It is not clear that this adjustment phase has run its full course and as such we remain cautiously invested.
Asset markets are in the process of adjusting to a weaker economic outlook, continued stresses in the eurozone and also a downgrade to the US credit rating. This adjustment is happening very quickly, and occurring in a period of the year typically characterised by low volumes. The price swings in both bond and equity markets have been acute, and measures of market volatility have picked up significantly.
Market corrections
Equity markets have been at the centre of this, with both developed and emerging market indices correcting significantly since July, and all are now in negative territory for the year. US and UK bond yields have also declined further, base metal (particularly copper) and oil prices have pulled back, evidencing that markets are moving to discount lower growth going forward.
Meanwhile, the gold price has remained elevated and both the Swiss franc and Japanese yen have strengthened, indicating that we are also observing a move to perceived safe haven assets. Problems in Europe have been one of the key drivers of this correction.
In Europe, contagion has spread to bond markets in Italy and Spain, and to a certain extent, France. Italian and Spanish Bonds had been marked down significantly in the market, with yields for both approaching levels at which Portugal and Ireland had to seek aid.
The European Central Bank, initially reluctant to provide support, has stepped in to purchase bonds of both countries, which has had a powerful impact on their markets, with yields declining substantially. In the first week of buying the ECB has spent €22bn, higher than expected, thus demonstrating their commitment to ease any potential funding issues for two of the region’s largest economies.
Contagion spread
Latterly, France was highlighted as an area of concern, amid rumours of a downgrade to its AAA credit rating. This manifested itself primarily through French banks, with the stock prices of Société Générale and BNP Paribas falling significantly. Pressures have eased somewhat subsequently, with the three major credit agencies reconfirming the country’s credit rating.
Regulators across Europe have also taken action to stabilise financial stocks, with a number of countries reinstating naked short-selling bans, last used during the financial crisis of 2008. Nonetheless, stresses are still evident in parts of the bank-funding market in Europe, and these need to ease further to boost confidence in the sector and region.
The extension of the US debt ceiling and downgrade to the nation’s sovereign bond rating by Standard & Poors has acted as a further catalyst for a correction in risk assets. This has been interpreted as a signal that the US needs to undertake significant fiscal austerity in coming years to address its debt issue, which in turn will result in lower growth for the country. The Federal Reserve, at its August meeting, added to concerns regarding the near-term outlook for the economy, stating that economic conditions are weaker than expected, that the pace of recovery remains low, and as such they have committed to keep rates low through mid-2013.
Forward look
At the same time, US GDP for the second quarter came in at 1.3%, below expectations of 1.8%, and first quarter growth was revised down to 0.4%, from 1.9%. Leading indicators, for both developed and emerging markets, also points towards a loss in economic momentum in coming months. None of these indicators yet suggest a recession is imminent, but future data points require monitoring to provide a clearer picture for the future path of global growth.
Going forward, we believe that markets are likely to remain volatile and news-flow driven.
European markets will continue to focus on progress and developments made by the authorities to address the ongoing financing problems for the weaker peripheral members. This will remain a sensitive issue for European financials, and we would need to see some easing in the interbank lending markets to provide confirmation that systemic risks are abating.
In addition, markets will remain highly sensitive to key economic data points in coming months, which we expect to confirm a slowdown in growth as opposed to contraction. Given this backdrop investors should remain focused on capital preservation.
