qualitative guidance. The upshot of this is that markets now see the first increase in US interest rates coming in mid-2015.

Draghi’ng their heels

In the early part of the year, the European Central Bank (ECB) meetings provided nothing in the way of action and confirmed what some had feared; that the governing council would only react when absolutely necessary and was not inclined to be in any way proactive in the fight against future possible low inflation or, worse still, deflation. It seemed that last November’s surprise rate cut was not a signal of a new policy trend for the central bank.

But, whether the result of the strength in the currency, the deteriorating picture for company profits, or the increasing risk of deflation in the region, one of the main points that emerged from the April ECB press conference was that European Quantitative Easing (QE) is very much on the table. Although the ECB left itself a lot of room to manoeuvre on what conditions might cause QE to be introduced and in what form it might take, the ‘psychological hang-up’ of QE has seemingly been overcome. The Governing Council is now ‘unanimous in its commitment to using also unconventional instruments within its mandate to cope effectively with risks of a too prolonged period of low inflation’. Perhaps the sidelines have become an uncomfortable place to be for Draghi et al.

When it comes to sector performance this year, it is both surprising and interesting to see the mix of sectors leading the market.

There are not many situations where you would expect a defensive sector such as utilities and a cyclical sector such as materials to be the standouts – but that’s what we have. And while there are many reasons posited, the truth may be as simple as that it reflects the lack of direction evident in markets overall.

As for what happens over the remainder of this year, to borrow from the scene in the movie Any Given Sunday, the American football coach, played by Al Pacino, tells his players that ‘football, like life, is just a game of inches’ and markets will likely have to grind out their returns this year inch by inch. It might not be attractive but ‘every inch is worth fighting for’.


Aidan DonnellyAidan Donnelly is senior equity analyst at Davy Private Clients. Views expressed in this article reflect the personal views of the author and not necessarily those of Davy or Business & Finance. You can follow Aidan on Twitter @aidandonnelly1 for more market musings.