Excerpt from Schroders Investment Managers overview of markets in Q4 2014
– Global equities delivered positive returns in a volatile quarter. The Federal Reserve (Fed) ended its quantitative easing programme but other central banks continued to ease monetary policy. Oil prices fell further, particularly after Opec elected not to cut output.
– The S&P 500 performed well despite some concerns over interest rate rises. Equities were supported by hopes that the lower oil price would help sustain the consumer-led recovery.
– Eurozone equity returns were virtually flat. Macroeconomic news remained downbeat with disappointing news from Germany’s industrial sector early in the quarter. The weak data fuelled hopes that the European Central Bank could soon start buying sovereign bonds.
– Japanese equities gained after further monetary policy easing from the central bank sent the yen lower. Prime Minister Abe called snap elections, which were won by his party, and delayed another consumption tax increase.
– Emerging markets posted negative returns. Russia was particularly weak amid deteriorating economic data, the falling oil price and pressure on the rouble. An interest rate cut supported Chinese equities.
US equities recorded strong gains in the period as the domestic economy continued to perform well amid hopes a lower oil price would sustain momentum in the consumer-led recovery. This was despite the threat of rising interest rates and associated market volatility. The S&P 500 bounced back strongly from October’s sell-off, when the Fed’s decision to fully taper its quantitative easing drive prompted the next question – when would base rates rise? But oil’s retreat quickly fed through to the pump, driving down inflation overall, which dropped sharply to 1.3% in November. Retailer Wal-Mart Stores cited lower gasoline prices for a turnaround in like-for-like sales revealed in the third quarter.
Consumer discretionary and consumer staples were the second and third-best performing sectors on hopes of strong holiday season sales, which got off to a good start on a busy ‘Black Friday’ even if traditional bricks and mortar retailers lost out to online competitors. The retail sector was further buoyed by merger & acquisition speculation as Starboard Value LP appeared on Staples’ register and raised its position in Office Depot. This prompted talk the New York hedge fund will agitate to merge these rival stationary sellers.
The utility firms topped the leader board. This traditionally defensive area, which is a bond proxy, rallied as Treasury yields further retreated, the 10-year note ending the period at 2.19%, versus 2.49% going into the quarter. Utilities also attracted support amid a general rise in volatility, which spiked again in October as the rouble’s precipitous retreat invoked memories of Russia’s 1998 debt default. The energy majors ConocoPhillips and Exxon Mobil both weighed on the index after Opec revealed it would not cut output in response oil’s retreat.
The MSCI EMU index posted a virtually flat return in euro terms for Q4. The quarter started on a shaky footing with a sharp sell-off in early October following some weaker-than-expected macroeconomic data. The disappointing data mainly stemmed from Germany’s industrial sector, with manufacturing orders falling 5.7% month on month in August while industrial production declined by 4.0%. However, macroeconomic releases later in the period showed an improvement with the German ZEW economic sentiment index for December reaching 34.9, compared to 11.5 to month before. Overall though, the eurozone’s economic performance remained lacklustre with GDP growth of just 0.1% in Q3 and inflation remaining low at only 0.3% in November. Markets were somewhat disappointed that the European Central Bank (ECB) took no further steps to boost growth at its December meeting, but ECB President Mario Draghi and other policymakers hinted that further easing could come early in 2015.
Individual country indices were mixed. The Italian market was the main laggard after banks Monte Paschi di Siena and Banca Carige were the main casualties of the ECB’s Asset Quality Review. Most leading European banks were given a clean bill of health. Italy’s flagging economy was also a concern with GDP contracting by 0.1% in Q3. By contrast, Germany’s DAX index was one of the stronger performers amid gains for telecoms and autos. Ongoing euro weakness versus the dollar supported German exporters. On a sector basis, energy was a sharp underperformer amid the precipitous drop in the oil price. Consumer-oriented sectors such as autos and media fared well.
The tail end of the period saw the re-emergence of eurozone break-up risk with Greece calling parliamentary elections for 25 January after the ruling party’s presidential candidate failed to garner sufficient support. Yields on three-year Greek debt jumped to around 12%. However, the reaction in the rest of the eurozone was relatively muted.
The positive influence of M&A activity meant the FTSE All-Share recorded a slight gain in the period, up 0.6%. This was despite worries about Chinese growth and a retreat in the oil price pulling down the market’s heavyweight resources sectors and driving a sharp devaluation in the Russian rouble. The accompanying rise in global risk aversion prompted a flight to safety as the yield on the 10-year gilt fell to 1.8%, its closing low of 2014.
Both fixed-line leader BT and wireless giant Vodafone were at the centre of M&A speculation as deal activity stepped up in the European telecoms sector. BT entered into an exclusivity agreement with Deutsche Telekom and Orange regarding the possible acquisition of their jointly-owned mobile telecoms group EE. Meanwhile, Vodafone was subject to talk it was planning an approach for cable operator Liberty Global, which owns Virgin Media.
The life insurance sector was another notable source of M&A activity as Aviva and Friends Life agreed a tie-up. Deals were done despite fears about the possible impact of rising US interest rates after the Fed fully tapered its open-ended quantitative easing drive. Russia added to the uncertainty, as did the prospect of renewed eurozone break-up fears on the unexpected news of a Greek general election. However, oil’s retreat helped push back UK interest rate rise expectations, supporting domestically focused sectors such as the general retailers.
Next nudged up its 2014 profit forecasts, reversing some of October’s weather-related downgrade, and the clothing retailer’s chief executive officer Simon Wolfson cited ‘strong’ UK employment conditions and an end to real wage declines. Inflation continued to tick down with confirmation that the UK Consumer Prices Index (CPI) struck a 12-year low of 1% in November as oil’s decline fed through into cheaper fuel at the pump. The FTSE 250 performed particularly well, up 5.2%, as rate rise expectations moved out.
The Japanese stock market surged in the final quarter of 2014 and gained 6.2%, in yen terms, after a dramatic end to October which saw the announcement of further monetary policy easing by the Bank of Japan (BoJ). This constituted a genuine surprise for the financial markets and much of the market gain coincided with a significant weakening of the yen, which at one point during the period was above 120 to the dollar. The easing of policy itself has been much-debated, but the BoJ had managed expectations such that virtually no commentators expected the move at the end of October. Regardless of the policy itself, if the aim of the central bank was simply to deliver a surprise, this was undoubtedly a success.
Following this, expectations were that Prime Minister Abe would take a decision in early December to implement the next increase in the consumption tax, which was originally slated for October 2015. However, within the space of just a few days in early November, these expectations changed dramatically. The final outcome was a delay in the consumption tax increase for 18 months, an unexpected dissolution of the Diet and a snap general election called for 14 December – which Abe handily won. The result was an effective endorsement of his policies, thus justifying his decision to dissolve parliament early. In fact, in combination with its smaller Komeito partner, the coalition government has maintained a two-thirds majority, providing a strong platform for Mr Abe to move forward with further reforms should he choose to do so. Although the result is positive for equity investor sentiment, it was achieved on a very low elector turnout and, in truth, owed much to the total disarray of the opposition parties.
Economic data released late in the period were generally weaker than expected. Industrial production was particularly disappointing and retail sales also declined slightly. Inflation continued to drift lower, despite the Bank of Japan’s rhetoric. However, the most significant downward pressure on CPI in recent months has come from the weakness in the oil price which will ultimately provide a boost for Japan’s economy.
Asia (ex Japan)
Asia ex Japan equities finished the last quarter of 2014 flat as negative December returns offset the previous months’ gains as sentiment was hit by the falling price of oil and slowing global growth. Despite weakening economic data, Chinese equities posted strong gains for the quarter, spurred on by a November interest rate cut by the People’s Bank of China (PBoC), the first one in two years. However, data continue to show the economy struggling to maintain its pace of expansion as the widely-watched HSBC/Markit November manufacturing purchasing managers’ index (PMI) reading fell to a six-month low of 50. Trade data also disappointed, with exports up just 4.7% year-on-year in November, while imports fell 6.7% over the same period. Inflation continued to be muted and slowed to a five-year low in November as consumer prices rose only 1.4% year-on-year, down from October’s increase of 1.6%.
In Hong Kong, the market finished up as the end of disruptive pro-democracy street protests ended while the start of the much-awaited Shanghai-Hong Kong Stock Connect in mid-November proved to be disappointing on limited take-up and muted trading volumes. Taiwan’s market also finished up as third quarter GDP growth came in at 3.6%, with increasing domestic demand and manufacturing growth driving expansion. Meanwhile, Korean stocks fell to a 10-month low over the quarter as a slew of disappointing corporate earnings announcements and the negative impact on Korean competitiveness of the Japanese yen’s steep depreciation continued to concern investors.
In ASEAN, Thailand’s market fell as the economy posted worse-than-expected third quarter GDP growth of 0.6% year-on-year while the Philippines saw its market advance over the quarter on continued positive investor sentiment surrounding its strong economy going into 2015. In Indonesia, the market gained on the pro-reform moves of President Joko Widodo, who raised government-subsidised petrol prices by 30%, which should benefit the country’s current account deficit. In India, stocks fell over the period as investors pulled money out of emerging market assets in December on worries over the falling price of oil and sluggish global growth.
Emerging markets posted declines and the MSCI Emerging Markets (EM) index lagged the MSCI World in the fourth quarter. Emerging Asia was the best performing region. In China, an interest rate cut by the central bank was perceived as supportive and equities rallied. Economic releases were relatively lacklustre through the period and the People’s Bank of China (PBoC) underlined its commitment to use various monetary tools to maintain reasonable liquidity and growth in both credit and social financing. This was well received by financial markets and came as speculation increased that the PBoC may be considering further stimulus measures, supporting equities through late December. Malaysia was the worst performing market, primarily due to the heavy fall in oil prices.
Latin American emerging markets all finished in negative territory. Peru capped only slightly negative returns, where the small market held up primarily due to the performance of large index stock Credicorp. In what was a relatively volatile quarter, Brazil underperformed. Following several shifts in opinion polls, Dilma Rousseff was re-elected in October’s presidential election, precipitating sizeable falls in the Brazilian equity market. Meanwhile underlying macro data remained weak. Despite ongoing concerns, policymaker action post the election has been well received, signalling a possible return to more orthodox decision making; the central bank hiked rates to 11.75% and President Rousseff appointed respected former Treasury Minister, Joaquim Levy as Finance Minister. Colombia was the regional laggard, given the economy’s heavy reliance on oil exports, and the market fell more than 20%.
Emerging EMEA was the worst performing region. Turkey was the best performing market. The country faces underlying concerns over Fed rate hikes, owing to its high current account deficit and large external debt.
However, as a net importer the market is expected to be a key beneficiary of lower oil prices which should help reduce inflation from a current level of 8.4% year on year. Russia was the worst performing market in Q4. Ongoing tensions in Ukraine, increasingly isolationist rhetoric from the Kremlin, deteriorating economic data, coupled with the sharp decline in the price of oil continued to put downward pressure on financial markets. The central bank moved to increase rates to 9.5% and brought forward plans to allow the rouble to free float in November. However, this failed to stem losses and was followed by a surprise overnight, decision to hike rates to 17% and renewed currency market intervention in mid-December, in an effort to support the rouble which declined 34.8% relative to the US dollar over the quarter.
The final quarter of 2014 presented a number of challenges to fixed income investors. Though fixed income broadly generated positive returns, bouts of elevated volatility led to riskier assets underperforming perceived safe havens. Persistent policy accommodation from the world’s major central banks, as well as sustained weakness in the oil price, was the principal driver of returns for fixed income markets.
The 10-year US Treasury yield fell from 2.49% to 2.17%, and the equivalent gilt yield fell from 2.43% to 1.76%. The 10-year Bund yield fell further into historically low territory, from 0.95% to 0.54%. Peripheral eurozone debt also continues to make progress, with Italian 10-year yields falling from 2.33% to 1.89% as the equivalent Spanish yield fell from 2.14% to 1.61%.
Corporate indices broadly progressed, with the exception of US high yield bonds (high yield bonds are speculative bonds with a credit rating below investment grade). The investment grade BofA Merrill Lynch Global Corporate Index gained 1.60% in Q4, while the high yield index fell -1.07%, led by US high yield’s losses of -1.48%. Investment grade dollar bonds rose by 1.43%. Sterling investment grade bonds gained a robust 4.37% over the quarter, while sterling high yield bonds rose 1.18%. Euro investment grade credit also rose, though by a more limited 1.42% as euro high yield bonds gained 0.74%.
If you would like to discuss your own existing or potential new investments you can contact us to arrange a meeting with one of our Independent Financial Advisers.