Market View - July 2012

What a difference a month can make as May’s debacle in markets turned into a very positive June and “risk on” became the buzzword once more as almost every major market soared dramatically following yet another European Council Summit promising to deliver the elusive solution to the Eurozone debt crisis!

The euphoria that greeted the ratification of the European Stability Mechanism by the German Bundestag and Bundesrat on the last trading day of June, together with increasing speculation that the European Central Bank (ECB) would restart the Securities Market Programme (SMP), ensured a rallying month-end close for most markets with the German CAC up 3.42% in the final week alone! Overall during June the MSCI Global equity index rose 4.93% giving an overall positive return for 2012 to date of 4.49% while the JPMorgan Global Bond index is up 0.40% year to date.

The best stock market returns during June came from the Indian market with the MSCI index there rising 6.33% (and up 13.07% Year to date), followed by the Nikkei 225 in Japan climbing 5.43% (6.52% YTD), then the FTSE EuroTop 100 rising 5.30% (0.53% YTD), the FTSE 100 in the UK up 4.70% (-0.02% YTD). The Hang Seng in Hong Kong rose  4.36% (5.46% YTD), and the S&P 500 in the US was up 3.96% (8.31% YTD) while the Shanghai Composite in China spoilt the party by falling 6.19% (but is up 1.18% YTD).

Whether the euphoria that greeted the initial policy details from the latest attempt at a solution to the Eurozone crisis will be justified, remains to be seen, although European stock markets have retreated back to where they were previously a week after the latest solution was announced, despite the ECB having now cut both its repo and deposit rates by twenty five basis points to 0.75%! At the same time the Bank of England (BOE) announced a further £50 billion of Quantitative Easing (QE) hoping that further action from the printing presses will “combat continuing tight credit conditions and the increased drag from the heightened tensions within the Eurozone”

The BOE have now taken the money pumped into the UK economy via QE to a total of £375 billion, market analysts however remain sceptical of the benefits. As the BOE’s Monetary Policy Committee (MPC) warned “UK output has barely grown for a year and a half and is estimated to have fallen in both of the past quarters”, while slowing exports and falling business confidence suggest a reversal in economic fortunes seems unlikely in the short term! As if this were not bad enough when combined with one of the wettest and most miserable summers on record in the UK and elsewhere, markets had to contend with more shenanigans from the big global investment and commercial banks as news of the Libor fixing scandal involving Barclays and other major banks rocked markets in late June!

The fallout from the latest revelations about Libor fixing is likely to be felt by all of us in the financial industry for some time.

Meanwhile the total federal debt of the United States now officially stands at $15.7 trillion, which is more than the sum of its annual economy (or GDP), and if future unfunded liabilities are added the total according to some market sources is in excess of $75 trillion (and the European PIIGS thought they have problems)! Considering these obscene debt levels, it is extraordinary to observe that the yield on the benchmark ten year Treasury is just 1.58%, the lowest according to Bank of America Merrill Lynch in the 220 year history of American debt!

Arguably the various policy easing tools deployed by the Federal Reserve System (Fed) including QE, Operation Twist (OT) and its Zero Interest Rate Policy (ZIRP) have satisfied capital markets that the United States can comfortably continue to pay interest on its national debt to bond holders for the foreseeable future. A quid pro quo however is that unless the growth of the US economy begins to match that of emerging markets in recent years (which is extremely unlikely) or inflation begins running out of control (decidedly possible longer term), it is highly unlikely that the Fed will be able to move away from ZIRP for many years as to do so would risk frightening the bond markets and bankrupting America as the yields on its bonds rose to non-fundable levels! The debt situation in the UK and the Eurozone is similar and therefore ZIRP policies are most likely to remain in place indefinitely here also!

Consequently the investment options for risk adverse portfolios will remain very challenging with cash and developed market government bonds offering negative returns after inflation! Thankfully however, there remain many attractive dividend paying stocks from proven global leaders in their sectors which when combined with lower risk corporate bonds from similar companies and a limited exposure to growth opportunities in emerging markets (equities, government bonds and currencies) provide the opportunity to construct portfolios that offer the best capital preservation potential.