Please find below our Weekly Market Update for the week ending 3rd August 2018.
A brief insight into the latest market dynamics and details of any changes occurring within our model portfolios.
In 2005, the then-current head of the US Federal Reserve, Alan Greenspan, stood before Congress and assured them that the bond market’s ability to predict a recession isn’t what it used to be. The reason why it was necessary for him to do so, was that short-term bond yield rates threatened to climb above long-term rates, a rare event in markets and one that has, historically, been a reliable indicator of a looming recession. 13 years later, the newest Fed Chair, Jay Powell, has found himself having to do the same as his predecessor, as short-term yield rates are close to exceeding long-term yield rates, in what some investors once again believe is an early warning of an economic slowdown.
Of course, we now know that Greenspan was ultimately wrong in 2005, as short-term rates eventually exceeded long-term ones in 2006, and the Financial Crisis that led to a global recession followed in 2008. Therefore, it is interesting that Jay Powell has, this week, stood in the same position as Greenspan did in 2005, and purveyed the message that the current US economy is still growing steadily, and it is robust enough and inflation is firming sufficiently enough for the Central Bank to continue to raise Interest rates – the steady pace of interest rate increases from the Fed is arguably the main reason short-term bond yield rates are close to overtaking long-term yields. Whatever happens in the future, investors are beginning to worry that the present bond market environment is pointing towards a nearing downturn in economic performance.
But what if the bond market is wrong this time? It’s always a risk to say that this time it will be different, but rising bond yields have undoubtedly been distorted by the unorthodox global monetary policy of Quantitative Easing, so this could suggest inaccuracy in predictions. Even more so, economic expansions don’t just die of old age. Other nations have enjoyed much longer runs in the past than the US’s current economic expansion, most notably being Australia, who have now gone 26 years without a recession. The UK and Canada saw 16-year expansions before the 2008 crisis, and Japan’s economy grew undisturbed between 1975 and 1992.
Strong economic growth, steady inflation and a stable labour market look to bring the US over the line in having the longest economic expansion in US history, and could easily continue beyond that. However, the signals from the bond market, coupled with a widening budget deficit which limits the ability to stimulate a struggling economy, means that the chances of reaching similar heights to Australia’s 26-year economic marathon is looking increasingly difficult
Gary’s market comments in conjunction with our investment partners
Just over half the S&P 500’s constituents have reported for Q2, and 83% have exceeded earnings expectations. Looking at the 277 of the 497 companies by sector, 70% of the sectors have posted higher sales growth than Q1, with an average sales growth of over 10% versus Q1 sales growth of 8.2%.
It is pleasing to see that the very strong Earnings Per Share (EPS) growth that was experienced in Q1, boosted mainly by Trump’s tax reform, has continued. 80% of the sectors have actually experienced higher EPS growth in Q2.
This paints a picture of strengthening growth with corporate earnings beating expectations. However, since January, this has not translated to stock market performance due to worries about the global trade war, concerns over the impact of interest rate rises and asset price appreciation over the past nine years.
The investment team has switched 7IM’s gold allocation to an investment in commodities, buying a holding worth 2% of the value of the portfolios across the whole risk profiles. The investment was in the form of a structured note that was issued by BNP and offers dynamic curve positioning. This means that BNP systematically buys either the near or long dated contracts to minimise the cost of carry from holding the position. The long-term aim (although there are never any guarantees) is to deliver better returns versus the benchmark.
Sources: LGT Vestra and 7IM