Equity market volatility has fallen to its lowest level since the Lehman Brothers crisis allowing the majority of global equity markets to grind higher, while the US stock market has just reached its four-year high.
This new air of calm was initiated by ECB President, Mario Draghi’s speech ahead of London 2012, in which he committed "….to do whatever it takes to preserve the euro." This was further supported by Angela Merkel. But should we be wary? Was this a ploy to allow politicians to enjoy their family summer holidays this year without disruption?
I suspect this may be the calm before the storm and that September will see volatility pick up as investors are reminded that the global economy is still slowing and that problems in the eurozone have probably worsened rather than gone away.
Over the past month, Draghi’s positive words have prompted both Spanish and Italian bond yields to fall and their equity markets to rise. There has been virtually no news as to how the ECB intends to tackle the sovereign debt crisis, although we know that any jointly issued eurozone bonds will harbour conditions. As we head into autumn, we are about to discover how acceptable those conditions will be.
The direction of both equity and bond markets will continue to be driven by how politicians and their central banks deal with government debt. Not only will this influence markets, it will shape the future of the eurozone and the speed of global economic recovery.
Policy makers continue their delicate balancing act in fostering economic growth. At one end of the scale, peripheral Europe has embarked upon severe austerity to reduce debt; at the other, the US has printed an enormous amount of dollars to keep bond yields low in order to stimulate growth. While the US approach has produced better, relative economic growth it has come at the cost of ballooning government debt. The UK has attempted the middle ground, but has suffered from a large number of its trading partners funding themselves in recession, coupled with a weaker, scandal-ridden banking sector.
We have recently raised our cash weightings in client portfolios as we suspect the next few months will be fairly turbulent. The US presidential election campaign, now in full swing, has become a debate on fiscal policy and the role of government in society. History shows that the best outcome for equity markets is a win for the incumbent. However, polls are showing candidates neck and neck as Obama’s hope for a pick-up in economic growth fades.
Back in the eurozone – hard decisions and compromises will have to be made if the ECB is to intervene to reduce the cost of borrowing. If this does happen, it will create a better entry point for us to buy equities, which we continue to believe will be higher a year from now.
