There is a lot happening! 21 August 2012 This week’s focus is on the continued rally in risk assets and upcoming political events such as the US presidential election campaign are also being watched by the markets. Global equities completed another positive week to cement a five-week winning streak. Economic data continues to support steady, if low growth. European data has been poor, in line with expectations while the US continues to surprise to the upside with an improving outlook and leading indicators. Economic surprise indicators continue to move higher across the world with exception of China, which has been flat in recent weeks. Government bond prices came under pressure this week, with US treasuries and German bund yields rising between 10 and 20 basis points (bps) at the 10-year point. The S&P 500 Index is almost back to year-to-date highs of 1419 (close 2 April). One exception to the rally in risk was US investment-grade credit, which sold off 1% in the last week, using exchange traded funds (ETFs) as a proxy.
Comments by Draghi are seen as positive Markets have taken recent comments by ECB head Draghi - indicating a readiness for ECB bond buying in shorter-dated secondary markets for Italy or Spain - quite positively. Some scepticism remains regarding the lack of detail around this announcement, which may worry markets in the weeks ahead. In addition, there are still concerns about the global risks to growth. Allied to this are low short rates, central bank buying and disinflation concerns, the combination of which suggests that long-term interest rates in major developed countries could stay at exceptionally low levels for a considerable period of time.
Global equities in euro terms have gained 17% so far this year. While this figure is flattered by a weaker euro exchange rate - in local currency terms markets are up 12% - it is nonetheless a very strong performance. Valuations continue to be seen as reasonable, as they have been for some time now. But it is investors’ perception of the macroeconomic backdrop – partly fuelled by the eurozone crisis – that has been the main driver of sentiment this year. While equities have had a stronger couple of weeks on Draghi’s comments, we believe that the rally will more likely fade than be sustained in the immediate period ahead. For now, we will stick with a close-to-neutral stance on equities, preparing to reduce from current levels.
South African strike In commodities, oil rose as tensions between Israel and Iran intensified. The price spread between Brent crude and WTI rose back to all-time wides. Different supply conditions exist in Europe and US. Gold and other precious metals were broadly flat, except platinum which jumped over 4% due to the
escalation of a mining strike in South Africa. Industrial metals continued to struggle. In recent weeks we have seen a spike in agricultural commodities, but prices have started to come off the boil. In FX, it was a mixed bag as the USD gained against AUD and JPY, while falling against most European currencies. The USD made headway against most emerging market currencies this week, with South Africa’s rand depreciating the most, which is likely to be linked with the miner’s strike. One observation is that the nature of the rally in risk assets is changing; previous risk rallies this year were not accompanied by the selling of government bonds. Also, the beaten up parts of the equity market started to outperform the IBEX, up over 6%.
Investment views The investment views remain focused on three issues – firstly, the US and Chinese economies, secondly, the eurozone crisis and, thirdly, the US fiscal cliff. Comparing where we are now to April of this year, economic momentum is bottoming out rather topping out. The European Central Bank has been more explicit about how it plans to help keep the eurozone intact. We have seen little progress on the US fiscal situation. Based on this, risk assets are better supported. However, politicians return from holiday to a packed agenda in September, beginning on September 12 when Dutch elections are held and Germany’s constitutional court rule on whether new European bailout and fiscal pact break German Law. For these reasons, there is likely to be more volatility on the horizon across all asset classes. Currencies On currency markets, the dollar received support from the release of better-than-expected US sentiment figures, pushing the currency marginally up against the euro over the week. The €/$ rate ended the week at €1.23.
Oil The West Texas oil price ended the week 3.4% higher at $96 a barrel, supported by better-thanexpected demand and some supply disruptions, particularly in Iran. In fact, oil prices denominated in euro currency rose above 2008 levels, prompting governments to review plans to release their strategic stocks in response to escalating oil prices. Bonds Spanish 10-year bond yields fell below 6.5% for the first time in six weeks, amid increasing investor confidence of more decisive ECB actionto support the eurozone region. Meanwhile, the rally in Spanish bonds was even more evident in shorter-dated paper with two-year bond yields falling from a peak of 7.15% in late July, to 3.73% last week. Conversely, easing risk aversion reduced demand for the safe haven status of German sovereign debt. The Merrill Lynch over 5 year government bond index ended the week 0.1% lower.
Source: Blackrock, Bloomberg, Zurich Investment Managers, Aviva Investment Managers