Market View - June 2013

The roller-coaster ride that has typified global markets during 2013 continued in June with most asset classes with the exception of the US Dollar plunging following the statement from the Federal Reserve System (Fed) at its latest Federal Open Market Committee (FOMC) meeting, which suggested that if the US economy's key data including the all important unemployment numbers continued to improve, then it would begin "tapering" its current quantitative easing (QE) programme (whereby it prints $85 billion a month to purchase US Treasuries and other fixed income assets), with a view to finally stopping the stimulus next summer.

This came as a shock to most Wall Street practitioners whom failed to see the rosy economic scenario put forth by the Fed in the minutes of its FOMC meeting, especially as the majority continued to perceive the continuing deflationary threat from the implosion of the shadow banking assets assembled by the major investment and commercial banks of the developed West over the past several decades as being a much greater threat than any future inflationary worries from the Fed’s QE printing presses! Faced with what appeared to many market commentators as the premature withdrawal of the QE wonder drug that had been propelling global stock markets as well as most other asset classes (including Western government bonds, commodities and precious metals) to ever higher valuations, market sentiment suddenly changed for the worse.

The market gloom was compounded by serious question marks surrounding the continuation of the Chinese growth miracle due to over expansion and worrying cracks in its own shadow banking liabilities. Accordingly most asset classes fell in the latter stages of June with emerging market equities and currencies most badly hit, while the bear markets in gold and silver gathered pace and potentially most worryingly of all the yield on the bell weather US Ten Year Bond rose above 2.5% for the first time in two years.

As investors braced themselves for increased volatility and gathering downside momentum, calming reassurances came to the rescue from senior members of the Fed's FOMC which included William Dudley, President of the New York Federal Reserve Bank suggesting the market had misinterpreted the post FOMC statement, and that the end of QE was not necessarily imminent after all!

Almost magically most markets quickly recovered, with the S&P 500 in the US once more climbing above 1600 to within reach of its all time nominal high of earlier this year. Since the start of 2013, the S&P 500 was up 12.63% at the year’s half way point, having been up 17.04% on the 21st May when the index hit its all-time nominal closing price of 1669.16.

By comparison, the FTSE 100 in the UK was up 5.39% over the first half of this year closing at 6215.47 on the 28th June, having at one point been up 15.98%, when on the 22nd of May, the index closed at 6840.27. The CAC 40 in France ended June up 2.69% higher in 2013, after having at one stage been 11.26% higher in May, while the Dax in Germany was up 1.16% at the half way stage having previously been up 8.82% year to date at its peak in May.

The Asian emerging market giants of China and India had been struggling somewhat even before the fallout following the QE announcement, and ended June with the Shanghai Composite down 12.78% (having at one point in 2013 been up 7.29%), the Hang Seng in Hong Kong, down 8.18% (having been up 5.15% earlier this year) and the BSE Sensex index in Mumbai down 0.16% (having been up 4.42%).

Meanwhile the star of the major stock market indices during 2013, namely the Nikkei 225 in Japan was up an extraordinary 31.57% at the end of June having at one stage been up 50.33% on the back of the so called Abenomics which has seen Japan in the past year embark upon its own QE programme which as a percentage of GDP, is even larger than that being undertaken in the US by the Fed. However the Nikkei 225 has been extremely volatile having at one point during June fallen more than 20% intraday since its 2013 closing price high of 15627.26, making many market analysts question whether the relatively brief but dramatic cyclical bull market in Japanese equities is already over?

Most agree the increased volatility is almost certainly here to stay while the biggest concerns in the land of the rising sun for most investors remain the bond and currencies markets, with renowned hedge fund manager Kyle Bass of Hayman Capital who has been warning about Japan’s precarious debt to GDP ratio for some time reiterating that in the global currency wars which have been going on for some time, the Yen will be the first currency to crash and burn.

The Future of US treasuries is arguably even more difficult to predict with several leading commentators suggesting the long bull market is finally over. For example bond king Bill Gross of PIMCO said on the 10th May that the three decades bull market in American government debt ended when the yield on the 10 year Treasury hit 1.67% earlier that month. Last month the yield went above 2.50% for the first time in two years having hit a low of 1.43% last summer.

All in all, it hasn't gotten any easier for investors seeking capital preservation for minimal risk, since the yield on cash has been negligible and negative in inflation adjusted terms for a long time now. At the same time yields on government bonds in the US and elsewhere look set to continue rising, and the long bull market in the gold and silver markets appears to have ended with the prices of both metals having fallen dramatically this year.

While many valuation measures suggest the US equity market is expensive by historical standards, it could be argued these are exceptional times and that the extraordinary stimulus programmes deployed by Western central banks following the collapse of Lehman Brothers in 2008 means many historical methods of valuing markets are less reliable. An interesting alternative method of measuring how expensive or cheap the US stock market currently is, involves comparing how many ounces of gold it would take to buy the Dow Jones Industrial Average (DJIA) compared to other times over the past century?

This has often proved a useful indicator in the past and at the end of June when the DJIA closed at 14909.60 and gold bullion was approximately $1200 an ounce, it required just over 12 ounces of gold to buy the DJIA, whereas in March 2009 when the cyclical bull market in US equities began, it needed just over 7 ounces. However back in late 1999 and through most of 2000 when the US equity market was at its real inflation adjusted all-time high (and gold trading for $300 an ounce or less), the ratio was often more than 40 ounces.

With hindsight investing heavily in gold bullion in preference to stocks back in 2000 looks an easy decision, whereas today stocks look much more attractive, while gold looks overvalued. Most commentators agree equities continue to look the most attractive asset class on a relative value basis despite many markets having more than doubled since March 2009 when the current American bull market began, with the S&P 500 up 146%, the Nikkei 225 and the Hang Seng both up 120%, the BSE Sensex up 157%, the Dax up 94% and the FTSE 100 up 93%!