Spanish construction rebuilds after market collapse

Property developer Olivier Crambade founded Therus Invest in Madrid in 2004 to build offices and retail space. For five years business went quite well, and Therus developed and sold more than €300m of properties. Then Spain’s economy imploded, taking property with it, and Mr Crambade spent six years tending to Dhamma Energy, a solar energy […]

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Euro suffers worst month against the pound since financial crisis

Political risks are still all the rage in the currency markets. The euro has suffered its worst slump against the pound since 2009 in November, as investors hone in on a series of looming battles between eurosceptic populists and establishment parties at the ballot box. The single currency has shed 4.5 per cent against sterling […]

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RBS falls 2% after failing BoE stress test

Royal Bank of Scotland shares have slipped 2 per cent in early trading this morning, after the state-controlled lender emerged as the biggest loser in the Bank of England’s latest round of annual stress tests. The lender has now given regulators a plan to bulk up its capital levels by cutting costs and selling assets, […]

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China capital curbs reflect buyer’s remorse over market reforms

Last year the reformist head of China’s central bank convinced his Communist party bosses to give market forces a bigger say in setting the renminbi’s daily “reference rate” against the US dollar. In return, Zhou Xiaochuan assured his more conservative party colleagues that the redback would finally secure coveted recognition as an official reserve currency […]

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Carney: UK is ‘investment banker for Europe’

The governor of the Bank of England has repeated his calls for a “smooth and orderly” UK exit from the EU, saying that a transition out of the bloc will happen, it was just a case of “when and how”. Responding to the BoE’s latest bank stress tests, where lenders overall emerged with more resilient […]

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Archive | Capital Markets

Saudi Arabia on the verge of $30bn capital injection

Posted on 25 November 2016 by

Saudi Arabia is hardly an emerging market success story at the moment, with a bout of austerity driven by low oil prices resulting in public sector pay cuts and a slump in non-oil growth to 0.07 per cent in the second quarter of 2016, putting the country on the brink for its first non-oil recession in 30 years.

Yet Saudi could be on the verge of attracting more than $30bn of foreign capital to its $380bn stock market, according to estimates by Bank of America Merrill Lynch.

A buying spree of this magnitude would represent a seismic shift for a widely ignored bourse that accounts for just 0.2 per cent of the holdings of the global emerging market fund sector.

“There is a level of apathy towards the market,” says Hootan Yazhari, research analyst at BofA, who estimates that foreign investors account for only 1 per cent to 1.5 per cent of Riyadh’s daily trading volumes.

The Saudi stock exchange’s problem is that the country is not in either of MSCI’s emerging or frontier markets indices, meaning it is entirely ignored by passive funds following these indices, and largely ignored by the myriad of “closet-tracking” active funds that do.

It does attract some interest from actively managed frontier market funds, many of which are perfectly happy to invest outside of their benchmark. Saudi Arabia accounts for about 4.5 per cent of the assets of frontier funds, according to EPFR, a data provider, making it the eighth largest market for these funds.

However, Riyadh would attract far larger flows if it could win access to one of the MSCI indices, ideally the EM one.

To this end, in May the Saudi Capital Markets Authority doubled the limit on the amount an individual foreign investor can hold of a stock to 10 per cent and scrapped a rule limiting foreign ownership of the overall market to 20 per cent, although it retained a 49 per cent cap on foreign ownership of an individual company. It also introduced stock lending and covered short selling, becoming the first Gulf market to do so.

Moreover, the CMA said foreign groups with as little as $1bn under management (rather than $5bn) could now enrol in its Qualified Foreign Investor programme, which is necessary to enter the market (other than by investing via swaps), and made some other technical changes to this regime.

While there are no specific requirements a country needs to meet to be deemed eligible for the MSCI EM index, Riyadh’s moves to ease the restrictions on foreign investment will certainly strengthen its case for inclusion.

As of May, some 25 overseas investors had entered the Saudi market, known as the Tadawul, but Mr Yazhari says that “in the last two or three months the number of QFIs has gone up quite sharply”.

He sees the May reforms not only as bringing Saudi “one step closer” to inclusion in the MSCI index, but also as indicating the country “is seeking an expedited path to inclusion”.

Such a move would potentially fit with Riyadh’s National Transformation Plan, an ambitious project launched in June designed to ween the country off its over-reliance on oil.

“Given the NTP is seeking heavy involvement and investment from the private sector, we believe the measures introduced by the CMA to attract direct capital inflows to the country are likely [to be] linked with the larger NTP process,” he says.

BofA’s core thesis is that Saudi Arabia is likely to be admitted to the MSCI EM index in 2019, with an announcement made in 2018. However, Mr Yazhari believes the reforms mean inclusion in 2018, with an announcement in November 2017, “is by no means out of the question”.

As things stand, Saudi Arabia’s weight in the EM index would be about 1.5 per cent. With about $740bn worth of active and passive funds tracking this index, according to EPFR, this would imply inflows of about $11bn as foreign investors get up to weight.

However, if Riyadh were to ease its restrictions on foreign ownership still further, something BofA thinks very possible, this would raise the “foreign ownership limit” factor that MSCI uses in its weighting calculations, potentially raising the Saudi weight to nearer 3 per cent and attracting $22bn of inflows.

Furthermore, inflows of this size could ensue even if the CMA does not loosen its regulations further. Under the NTP, Saudi Arabia is planning a series of privatisations over the next two years, probably led by the listing of a 5 per cent stake in Saudi Aramco, a company Riyadh is believed to value at about $2tn.

Assuming that these privatisations go ahead, BofA calculates that Saudi Arabia’s putative weighting in the MSCI index could be about 4.3 per cent, implying inflows of about $30bn.

In this scenario, Saudi would be the seventh largest country in the MSCI EM index, behind only China, South Korea, Taiwan, India, South Africa and Brazil, but ahead of Mexico, Russia and Turkey, as the first chart shows.

Moreover, if Saudi Arabia did succeed in engineering an expedited entry into the index, Mr Yazhari believes these flows would largely occur during 2017.

“What we have typically seen [in previous cases of entry into the MSCI index] is that passive and active funds that track an index will start the process of gaining exposure to the market well ahead of the event itself. The announcement of inclusion is when you really start to see the inflows,” he says.

The lessons from neighbouring Qatar and UAE, which both joined the MSCI index in May 2014, are a little unclear, however. Both countries’ accession was announced in June 2013. During the course of that calendar year the Dubai Financial Market, the largest bourse in the UAE, surged 108 per cent, while the Qatari market rose 23 per cent. Both markets also saw smaller gains in 2014 itself.

“We saw record levels of market activity and a massive pick-up in liquidity. It was a one-way trade,” says Mr Yazhari.

However, part of those gains would have been driven by high oil prices, as suggested by the fact that the Saudi market also rose 25 per cent, as the second chart shows, despite its lack of index inclusion.

Mr Yazhari remains confident that the examples of UAE and Qatar “provide a very good precedent” and that index inclusion “would have a profound effect” on the Tadawul.

However, he does caution that the impact of index inclusion on the Saudi bourse may be smaller than for its neighbours, given it is more liquid than they were before entry.

“Saudi is already a very liquid market, even without international investors, so maybe it wouldn’t have the same effect because you are not doubling or tripling liquidity overnight,” he says.

At present, 19 of the 168 stocks on Tadawul are included in MSCI’s standalone Saudi market index, suggesting that they would be likely beneficiaries if Riyadh were given the nod.

This index is dominated by state-controlled petrochemicals group Saudi Basic Industries, also known as Sabic, with a weighting of 25.6 per cent, followed by Saudi Telecom, (13 per cent) and Al Rajhi Bank (10.1 per cent).

Overall, banks account for about a third of the index, followed by petrochemicals and real estate, at 10 per cent.

Prospect of more gilts sales challenges UK bond market

Posted on 24 November 2016 by

If there are political similarities in the impulses which led the UK to vote for an exit from the EU and the US for Donald Trump, the market reaction to Wednesday’s collection of new British tax and spending measures served to illustrate economic differences between the two countries.

While Trumponomics has fast become shorthand for a promised programme of tax cuts and infrastructure incentives which could rival the actions of Ronald Reagan, there are no neologisms yet to describe the fiscal programme of the Conservative government revealed by the chancellor’s Autumn Statement.

“It’s not Reaganomics we’ve seen from Philip Hammond, it’s just a response to expectations of an economic slowdown following Brexit,” says Jim Leaviss, head of fixed income at M&G Investments.

He points to the movements in short term bond yields to underline the point. In the US, two-year Treasury yields have jumped from 0.78 per cent to 1.13 per cent since the election, the highest level since early 2010, as traders finally anticipate multiple increases in interest rates set by the Federal Reserve as the US economic recovery gathers pace.

In the UK, by comparison, two-year yields were 0.17 per cent on Wednesday, tumbling in the past month to leave them barely changed from the day after the EU referendum.

The challenge for gilt investors may be to disentangle the market from that of others, such as the US. Growth of the UK economy is expected to slow next year, when negotiations over the terms of exit from the EU are expected to begin.

Yet at the same time the collapse in the value of the pound is likely to contribute to higher import prices. Prices for securities linked to inflation imply an average UK rate of more than 3 per cent during the next five years, versus less than two per cent for the US and less than 1 per cent in Europe.

Inflation eats away at fixed income securities, and the context for the gilt market is a reversal of the rally in global government bonds which drove the UK’s 10-year borrowing rate to a historic low of just 0.5 per cent in August.

Longer dated bonds did react to Mr Hammond’s announcement that the UK must borrow more in coming months to combat a slowing economy, as investors speculate on the market’s ability to absorb billions of pounds of new debt at a relatively quiet time of year.

Of the additional £20.6bn the government needs to raise between now and April 2017, £15bn will be funded via gilt sales.

As the coupon on sovereign debt is fixed at the time of issue, it falls in value as market yields rise. On Wednesday the yield on benchmark gilts jumped 11 basis points, to 1.47 per cent.

“The increase in gilt issuance came as a surprise to all of us,” says Thomas Sartain, a fixed income fund manager at Schroders.

“Gilts have been trading very poorly since the summer and there are some concerns the market will struggle with a 10 per cent jump in total issuance. We’re not approaching a crisis, but the market is signalling that it is aware that the country’s borrowing needs have changed significantly,” he says.

Mike Amey, a portfolio manager for the bond specialist Pimco, says the reaction also reflected a shift in the approach to deficit spending, with previous deadlines and targets abandoned: “Getting the budget to balance is not something at the forefront of the government’s agenda”.

However, like others he says not to overplay the movement in a market where yields remain low and the Bank of England continues to buy government debt.

Bond yields were also rising across Europe and in the US on Wednesday, in markets dominated by debate about the extent of improvements in the US economy likely under a Trump administration.

Until now, gilts have been cushioned from larger moves by persistent demand from domestic pension funds with payment promises to keep, in addition to central bank purchases of gilts every week as part of a new quantitative easing programme to support the economy following the vote for Brexit.

“That dynamic hasn’t changed,” says Luke Hickmore, investment director at Aberdeen Asset Management. “But investors are having to get their heads around a huge shift in the country’s balance sheet. Those extra debt requirements combined with the US reflation trade is going to increase the cost of borrowing at a tricky time for the UK government.”

The problem for the UK may come if US politics continues to influence bond prices around the world at the expense of domestic efforts to keep borrowing costs down.

“The market is placing a huge reliance on price insensitive investors such as [pension and insurance fund] managers to close their eyes and buy,” says Craig Inches, head of short rates at Royal London. “But I fear even they may be a little less hasty in an environment where yields are rising.”

Bond fund managers help limit clients’ post-election losses

Posted on 24 November 2016 by

Managers of the largest US bond funds have helped limit the damage to their clients’ savings from the post-election market rout, in a rare — albeit limited — piece of good news for advocates of active management.

Nine of the top 10 largest “core” bond funds, which are designed to be the linchpin of a saver’s fixed-income holdings, outperformed the bond market benchmark in the 10 trading days after Donald Trump’s victory, according to an analysis of data from Morningstar.

That came against the backdrop of tumbling bond prices, as investors adjusted to the idea that interest rates will be higher if President Trump’s proposed infrastructure spending and tax cuts boost inflation. The Barclays US Aggregate bond index, the widest measure of the fixed-income market, returned minus 2.3 per cent over the period.

“If you choose the index, you are going to be about one-third in US Treasuries, which get hit hard when rates start moving,” said Karin Anderson, analyst at Morningstar. “Active managers have many more tools at their disposal.”

The largest active mutual fund, Pimco’s $83bn Total Return fund, matched the index over the two weeks following the election, while its nine nearest rivals beat the index by amounts ranging from 2 basis points, in the case of the T Rowe Price New Income fund, to 82 basis points, in the case of the DoubleLine Total Return Bond fund.

The largest bond fund in the US is the Vanguard Total Bond Market Index fund, which aims only to track the bond market rather than to beat it. In contrast to the outperformance by most active funds, it slightly underperformed the Barclays Agg, falling 2.4 per cent over the 10-day period.

Core bond funds can lean more heavily on corporate debt, mortgages, junk bonds or overseas bonds to try to beat the index when rising interest rates are weighing on the long-dated Treasuries that make up much of the wider market. They are also able to emphasise shorter-dated bonds that are less sensitive to interest rates.

Steve Kane, co-manager of the $80bn MetWest Total Return Bond fund, said his fund’s tilt towards shorter-dated instruments helped it outperform after November 8, even though it does not view Mr Trump’s election as significantly improving the economic outlook.

“We have a laundry list of concerns,” Mr Kane said. “There is excess leverage, our major trading partners are mired in weak economic conditions and there are major excesses in China, not to mention that the strong dollar can cause negative feedback consequences to emerging markets and then back to the US.”

The prospect of an extended period of rising interest rates will inflame the debate about indexing in the bond market. While studies have proven that almost all actively managed equity funds underperform the index over the long run, the data are more equivocal in the bond market.

Nonetheless, index tracker funds continue to take market share from actively managed bond funds. Morningstar figures show that while $15bn has flowed into actively managed US bond funds in the past year, $135bn has flowed into passive funds, even though passive funds make up a much smaller percentage of the market.

Hopes flicker of a central bank fix for eurozone funding market

Posted on 24 November 2016 by

Hopes of a fix to the collateral squeeze facing the eurozone’s €5tn short-term funding markets were boosted this week after reports emerged the European Central Bank will consider ways to ease rules on how it lends its stockpile of sovereign debt.

A lack of good quality collateral, which market participants use to secure loans, has crippled the single currency area’s short-term funding markets. One big reason for the shortage is that the eurozone’s central bankers have spent the past year and a half buying €1.1tn in government bonds — some of the best collateral available — as part of their quantitative easing programme to boost growth.

While the ECB set up securities lending soon after launching QE in March 2015, to loan the bonds it buys back to investors, markets have remained stressed. National central banks are responsible in setting most of the terms for securities lending and market conditions are particularly difficult in Germany.

On Wednesday a Reuters report that the ECB would consider making it easier for banks to borrow the government debt central banks in the region have bought was seen as a positive step for the market.

“If it happens it will definitely be good news,” said one trader of potential changes. He added that it is currently seen as “very dangerous” to borrow from national central bank, because of the risk of failing to return the bond at the end of the transaction.

It comes ahead of the December 8 meeting of the ECB. A spokesperson for the bank said: “The ECB securities lending is proving valuable for smooth market functioning and it is being reviewed on an ongoing basis.”

Discussion at governing council level would signal there may be a move to harmonise practices across national central banks, which are responsible for most of the bond buying that takes place under QE.

Benoît Cœuré, a member of the ECB’s executive board, said earlier this month securities lending could be “scaled up” and that it was “well within central banks’ operational capacity to play a more structural role in supplying safe assets to the financial system.”

A driving principle behind QE is that the ECB adds liquidity to the system by buying government bonds in exchange for cash. Because of this, national central banks tend only to accept collateral other than cash for securities lending.

While this principle on so-called “cash neutrality” is set by the ECB, national central banks have a say in which collateral they accept in exchange for their holdings of government bonds, as well as the haircuts applied on the collateral and the duration of the swap.

The Bundesbank loans out its stockpile of German bonds, but only for limited periods and in exchange for other forms of high-grade German debt.

Some in the market point to technical aspects of the way the Bundesbank securities lending works for failing to relieve the collateral problems. “The fact you have to give German government bonds to get German government bonds means you aren’t alleviating market stress”, said Anton Heese, fixed-income strategist for Morgan Stanley.

He also pointed to other problems, including a punitive fee charged if the borrower does not return the bonds in time. “If there is a general squeeze in the market for a Bund, you will struggle to get the Bund back to the Bundesbank”, said Mr Hesse.

A relaxation on some constraints of the German programme, for instance by extending the loan period from a limit of a week, would be one way to ease difficulties for banks and investors.

Another route is the relaxation of collateral rules. Market participants hope investment-grade corporate bonds, loans or even cash might be accepted, which would help increase the supply of German government bonds in circulation. Centralised control over collateral rules would, however, be controversial — it is the national central bank that is exposed to losses on its government bond purchases.

The European Repo and Collateral Council, an industry representative, has recently engaged in “dialogue” with the ECB on a range of issues, including the challenge of collateral shortages.

US Treasuries suffer fresh sell-off as inflation fears mount

Posted on 23 November 2016 by

The US government bond market suffered a renewed fierce sell-off and the dollar powered to a fresh 13-year high on Wednesday, as stronger economic data bolstered the case for an interest-rate increase and reinforced the view that the multi-decade bond bull market has reached a turning point.

The Republican sweep of the White House and Congress, coupled with president-elect Donald Trump’s promise to unleash a $1tn economic stimulus package of tax cuts and infrastructure investments, has caused a seismic shift in global bond markets, with prices tumbling and borrowing costs rising as investors bet that inflation will finally reappear.

European bond yields had already jumped earlier on Wednesday on the back of reports that the European Central Bank was considering changes to its securities lending programme, which would ease a bond shortage. The moves were reinforced by strong US durable goods data, and exacerbated by thin trading in bond markets ahead of the US Thanksgiving holiday.

“In what was supposed to be a quiet day, bond vigilantes are putting it to the Treasury market,” said Andrew Brenner, head of international fixed income at National Alliance Capital Markets.

The 10-year Treasury yield shot up by as much as 10 basis points, its biggest move since the presidential election, to over 2.4 per cent for the first time since the summer of 2015. The two-year note yield — the one most acutely sensitive to interest rate expectations — climbed to a six-year high of 1.14 per cent. The 10-year yield later fell back to a rise of 4bp.

The moves came after the US Commerce Department said orders for durable goods rose 4.8 per cent in October, smashing economists’ expectations and reinforcing the sense that any stimulus package will come at a time when the economy is already in reasonable shape, and therefore fuel inflation.

“Donald Trump’s surprise election victory should be viewed as a new global shock, mixing positive demand and negative supply elements. There remains considerable uncertainty about the actual mix of policies to be enacted but the bias of risk reinforces the tilt toward reflation,” JPMorgan’s analysts said in a note.

As a result, mounting expectations of more aggressive US interest rate increases in the coming year has reawakened the slumbering dollar rally, sending the DXY index of the currency’s strength against its major peers to a fresh 13-year high on Wednesday. Only two of the world’s top currencies managed to hold their ground against the greenback.

The yen led a retreat, while the gap between US and Japanese yields widened, opening up the prospect of the Bank of Japan having to intervene in the bond market to retain credibility.

With yields in other bond markets rising in tandem with Treasuries, analysts believe it is getting tougher for the BoJ to maintain its policy of “yield curve control”, keeping the yield on 10-year Japanese government bonds (JGBs) at zero.

The weakening yen was “not a bad thing” for Japan, said Alan Ruskin, a currency strategist at Deutsche Bank, but the widening yield spread was “a problem from a credibility standpoint”.

The jump in Treasury yields also reverberated through the US stock market, the day after all four of the country’s main equity indices hit a new record on the same day for the first time since 1999.

Industries that are considered safer and nearly “bond-like” — such as real estate trusts and utilities — got hit hard on Wednesday. Financial stocks, which benefit from rising interest rates, and smaller companies, that are shielded from the impact of a stronger dollar, rose to fresh records.

Trump bond sell-off deals blow to ECB buying

Posted on 23 November 2016 by

Eurozone corporate bond risk premiums have jumped to their highest level since July, as Donald Trump’s victory in the US election effectively erases gains generated by the European Central Bank’s policy of buying companies’ debt.

A sharp rise in global bond yields since Mr Trump’s triumph has also spurred an underperformance of European credit relative to the US corporate debt market.

Higher corporate credit spreads in euros, which measure the risk of company debt compared to a benchmark rate, come despite ongoing purchases by the ECB which began buying in June and initially drove down borrowing costs for the continent’s companies. The ECB has purchased €44bn of corporate bonds so far.

“The benefit that accrued to [European] companies as a result of [ECB purchases] has been offset by various factors that have come into play since the election of Donald Trump,” said Zoso Davies, a strategist at Barclays.

The spread on the Bloomberg Barclays euro aggregate corporate index has risen to 77 basis points this week, compared to 65 basis points immediately before the election. Over the same period, spreads on investment grade corporate bonds in the US have edged lower.

Analysts expect a Trump presidency will benefit US companies more than competitors in Europe. The president-elect’s polices include a large cut in US corporate tax rates and also incentives for companies to repatriate profits generated overseas.

“US credit has done better from Trump’s victory than European credit,” Mr Davies added. “US equities have done better than US equities. It lines up with the stated thrust of his policy, America first. If his policies, whatever they’re going to be, put America first, benefits should accrue to US companies.”

Spreads on European corporate bonds have also weakened in the face of a looming calendar of events high in political risk, including a referendum in Italy next month and elections in France in 2017, as well as an eagerly awaited ECB meeting in December.

Over recent weeks, yields on the bonds of periphery eurozone countries have widened as well. The Italian government bond yield has risen to over 2 per cent in November for the first time in more than a year.

“Unlike in the euro market, the USD market doesn’t have these peripheral versus core market dynamics,” said Armin Peter, global head of syndicate at UBS. “There is a renewal of the awareness around political risk around the weeks to come.”

Weakness for European corporate bonds comes against a backdrop of rising government bond yields and increased expectations of inflation in the near future. Last week, a Bank of America Merril Lynch survey showed that inflation expectations among portfolio managers had reached their highest level in more than a decade.

Summer origins of ‘Trump rally’ suggests it’s serious

Posted on 23 November 2016 by

Can we believe it? The US has had two weeks to digest the fact that it has elected Donald Trump as its next president, and many on both left and right are finding it hard to swallow. The US stock market is just as hard to digest.

In those two weeks, US stocks have gone on a tear, with all four of the most widely quoted indices — the S&P 500, the Nasdaq Composite, the Dow Industrials and the Russell 2000 index of smaller stocks — simultaneously hitting new record highs on Monday and Tuesday of this week. This had not happened since New Year’s Eve of 1999, as the tech bubble was about to reach its climax.

It looks like a widespread breakout from a market that had been becalmed ever since the end of the Federal Reserve’s QE bond purchases at the end of 2014. Should we believe it? And if the indices are not quickly to slip back, is this the beginning of a solid final leg to the bull market, or the beginning of a speculative “melt-up” like the one seen in 2000?

First, it is as well to take this seriously. Investors have gripped hold of the idea that the new presidency, accompanied by unified Republican control of Congress, will mean a new move to fiscal policy after eight years of dominance by monetary policy. Until either the fiscal policy fails to happen, or there is emphatic evidence that it has failed to spark growth, it is best to expect that markets will hold on to that assumption.

The accompanying sell-off of bonds is startling, and suggests genuine belief that inflationary growth policies are coming. The turn came during the summer, and stocks have sharply outperformed since the election.

At the level of sectors, the same trend is in evidence. Banks, particularly prone to interest rates and benefiting from a steeper yield curve, had already started to outperform in late summer, after many dreadful years. Their rocket-like performance since the election — aided by the steepening yield curve, but also by the slightly incoherent hope that a president elected on a populist platform will deregulate them, is startling. Indeed, the S&P 500 excluding financials is still below its record high, providing at least one reason to distrust the rally.

The pattern is also clear from the sharp outperformance of smaller caps. Again, smaller stocks, as shown by the Russell 2000, had begun to beat the Top 50 mega-caps during the summer, but this has become a rout since the Trump victory. This is easily explained. They tend to be domestically focused, unlike mega-caps, and are less likely to be affected by the vagaries of Trumpian trade policy. Also, unlike mega-caps, they tend to pay their corporate taxes in full, so they should gain greater proportionate benefit from tax cuts.

The notion of a market regime that had already turned before the election is borne out further by the performance of yield substitute stocks. During the QE era, stocks that pay regular and growing high dividends have outperformed. Such stocks, labelled “defensive value” by Ed Clissold, US strategist at Ned Davis Research, have gone into eclipse, as shown by the underperformance of the S&P 500 Dividend Aristocrats index.

Meanwhile, other measures of value, such price/earnings and price/book multiples are performing superbly, having turned the tide in the summer. These are dubbed “cyclical value” stocks by Mr Clissold — companies that tend to be inflexible, and have high operating leverage, making it hard for them to cut back in hard times, and allowing profits to rebound sharply when good times return.

More broadly, cyclical stocks also started to outperform defensive stocks during the summer, in response to broadly more positive economic data from the US and China — and this process was accelerated by the election.

A rotation was also evident in the performance of factors, which make the backbone of currently popular “smart beta” portfolios. While value and momentum (the tendency for winners to keep winning and losers to keep losing) have both enjoyed a resurgence, the low-volatility factor has fared very poorly recently.

Andrew Ang, who heads factor investing at BlackRock, suggests that this, again, shows that market is calling for reflation and stronger economic growth. Economic conditions offer the best guide to shifting between factors, and the strong economic optimism would lead to relative overweighting of momentum and value while cutting back low-volatility — or, effectively, taking more risk when times appear good.

From almost any angle, the market suggests that a regime change started this summer, as economic data appeared to improve, and that the Trump election, following improved third-quarter earnings, was the catalyst for a further advance. After years in which the market continued to advance (albeit slowly of late) led by stocks that normally only outperform in a bear market, the pattern of performance is now typical of the late stage of a bull market at the end of an economic cycle. A melt-up or a firmer advance are both conceivable.

None of this means that the next few months will be without volatility. Much of the Trump programme is sketchy, and the response from Congress to his plans is also questionable.

High valuations give the stock market little room for manoeuvre, particularly with bond yields rising, and a pullback is in any case likely after such a swift move upward. The extent of the optimism smacks of desperation to break out of a logjam that had lasted for years and appears overdone. But for now this rally looks like a typical final stage of a bull market, and it should be taken seriously.

Trump’s win means I’m sticking with US and UK equities

Posted on 22 November 2016 by

Donald Trump plans to change things. He wants to spend more on infrastructure in both the public and private sectors. He wants to slash corporation tax to 15 per cent, and make an offer companies cannot refuse to bring back onshore the large sums of tax-shy cash sitting outside the US. He wants everyone who earns less than $25,000 a year to be taken out of income tax. He wants better trade deals that give the US more chance to compete.

I confess I did not dare write last month that I thought Mr Trump might win. I just got on and positioned the portfolio for that event. Everyone I spoke to was so negative about Mr Trump, disliking his views and convinced he could not become president, so I assumed the markets would take a tumble if he surprised them. Sure enough, the first reaction was a 5-6 per cent markdown of prices on the news.

I soon realised, however, that the gloom would not last long and I had to scramble to put the money back into the markets as they turned upwards. I guessed that other investment managers were in practice quite liquid, and all could see the intended reflationary impact of Trump policies after the event.

More successful was the action I took last month to protect the big currency gains made so far this year by holding shares out of sterling. I took out currency cover where I could, and this is now needed. Sterling has started to rise against both the dollar and the euro. The pound was too cheap, and the Bank of England, as I imagined, has had to admit it does not need to make further rate cuts or create more money under an extended quantitative easing programme. I always thought the July package was unwise. Cash and credit were accelerating before it, the economy was fine, and such action served to undermine the pound more than was needed just to give the UK a better competitive edge.

In similar vein, the decision to sell all the conventional UK government bonds was a good call. Interest rates have since risen from their rock bottom lows of August. The short corporates I hold have been more resilient and pay a better income. There is now also a trend of rising rates in the US. I don’t think the BoE should let UK rates get out of line with US ones, as our economies are recording similar rates of growth and will experience rising inflation from here, leaving aside the additional one-off effect on prices from lower sterling. The BoE and some in the market are still worried about deflation, when the new issue is inflation.

So what should we expect next? Growth in the UK looks set fair. I have stuck with the Treasury forecasts in March of 2 per cent growth this year and 2.2 per cent next year. I have looked with bemusement as the BoE and many other forecasters slashed their figures for both years, and then with relief as they have written their 2016 forecasts back up to where they were before the Brexit vote. The UK property market has remained strong despite all the efforts of some valuers and the BoE to talk it down, and UK consumers have been keen to buy and go to restaurants and hotels.

I am still more optimistic than the pack over next year. Forecasts have tiptoed their way back up from 0.8 per cent UK growth; in the case of the BoE, to 1.4 per cent. I can’t see how it can be that low, when you look at the current rates of money and credit growth, employment growth, housebuilding and the other main indictors.

It will take time and probably compromise and some disappointment for Mr Trump to put in place his reflationary packages, but the direction of travel is clear. That should mean a more positive result from the US by the back end of next year. Congress may want to argue over debt ceilings. There will be long debates about how much extra revenue cutting tax rates might bring in from extra activity, and when. The Democrats, who should favour a fiscal stimulus, may not be able to get over their shock and dislike of a Trump win quickly enough to co-operate. The good news is the US economy is growing reasonably well anyway, and there will be corporate and popular pressure behind Mr Trump to spend more and tax less to get it going faster.

This is a good background for equity investment and is why I have again increased the proportion of the FT fund held in shares. It is not such a good background for bonds. I have put most of the money into short-dated company paper which will go down less as rates rise, and offers a bit more income as a cushion. I also continue with the inflation linked bonds, though they have not been exempt from some of the gilt market fall. These have nasty negative real yields, but they will be paying out more income and have some capital protection as inflation rises. More are likely to want some inflation insurance.

The ‘Redwood Fund’ — performance

Year to date — 31/12/2015 – 21/11/2016 11.8 %
Since inception — 14/11/2012 – 21/11/2016 31.4%
Annualised since inception 7.0%
Source: APX

I hope the arrival of Mr Trump signs off any thoughts of lower rates and more money printing in the US. Though the BoE and the experts don’t admit it yet, I think it also does the same for the UK. The long bond bubble may not deflate drastically, but more will now worry about the elevated valuations of government loans. When something looks absurd to the layman but can be well explained by the expert, it probably is absurd. I refuse to own bonds that offer a negative nominal income, and think US and UK government bonds are still dear even after the recent little sell-off.

The FT fund is up 11 per cent year to date, and 30 per cent since inception. That’s a useful annualised return of 7 per cent, from a balanced portfolio with roughly 50 per cent held in shares.

John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing.

The ‘Redwood fund’ — assets

Holding % portfolio
Cash Account [GBP] 0.9
iShares Nasdaq 100 ETF 7.1
WisdomTree Germany Equity UCITS ETF — GBP Hedged 1.3
iShares Core MSCI Emerging Markets IMI 4.9

iShares Global High Yield Corp Bond GBP Hedged ETF

iShares FTSE EPRA/NAREIT Asia Property 3.7
iShares MSCI World Monthly Sterling Hedged 10.4
iShares GBP Corporate Bond 0-5 ETF 8.7
iShares FTSE EPRA/NAREIT UK Property 4.9
L&G All Stocks Index-Linked Gilt Index I Acc 8.2
L&G Short Dated £ Corp Bond Index I Acc 12.3
L&G Global Real Estate Dividend Index Fund (L Class Acc) 2.7
iShares Global Inflation Linked Government Bond ETF 8.7
iShares Sterling Corporate Bond 3.7
UBS CMCI Composite UCITS ETF A-acc 2.7
SPDR S&P UK Dividend Aristocrats ETF 2.4
Vanguard FTSE Japan ETF 4.1
db x-trackers S&P 500 UCITS ETF (DR) 2C (GBP Hedged) 6.2
db x-trackers MSCI Taiwan ETF 1.9
db x-trackers FTSE China 50 ETF 2.7
Source: Charles Stanley Pan Asset

What markets expect from the Autumn Statement

Posted on 22 November 2016 by

The UK’s Autumn Statement arrives laden with investors waiting to see whether the British government will make good on recent heavy-handed hints about fiscal expansion.

Past Treasury updates have tended to be a damp squib in global financial markets — political posturing and fiddling with tobacco taxes rarely able to catch the interest of international money.

This year, however, Philip Hammond, the chancellor, has an opportunity to outline the UK’s priorities on tax and spending for the first time since the vote for Brexit — and investors are all ears.

Will there be more government spending? Greater direction on the country’s transition out of the EU? Deals for companies that threaten to remove their operations?

These are the key points that financial markets will be looking out for on Wednesday as the chancellor steps up to the despatch box to present his first Autumn Statement.

1. August 4 — Bank of England cuts rates and starts quantitative easing

2. October 7 — Sterling suffers flash crash

3. October 14 — Gilt yields rise on fears of “Hard Brexit”

4. October 23 — Third-quarter GDP figures show better than expected growth

5. November 9 — Donald Trump wins US election

Is the UK about to borrow more?

The economy may have sailed through the immediate aftermath of the vote for Brexit in better shape than expected, but a gloomy period of lower growth and weaker tax revenues remains on the cards.

Add the government’s failure to sell off Lloyds and RBS shares and the official forecast is showing a £100bn hole in UK finances by 2020.

To shore that up, the UK is expected to increase its borrowing — with RBC anticipating net government borrowing will be revised up by £8bn for 2016-17 to £63.5bn and Bank of America Merrill Lynch expecting an extra £18bn.

If that sum is added to gilt issuance it would represent a significant increase, and one that credit analysts say would be likely to raise the country’s cost of borrowing — currently at 1.39 per cent and up from a post-Brexit vote low of 0.51 per cent, for 10 years.

“If the chancellor announces a surprisingly big increase in future borrowing at the Autumn Statement, that will send yields higher,” says John Wraith, head of rates at UBS. “Even though the new supply dynamic that implies won’t happen immediately.”

Gilt yields have risen sharply in recent weeks as investors bet on the return of inflation and slowdown in central bank stimulus — curbing appetite for assets that pay out fixed sums.

However, overseas demand for British government bonds proved robust in September, offering hope that international markets will be able to soak up any extra gilt supply.

There is also the chance that the increase in borrowing will skip gilts altogether and be funded elsewhere. Possible alternative sources include an increase in ultra short-term Treasury bills or National Savings & Investment inflows, which could leave gilt yields around current levels.

What impact will the statement have on the pound?

Since the Brexit vote, sterling has risen more than usual on strong data — mainly because forecasts about the economic impact of a No vote were so dire.

But that was before the Article 50 High Court ruling made investors factor in the legal quandary of triggering Brexit. And it was before Donald Trump’s victory in the US election. Both of these, according to Kamal Sharma, FX strategist at Bank of America Merrill Lynch, are perceived by some investors to have given the UK “a stronger bargaining edge against Europe”.

The upshot is that sterling, while still volatile, has been edging higher against the dollar and strengthening against the euro — at $1.248 and €1.17 respectively. Against that backdrop, the Autumn Statement is unlikely to shift investors’ sentiment towards the pound.

“It looks like sterling is going to trade sideways, until we get more into the politics of Brexit,” says Mr Sharma.

Will there be a new infrastructure bond?

Infrastructure is the buzzword that has investors most excited right now — witness the market moves generated by Mr Trump’s talk of boosting spending on roads, bridges, airports and hospitals in the US.

In the UK, public sector investment on rail and road improvements is seen as the most likely form of stimulus, according to RBC’s Sam Hill, senior UK economist.

But while Theresa May’s government is reported to be considering Treasury-backed bonds to finance more projects, no one is sure how they might work.

One gilt investor calls the idea a “ludicrous marketing exercise”, pointing out that the rate of borrowing would probably be higher than straightforward government debt, while the pool of potential investors will be smaller.

Will there be sweetheart deals for companies post-Brexit?

Last month, Greg Clark, the UK business secretary, said the government was trying to protect Britain’s car manufacturing industry from the impact of Brexit — leading other industries to call for similar help.

Assurances given to Nissan persuaded the Japanese carmaker to stay and commit to building two key models in the UK.

But last week, as US stocks just saw the biggest weekly inflow since late 2014, the UK market did not receive the same treatment. Uncertainty about the impact of Brexit and the pound’s slight strengthening has undone some of the help that a weaker currency provided to companies in the FTSE 100 and 250 that derive their earnings overseas.

The FTSE 100 is down 2.7 per cent in the last month while the FTSE 250 is down 1.5 per cent, although both remain close to record highs.

“Nissan is just one of many companies — it illustrates the uncertainty that is building in the UK and why investors here may be more cautious than they are in the US,” says Armin Peter at UBS.

Markets Spotlight: No ‘shy’ Trump investor, just game-changer doubt

Posted on 20 November 2016 by

Our round-up of the week’s best comment and analysis from the Financial Times focuses on how Donald Trump’s election produced an abrupt change of mood in the markets and examines which assets will now benefit.

The selection is taken from our Markets Insight and Smart Money columns, written by industry contributors and FT commentators.

Was there a financial markets equivalent of the “shy” Trump supporter to explain why investors went from fearing the worst to being immediately buoyed by the election of the US property tycoon to the White House?

The FT’s Miles Johnson argues that the evidence points more to markets realising “some of the things a Clinton victory were expected to bring, such as higher interest rates, were likely to also arrive with Mr Trump. The idea of his victory marking a game-changing moment may be illusory.”

US and emerging market investors are taking opposing bets on Trump’s presidency, says Allianz’s Mohamed El-Erian, adding that favouring EMs over American assets might now be warranted, but risks still remain.

In contrast, the FT’s John Authers argues that lower corporate tax would be an unambiguous positive for the US stock market and searching for underpriced companies that stand to benefit should repay the effort.

“There is a justification for share prices to rise sharply, despite huge headwinds from the dollar and the bond market, if investors believe a big corporate tax cut is a racing certainty.”

In his weekly Long View column, John focused on how after Mr Trump’s win, developed world institutions are fragile. “If governments fail to deliver growing prosperity or — more importantly — even a sense of fairness, the critical institutions can weaken swiftly. That is the greatest risk at present.”

Ben McLannahan, the US banking editor, examined how Neel Kashkari, president of the Federal Reserve Bank of Minneapolis has unveiled a plan to safeguard the biggest banks. “The way Mr Kashkari sees it, various reforms since the crisis have not got near to ending the problem of ‘too big to fail’. His solution is simple: more equity to absorb losses. Lots more.”

Meanwhile, the FT’s Henny Sender highlights that Trump’s pledge to generate faster economic growth through tax cuts and infrastructure spending is bringing what many believe is a turning point for the bond market.

Caution over the Trump trade of selling bonds because huge government borrowing is on the way may be misplaced, the FT’s Dan McCrum argues.

“Yet the bond market lesson, to always buy bonds, has been learned in a world where central banks were the only institution that mattered. Very few were trading in 1994, when 10-year bond yields jumped 200 basis points in the space of five months.”

But China’s A-share equity markets are a good long-term bet in light of the new Shenzhen-Hong Kong Stock Connect, says Morgan Stanley’s Jonathan Garner, as such exposure can be a useful risk diversifier to a global portfolio.

“Our work suggests that the A-share equity markets are already more mature and less a universe apart than is widely perceived. Over time, they will probably take a significant weight in global investor portfolios.”