World Markets at a Glance

In this week’s issue:

• Global equity markets are continually supported by loose central bank policy.
• Central banks have become more hawkish in their language on future monetary policy.
• History has taught us that financial assets react differently in a phase of tightening.
• Wall Street’s equity benchmarks register new record highs on a wave of new euphoria.
• Asian markets trade higher on Chinese data whilst Japan hits a twenty year high.
• Whilst some global equity markets look stretched they could rally higher.

“Stock markets march on under a cloud of central bank uncertainty”

Clearly the financial markets are still being supported by loose central bank policy and by the current “goldilocks effect” when the global economy isn’t too hot causing inflation, or is not too cold causing a recession. However, there seems to have been a shift in the approach of central banks around the world over the past six months, in fact, many of them are now talking more openly about the current financial stability of the global economy and from their transcript talk of a period of normalization with respect to the tightening of interest rates.

This inevitable change in direction of interest rates will have ramifications for the markets and asset classes given that over the past eight years the implementation of quantitative easing and a period of zero interest rates has meant that financial markets have benefitted from vast amounts of global liquidity leading to the second longest bull market in living memory. Logically, this in turn, has led to some asset bubbles which are likely to react negatively to any period of quantitative tightening, given that on certain valuation metrics they appear to have become rather expensive.

But of course, the central banks do have a very difficult job on their hands now, trying to measure the actual economic climate that we currently find ourselves. Clearly, there are very few signs of growth being overly excessive, with inflation probably having peaked, but central banks are renowned for making errors of judgement in policy which can affect market sentiment very quickly.

Understandably, important measures such as unemployment rates have seen positive outcomes in recent years in countries such as the United States and the United Kingdom, with Europe now having seen some success. Leverage is not excessive; indeed, bank balance sheets have deleveraged whilst seeing banks easing, not tightening credit conditions, and corporate profitability has been resilient over the past few quarters showing signs of good recovery in numerous parts of the world.

Therefore, after a decade of ultra-loose monetary conditions it is now reasonable to think that the US Federal Reserve Bank, Bank of England, and the European Central Bank are setting a course for monetary conditions to change whilst also embarking on a period of balance sheet reduction after embarking on an unprecedented balance sheet expansion period since 2009.

Equally, history has taught us that in times of meaningful change, particularly from a fiscal, or indeed, a monetary perspective, financial assets begin to perform differently. Clearly, fixed income assets do tend to lead the way, given their sensitivity towards a change in the direction of interest rates and inflation, whilst global equity markets around the world begin to join up the dots in respect to any change in central bank policy, future expectations for corporate profitability, M&A activity, and the overall prospects for an adjustment in global economic growth.

Looking ahead, it is possible that global growth will continue to surprise to the upside whilst some tightening from central banks takes place. As a result, global equities should continue to deliver better returns than bonds, however, investors need to accept the fact that at times volatility will increase, and the odd flash crash is likely to happen, given that we must address issues such as geo-political risks, and for us in the UK, the issues surrounding Brexit, which at the current time is looking rather ugly. None-the-less, global conditions continue to be supportive of risk assets with duration a more challenging backdrop.

That’s not to say that there will not be any opportunities in the bond markets, indeed, whilst corporate credit spreads are tight, and duration likely to be more demanding over the coming years, we have seen the likes of emerging market debt respond positively to the fall in EM inflation, which in turn, has seen a pick-up in global investor’s appetite for this asset class.

Therefore, to conclude, it is likely that the central banks will remain cautious whilst analyzing the geo-political risks, and conflicting forces that are driving financial markets at this current time, but of course, the markets are still expecting the Federal Reserve Bank, and the Bank of England, to raise interest rates by 0.25 basis points before the end of this year, whilst continuing their strategy of reducing their balance sheet.

And so, onto to last week in the markets, once again, we saw Wall Street’s main equity benchmarks register new record highs whilst the US dollar and Treasury yields were pushed lower after subdued core US inflation figures, which to be fair, will add some uncertainty to whether the Federal Reserve Bank will raise interest rates this side of Christmas.

In respect to other markets, we saw Asia trade higher on the back of stronger Chinese imports for September whilst Japan’s Nikkei 225 Index closed above 21,000 for the first time since November 1996. Unquestionably, we are now seeing investors become more creative in their geographical diversifications, as the global economic recovery broadens out, and earnings expansion across the globe materializes, but of course, this does leave some markets priced to perfection and therefore any financial or geo-political shocks could create a period of nervousness and higher volatility.

However, at the current time we remain in calm waters, therefore, it is likely that the equity markets could rally higher over the coming week which is good news for markets traders and ultimately for global investors.