Overall, stock markets have made progress in the first half of the year with the MSCI World Index advancing 1.75%* although most gains were made in the first quarter. The strongest performances came from Japan and China. Japan, up 11.9%*, was boosted by strong economic and corporate earnings growth as the government’s monetary intervention policy and fiscal and structural reforms started to take effect. China has been extremely volatile with a surge of 45%, driven by private investors using debt, followed by a sharp correction of over 20%. Other major emerging markets have struggled this year, notably Brazil and Russia, due to their exposure to the falls in oil and commodity prices. India has fared better though as the government continues to make headway with its economic reform programme.
Europe performed very well in local currency terms but the weakness of the euro meant returns for a sterling investor were less impressive unless their exposure was hedged. Europe also surrendered some of its earlier gains as the Greek financial crisis escalated. Despite increased volatility the UK market has managed to advance over the period, with the FTSE All Share up by 3% over the period while the US has lagged with a small decline. The FTSE 100 breached the significant 7000 mark in March before falling back ahead of the election. A decisive victory for the Conservatives, enabling them to form a government with a small majority, initially restored confidence but the uncertainty caused by the proposed referendum on Europe has continued to unsettle the stock market.
The global economy generally remained subdued and the rises in equity markets were partly driven by Monetary Policy outside the US. The European Central Bank (ECB) began an extensive programme of quantitative easing (QE), the printing of money to purchase bonds with the aim of redirecting capital towards lending for investment by businesses. This led to a sharp contraction in government bond yields across the Eurozone and also a significant depreciation of the euro which has improved the competitive position of member countries. Japan is also benefitting from a QE programme which has weakened the yen and is boosting exports and therefore GDP growth.
The Eurozone reported deflation for the first time in 5 years following the collapse in the oil price although economic data is showing improving confidence and falling unemployment. Consumers seem to be releasing pent up demand and taking advantage of lower prices. The UK Consumer Prices Index also had a brief foray into negative territory in April with a reading of -0.1% before returning +0.1% in May as the decline in fuel and food prices worked through the system and wage inflation picked up. The price of Brent Crude is now trading over a third higher than its January lows. Furthermore, with unemployment at a 7 year low, having fallen to 5.5% in the first quarter, spare capacity in the economy could quickly reduce. The Bank of England Governor, Mark Carney, has repeatedly warned that low inflation is a temporary phenomenon and he expects it to reach the 2% target by 2017. UK GDP growth for Q1 slowed to 0.4% quarter on quarter which may have contributed to the Monetary Policy Committees’ (MPC) decision to leave base rates on hold at 0.5%, a level that has remained unchanged for over 6 years. The MPC has expressed confidence that global growth will resume a steady pace throughout the rest of the year. An encouraging rise of 1.2% in retail sales in May has raised hopes that individuals are finally starting to spend, rather than save, wage increases which would provide a further stimulus to the economy.
China cut interest rates in May for 3rd time in 6 months in an effort to restore dwindling growth. While the earnings outlook has so far shown little substantive signs of improvement, the authorities have recently announced a series of fiscal and monetary stimulus measures.
Looking forward, leading forecasters have trimmed their global GDP forecasts for 2015 after sluggish growth in the first quarter. The World Bank now estimates growth of 2.8% for 2015, compared with 3.8% at the beginning of the year, and 3.3% in 2016. In June the OECD (Organisation for Economic Co-operation and Development) cut its forecast to 3.1% for 2015 and 3.8% for 2016. The Federal Reserve reduced estimates for the US for this year but raised long term expectations. Markets are expecting US interest rates to rise by the first quarter of 2016 and reach around 1.5% by the end of 2017.
The Bank of England forecasts growth in the UK economy of 2.5% this year, and 2.6% in 2016. Wage growth should continue to exceed inflation over the next year given the tightening labour market and economists are now predicting the MPC will raise interest rates in the first half of next year.
The European Commission has raised its forecast for growth in the Euro area to 1.5% for 2015 and 2.1% for 2016. Profit margins in Europe are significantly below previous peaks and capacity utilisation rates are modest. Therefore, earnings can pick up quickly from a low base. The Bank of Japan recently upgraded its assessment of the economy and if improvements in corporate governance continue, particularly regarding the improvement of shareholder returns, the Japanese stock market may become increasingly attractive. Many overseas investors are underweight in Japan so increased demand could propel the market further. The Asian Development Bank predicts the Chinese economy will grow 7% pa over next 2 years although this is above the consensus of around 6.5%.
The Greek confrontation with the EU has reached a critical point as it has now officially defaulted on debt repayments due to the IMF and called a referendum on whether to accept the proposed austerity measures. Talks with creditors about a last-minute deal continue. However, a confirmed exit would probably provoke an initial sell-off in the euro and equities and drive Eurozone bond yields higher.
In conclusion, the global economy should demonstrate a steady, sustainable recovery into 2016 although China's weakness continues to be the biggest risk to the outlook for global recovery. The recent pick-up in yields on 10-year Eurozone debt is consistent with a rebound in growth and inflation in the second half of 2015 which could result in a change in direction of monetary policies. A gradual tapering of QE programmes and subsequent increases in interest rates poses a risk to government bond markets but should be broadly positive for equities. Volatility may increase as central bank intervention diminishes which could present an opportunity to drip feed money into the stock market on a longer term view.
*In Pounds Sterling, total returns basis.
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