22nd September 2015
Markets are significantly influenced by backward-looking data releases and periodic Fed statements, says Rowan Dartington Signature’s Guy Stephens…
The historical big event of last week which preoccupied the markets was a damp squib in the end with no change from the Federal Reserve Bank on US interest rates. We can rarely remember so much noise and speculation surrounding an event that didn’t happen!
The press conference afterwards and formal statement read out by Janet Yellen has been analysed to death as usual with the most popular prediction of the next first move in US rates now being December. This will no doubt ebb and flow as data is released, both in the US and, most importantly, in China. The main reasons given for inaction were partly concerns regarding the impact of the recent market volatility and the Chinese slowdown but also the fact that the US economy could miss its CPI inflation target of 2% to the downside.
This is all good news for the consumer who continues to benefit from weak oil prices and strengthening wage growth. The consensus on China appears to be settling into a wait-and-see mode with eyes focusing on the official third quarter GDP release on October 19th. Until that point, we are somewhat in limbo. If it comes out at 7%, there will be considerable newswire comment pouring scorn on the figures. If it comes out at 6.7%, then that will also look like a managed trajectory towards reality over time. Either way, just like the emergency level of UK interest rates, it is a largely symbolic figure which has little correlation with commercial reality.
This is why the market’s preoccupation with both these current big issues is so misguided. If China owns up to a growth figure of say, 4%, well that only confirms what we already feel it should be and this will serve to correlate with the falls we have seen in commodity demand, Chinese trade and infrastructure spend, and this is largely priced into markets. The same goes for UK and US interest rates. They affect mortgagees and savers, but not by much as any move is likely to be no more than 0.25% and what difference does it make? Both data releases are symbolic and both are detached from the performance of the real economy which is measurable in many alternative ways, and has been driving bond and equity markets for weeks and months.
The reality is that China is slowing down, the important point being by how much and where will it lead in terms of the political regime. The US and UK economies are sufficiently robust and they should not be framed with an emergency interest rate of negligible value. However, the Central authorities, whether they be Chinese, UK or US, are terrified of upsetting the markets and the impact that could have on economic confidence. Interestingly for the first time on Friday the markets sold off on the fact that the Fed chose not to raise rates, viewing this as recognition that the Fed is more concerned about global growth following the Chinese revelations.
This is a new development and is a step forward in market evolutionary thinking. For the last two years at least, good economic news in the US has been viewed as a negative as rates are more likely to go up, thereby limiting market upside, whilst weak economic news has been viewed as supportive because interest rates are then less likely to go up. A bizarre catch 22, where markets are significantly influenced by backward-looking macro-economic data releases and periodic Fed statements, rather than the fundamentals of company profitability and commercial outlook. For the UK investor, this is particularly frustrating with the FTSE-100 now flat over two years to last Friday. Fortunately, there are areas outside of the FTSE-100 which have delivered nearer 20% over this timeframe and our clients have enjoyed some of these returns, but the general mood is that equities have disappointed because we are still 1,000 points below the previous FTSE-100 high in April, which everyone focuses on.
One could see a scenario whereby the Chinese slowdown fears are overdone, as much of the demand weakness in commodities and Chinese consumption is already priced in from the realities of the commercial environment, regardless of whether or not the Chinese authorities add up the numbers properly and deliver a realistic GDP figure. Admitting weakness is not in the cultural makeup of Eastern nations, as repeatedly evidenced in Japan. Why should we expect the Chinese to ever open up and provide anything other than a confident and positive assessment of their economic outlook?
So, with the markets in charge vis-à-vis Central Bankers, and long may they reign, market psychology is now moving into a place of worrying that the Fed may be getting behind the inflation curve when the oil price falls start to drop out of the comparative numbers. It was particularly notable that the market was split 50/50 as to whether rates would go up, but in the end all but one Fed member voted to keep rates unchanged, which was a surprise and more dovish than expected. This translated into fears that the Fed is more bearish on the economic outlook which is why the markets sold off. We can therefore see a scenario building that when interest rates do actually rise, inevitably accompanied by reassuring comments on the strength of the economy, the markets should approve.
That event could have happened last week, but clearly it is too soon to tell what the effect of China is on the US economic outlook. By December, this will be clearer and a rate rise may pave the way for a renewed focus on the fundamentals, which, at the very least, will be refreshing and could well be an excuse to move higher. This is all a game of cat and mouse, and reminds us of how the taper relief correction occurred in 2013 from some unscripted words in a Fed press conference in June 2013 which led to a 10% correction and dominated market psyche until October 2014 when the Fed finally stopped buying bonds in the open market.
The first rise in US interest rates since the credit crisis will be a noteworthy date in the history books, but the sooner it occurs the better so that we can get on with valuing companies and profits, and delivering good returns for clients who deserve more from this frustrating investment environment.