Tuesday, 26 August 2014


It has been another record setting week for equity markets. Despite summer normally being known as a 'quieter' period, the S&P 500 hit a new high, while bond yields retreated on the expectation that Federal Reserve Chair Janet Yellen would deliver a dovish assessment of US economic growth prospects

Summer trading volumes continued to be light, but that does not take away from the fact that investors appear to be in an optimistic mood and are increasingly favouring risk assets like equities. Corporate bond markets also moved tighter, relative to government bonds, but they remain more restrained than stock markets. Gold moved lower, falling 2% on the week and is crucially back below $1,280 a troy ounce, even as the US dollar fell on broad weakness (due to the strength of the Euro). US government bonds declined in the face of the strength of equities, with the 30-year yield down 3 basis points and the 10-year yield hitting around 2.4

Now that we have moved into the second half of 2014, it is becoming increasingly evident that different parts of the global economy are moving at different speeds. On a global level, the forward looking indicators are suggesting a further period of expansion is ahead, albeit within a fairly compressed range. However, the divergence in prospects for the US, UK, China, Japan and Europe could not be more clear. Purchasing Manager Indices show that the US and UK are powering ahead, while China looks to be re-accelerating as a result of stimulus measures and mildly accommodative monetary policy.

In contrast, the fortunes of the Eurozone and Japan appear more mixed. Japan has now essentially recorded almost no growth in GDP over the past year, as consumers come to grips higher sales taxes and businesses are seeing sluggish volume growth in exports, although a weaker Yen would provide a solid boost. Growth also seems to be elusive for the Eurozone, with countries stagnant or in outright recession. It is possible that the sanctions European leaders put on Russia could further dampen prospects in the near-term. Countries that have higher leverage to the Russian market are already calling for a moderation in the sanctions, as their economies are seeing export demand plunge and prices drop as supplies of agricultural produce, flood the market. German banks remain undercapitalised and their balance sheets loaded with sovereign debt, so any potential quantitative easing programme would need to be mindful of this fact

At some point, either European governments or the European Central Bank will have to bite the bullet and launch large scale structural economic reform (governments) or some form monetary stimulus (ECB), or potentially some combination of the two. All of the current ECB actions appear to have been designed to buy time and allow governments to enact structural reform. Italy's new youthful Prime Minister, Matteo Renzi has a large opportunity change the country for the better. Until some significant action occurs, the Eurozone may bumble along, flirting between mediocre growth and recession, like Japan did for nearly 20-years and this might act as a drag on the wider global economy.

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