Global stock and bond markets have continued to rise in April. A casual observer reading and hearing of all the “issues” that the Global economy is facing would be rightly dumbfounded. How can prices rise in the face of Middle East turmoil, rising inflation, European debt, high unemployment and stagnant property prices? As we have said before equity markets care only about profits. As long as they are rising and above expectations (which they are) the party keeps on going.
It is our job though to keep asking what if? As we enter May, traditionally a period of market weakness, “sell in May and go away…” we need to consider what happens after QE2? June officially sees the end of this American $600billion bond buying programme. Many observers believe that the rally in Global markets is built on soft sand and once the fuel for this growth, from QE2, has run out then so will the rally. Others point towards the recovery in corporate profits and say that the job has been done and the recovery is now self-sustaining. Who is right, only time will tell but as usual there are so many cross-currents that the answer is particularly difficult to predict.
S&P 500
During that period share prices fell and bonds rose, US 10 year Bond Yields moved from 4.0% to 2.5%. This move was counterintuitive; as the Federal Reserve Bank stops buying Bonds surely prices fall?
Well that would depend on what was going on in the economy, between QE1 and QE2 US unemployment rates were still rising and bond prices reflected fear of the “double-dip” a phrase that has been quietly forgotten about over the past few months, is it about to make a reappearance? This chart also shows that there is plenty of headroom for the US equity markets, to get back to pre-Credit Crunch highs would be a further 15% gain.
The US economy has definitely picked up with GDP growth over the last four quarters of 1.7%, 2.6%, 3.1% and 1.8%. Corporate results have been strong but consumer spending has remained sluggish. This can be seen as both a future opportunity to keep the economy going, but also a sign that all is not as yet well in the world’s biggest economy. House prices and sales continue to be poor with one measure showing a further 1.1% fall in prices in January/February. Over the past 12 months US property prices have fallen 3.3% but there are huge regional variations, Los Angeles and New York are down about 2% but Chicago, Seattle, Phoenix and Miami are down between 6% and 7% only Washington saw a rise in prices over the year. Not a healthy background for QE2 to be removed.
Politics as ever will add confusion to the mix. Obama faces re-election in 2012 and has to engineer a boom by then. No doubt he would prefer QE2 to be extended or indeed QE3 to be considered but with Standard and Poors putting US Treasuries on notice for a downgrade the Fed’s room manoeuvre is limited. As we have said before unemployment is the key, Obama and the Fed need the unemployment rate to continue dropping and preferably at an increased rate.
US Unemployment
Since then the rate of hiring has been a bit hit and miss, it dipped in July 2010 and led to QE2, seems to be a bit more stable recently. The US over the past 10 years has consistently created 200,000 to 400,000 jobs per month. Not there yet.
Bond Funds
As investors the one area where this will impact on us is in the Bond section of portfolios. These are the lower risk, lower returning funds that are there to balance out the riskier equity elements. Any sign that economic recovery is accelerating then Bond funds will fall in value. The fact is that as the end of QE2 approaches they are actually increasing in value suggests that the bond markets simply doubt the strength of the recovery. The equity markets are however being supported by corporate profits which are perhaps more to do with China than QE2 so we could have our cake and eat it, Chinese led growth for equities and sluggish domestic economies supporting bonds. The danger is though that the QE cash has been spent on buying equities and with no more to come the law of demand and supply means that share prices would come down.
Brazilian iPads
In Brazil, Apple’s iPad is going to be given to school pupils as part of the modernisation of Brazilian education. In return Foxconn the Chinese/Taiwanese Company that makes all of Apple’s iPads/iPhones will invest a staggering $12 billion over the next five years expanding production in Brazil. Foxconn already employs 1million people in China. The dynamic of an American designed Chinese manufactured technology transforming education in Latin America whilst the Chinese company searches for a cheaper location to make its products is fascinating.
Markets
Simply because it is May we will get “Sell in May and go away” headlines. However with QE2 ending there could be some validity in this suggestion. Markets do enter quiet phases during the summer months, QE2 ending brings uncertainty and we know markets hate uncertainty, but they can ride these periods out. Another famous investment phrase is “Bull markets climb walls of fear and worry”, they can do this as long as profits keep rolling in and the economy grows. The announcements are the key, good news is keeping the equity markets rising. With QE2 ending more so than ever the markets need these good news events to continue otherwise the dreaded Deflationists will make an unwelcome reappearance.
April 2011
