1st Quarter 2015

"History seldom repeats but it does rhyme" is an often quoted phrase that we would like to reiterate as we enter 2015 full of hope and expectation for the opportunities that potentially await us, while at the same time being mindful of the risks that also may lie in wait.

Last Quarter Review

US Gross Domestic Product (GDP) over the previous quarter expanded at a seasonally adjusted annual rate of 5.00%. In the same period, GDP in the UK expanded 0.70% and the Eurozone 0.20% including Germany (the world’s fourth largest economy) at 0.10%.

In Asia, the world’s second largest economy China expanded 1.90 % while GDP in Japan, the world’s third largest economy contracted 0.50%.

Base interest rates in most developed markets remained unchanged during the last quarter and indeed throughout 2014, while official unemployment in both the US and the UK fell steadily throughout the year to end at 5.8% and 6.0% respectively. The steady decline in official unemployment numbers prompted the market to increasingly speculate on the likelihood that 2015 would see the first base rate rises in both economies since 2009.

Financial markets saw a continuation of solid returns from developed market government bonds, despite a brief upward blip in yields during October when markets realised QE4 was not immediately forthcoming.

Global equity markets during the last quarter provided mixed returns as the traditional “Santa rally” failed to materialise. In local currency terms, the S&P 500 in the US rose 4.4% during the quarter to close at 2058.90, while in the UK the FTSE 100 rose 1.3% to close the year at 6566.10. In Europe, the German Xetra Dax rose 4.5% to close at 9805.55, while the French CAC fell 3.2% to 4272.75. The star performer of the quarter was undoubtedly China’s Shanghai Composite index, which rose a phenomenal 36.87%, to close at 3234.68, while the BSE Sensex in India rose 3.3% to close at 27507.54. In Japan, the Nikkei 225 rose 7% during the quarter to close at 17450.77, while the Hang Seng index in Hong Kong rose 2.9% to 23605.04.

Key Economic & Market Data 3rd Quarter GDP 12 month GDP Base Interest Rate at End 2014 Equity Index Returns Over Last 12 Months Sovereign Bond Index Returns Over Last 12 Months
% % % % %
USA 5.00 2.70 0.25 +11.39 +5.59
UK 0.70 2.60 0.50 -2.71 +11.14
EuroZone 0.20 0.80 0.05 +15.76 +11.89
China 1.90 7.30 5.60 +52.87 N/A
Japan -0.50 -1.20 0.00 +7.12 +4.34
Germany 0.10 1.20 0.05 +2.65 +10.31
NB. GDP Data to September 30th 2014; Equity data to 31st December 2014; Equity Indices used are as follows: - US – S&P 500, UK – FTSE 100, Eurozone - FTSEurofirst 300, China – Shanghai SE Composite, Japan – Nikkei 225, Germany – Xetra Dax. Government Bond Indices used are for US, UK and Eurozone - Markit iBoxx, and for Japan and Germany – Bloomberg;

Current Considerations

At the beginning of 2014, we cautioned, “Maybe the most worrying factor to keep us awake at night is that investors have become almost totally reliant upon the Federal Reserve’s quantitative easing (QE), zero interest rate (ZIRP) and other stimulant policies to help stave off global deflation, prop up a long in the tooth three decade old Treasury bull market (that may otherwise have long since collapsed) as well as propel equity markets ever higher.” Arguably little has changed in twelve months except that economically the collapse in the oil price has caught the market and most investment commentators by surprise, and judging by the comments made by a senior Opec minister in early December (namely that they had no plans to restrict supplies, which could send prices to $40 or lower), low fuel prices could be here to stay.

While initially the consensus view of a prolonged halving of the oil price from $100 plus to $50 or less, was that the benefits for the global economy and individual countries (with the exception of Russia and some Opec producers) would far outweigh any disadvantages. Further analysis by some commentators suggests a darker outlook, especially for the emerging and frontier markets of Asia, South America and Africa. Fears surround the momentum that has driven the dollar bull market that began in earnest during the second half of 2014, potentially exacerbating a shortage of dollars internationally which will, in turn, increase demand for US equities and Treasuries despite both currently being perceived as expensive.

During the two previous major dollar bull markets in the 1980’s and 1990’s, we saw a flight to safety via US Treasuries and Wall Street stocks, which of course contributed to one of the greatest equity bull markets in history between 1982 and 2000, but which resulted in economic pain and market losses for many emerging markets. Countries and markets that suffered most during the dollar’s eighties bull market were those in Latin America which had pegged their currencies to the reserve currency, while in the nineties, it was the turn of the Asian markets to suffer most as a result of the crisis created by the major surge in the greenback’s valuation.

Some commentators suggest this dollar bull market could be the biggest, and arguably the most damaging yet for emerging economies, as the equity and debt markets of Asia, Latin America and Africa which have benefitted from the unprecedented “hot” money created by the Federal Reserve, and other central banks through their QE programmes will see much if not all of that money flee into US debt and equity markets on the back of the reserve currency’s momentum, which will be magnified by a shortage of dollars following the end of QE3 at the end of 2014, and with no sign in the foreseeable future of QE4. Additionally the fact that the US is now able to satisfy its phenomenal appetite for fossil fuels almost exclusively through its recent shale oil bonanza, combined with imports from its Canadian neighbour means fewer petro dollars than ever are being introduced into the commercial world (as previously an enormous percentage of its fuel was imported from dollar hungry Opec Middle Eastern and Latin American oil producers), which will further exacerbate the global dollar shortage.

The negatives for the world’s largest economy of the United States is that in the last two decades, like in the case of most other developed nations, its economic growth rates have been decreasing rather alarmingly. In the fifties and sixties, America’s average annual GDP was more than 4%, while in the seventies and eighties, it dropped to around 3%, and this decline continued in the nineties until during the last decade, the average rate has been below 2%.

Arguably the steady decline of economic growth in developed markets led by the US has been the legacy of excess credit, as debt at government, corporate, financial and personal levels, has been building and gathering momentum every decade since the US finally abandoned sound money and the gold standard in 1971. Since then it has become increasingly difficult to discern genuine economic growth from credit induced gains (which unfortunately come with a long term cost legacy), and which has resulted in the world’s biggest economy’s total national debt (currently more than $18 trillion or equivalent to $154,061 for every American taxpayer), exceeding its annual GDP, while the total US debt when including unfunded liabilities (e.g. Medicare, Medicaid, Social Security obligations) runs to more than $59 trillion, according to US Debt Clock Org, although several other independent observers suggest it is nearer $100 trillion!

A similar debt problem exists to a greater or lesser extent in every major economy which explains why the global economic recovery over the past few years since the credit collapse of 2008 has been so anaemic, and why deflation (which could be argued is the debt piper coming to collect his dues) has become the main challenge for the major central banks following the collapse of the extensive shadow banking industry that existed in the West pre crisis. Despite all the stimulation put in place by the Fed and other central banks over the last several years, including ZIRP, and numerous QE programmes, the inflation they so desperately crave in prices to try and devalue their respective nations’ unprecedented peace time debt to GDP ratios remains stubbornly subdued, except of course in some of the financial markets such as equities and government and corporate bonds, which have been the biggest beneficiaries of the all the additional QE money created since March 2009.

Unfortunately history is not on the side of the policymakers who are trying to defy gravity and fight debt by simply creating more debt, since all fiat currencies have eventually collapsed, unless of course this time is different! As inevitable as the demise of the dollar as the global reserve currency almost certainly is, that time is however unlikely to be upon us just yet. Indeed all the omens, along with most fundamental, and technical analysis suggest the greenback potentially has one glorious bull market run left, from which investors could benefit handsomely.

Looking Forward

We believe the Dollar bull market could persist for some time. If correct, we also believe that selective equity and bond funds should continue to provide opportunities for investors within UK and European markets; albeit that the Euro’s likely weakness against both the US Dollar and Sterling as a consequence of its anticipated QE programme, will necessitate caution.

While we are cautiously positive on both US and UK equities, we are also mindful of the known unknowns facing both countries, including the outcome of this year’s UK general election and the possibility of a subsequent referendum on European Union membership. Markets have a general dislike of political uncertainty!

More globally, the known unknowns include the geopolitical fall-out from the decimation of the oil price on economies such as Russia, and while the cost of fuel imports should be a huge bonus for the two Asian giants of China and India, the huge downside risk of all the hot money invested into economies such as these heading for the safety of the dollar markets of the US could well impact negatively upon their economies which would have consequences for the global economy as a whole.

From all of us as Ash-Ridge Asset Management, we would like to wish you a healthy, happy, and prosperous 2015!