For Accredited Investors Only
June 2015
Monthly Viewpoint
Ranjiv Raman
ranjiv.raman@schroders.com
“Divergent fortunes”
“Equities took
back stage in
May, with market
attention fixated
on the
exaggerated
price swings in
both fixed income
and currencies”
The month of May saw a continuation of the trends that have accompanied markets for most of this year. In
Europe, the focus remained on Greece and whether its government could reach a deal with the Troika
ahead of a series of principal debt repayments due in June. Even if a deal materialises, we believe this will
come at a cost, with the involvement of the IMF likely to result in Greece mandated to reach a primary
surplus of up to 3.5% of GDP. This latter point is unlikely to be accepted by the Syriza government though,
thus setting the scene for more volatility in the coming months.
Away from Greece, the other key variables influencing European markets last month were moves in the
bond markets, where we saw extreme volatility in German bund yields. A lot of these moves were attributed
to a lack of liquidity in certain segments of the curve, but also reflect the danger of being “overpositioned” in
consensus trades – which proved to be the undoing in May. A similar phenomenon was noted at the time of
writing this report, as 10-year government Bund yields surged to hit 0.80%. The spike in the yield came on
the back of a stronger than expected reading on Eurozone inflation, which showed an annual increase of
0.3% in May. The about-face in German yields is all the more spectacular given that we were flirting with
negative yields only a few weeks ago.
Across the Atlantic, a similar move in US Treasury yields has been noted, although the move here of late
has been influenced by what is happening in Europe. Looking ahead, we expect domestic factors to
continue to pressure UST yields upwards in coming months as US growth gains traction and sets the stage
for a potential rate hike by the Fed – we now expect this to likely occur at the September meeting.
Supporting this view is the improvement noted on housing numbers including housing starts, home prices
and new home sales. There has been a rebound as well on the jobs front, as the non-farm payrolls report for
April showed employers adding 223,000 jobs. Encouragingly, the report highlighted a broad-based
improvement, and helped push the unemployment rate down to 5.4%.
“Chinese share
prices have
continued to
power ahead
despite concerns
of overvaluation
and a massive
build-up of
leverage and
margin financing”
In tandem with the volatility in fixed income have been swings in the FX markets. Here the big change was a
resumption of the US dollar’s upward trend in May. The USD Index gained 2.4% for the month, and in the
process reversed a large chunk of the previous month’s losses. As we had noted in our April review, we
believe the move in the US dollar this time around is structural and not cyclical, and thus expect the current
cycle to be more long term in nature. This also reflects our belief that the US economy is on a steady
recovery trajectory, a pattern echoed by many companies in the corporate sector that have reported
improvements in both the top and bottom line.
Exaggerated price action in both fixed income and foreign exchange saw global equities take back stage in
May. The MSCI World Index ended flat for the month, with a 1% gain in the S&P 500 Index countered by a
1.2% drop in the Eurostoxx 50. Emerging markets were disproportionately weaker, with the MSCI EM Index
falling by 4% in May, and the MSCI Asia Pacific ex Japan Index down 2.9%. The selloff in emerging markets
was led by Brazil, with Russia falling 5.9% and Singapore and Hong Kong H-shares both down more than
2%.
Elsewhere, the China juggernaut continues to both enthral as well as confound investors. Signs of frothiness
and overvaluation are now becoming commonplace -- for example, the average P/E of firms listed on the
Shenzhen stock exchange is 64x, whilst the multiples on ChiNext, a price index for Chinese start-up
companies, stands at an astounding 120 times! Even more worrying is the fact that retail participation on the
ChiNext is now at 75%, with an average holding period of just over 15 days – clearly not one for the fainthearted.
There is also the issue with leverage, which has continued to rise rapidly in line with the fast soaring
Chinese stock market. By some measures, margin financing for purchase of shares has jumped more than
five times in the past 6-9 months and now stands at more than US$300bn; this does not even account for
the loans advanced via the shadow banking channels. Meanwhile, brokerage accounts are being opened at
For Accredited Investors Only
June 2015
an alarming clip, with a reported 8-10 million accounts opened in the first quarter of 2015 alone.
All these point to a correction in the Chinese market, though the timing of this occurring is hard to determine,
given the increasingly accommodative stance of the central bank. This was further evidenced in May, when
the PBoC cut rates for the third time in the past six months.
“The current
environment of
desynchronized
monetary policy
settings will only
increase market
volatility in the
coming months ”
The key to our China positioning has always been to invest in companies that exhibit underlying earnings
growth; are able to monetise their core products; and thus have a fair degree of pricing power. We have no
exposure to banks, and prefer to access the Chinese financial potential via select insurance companies. The
internet sector and information technology is one of our favoured sectors, but here we remain mindful of not
overpaying for growth. As such, our main strategy through April-May was to raise cash in our discretionary
portfolios. A lot of the adjustments were concentrated in Hong Kong H-shares, which is unsurprising given
the sharp run-up seen here. Post the adjustments in our equity mandates, our cash allocation now stands
between 15-20%, which we intend to redeploy selectively as and when valuations normalise in the China
market.
Our outlook for the rest of 2015 is one premised with our central expectation of greater volatility. This has
already emerged in both the fixed income and currency markets, and we believe that the swings are only
likely to increase. The key challenge for investors is how to deal with desynchronised monetary policy
settings adopted by central bankers globally, coupled with global economic growth that remains uneven at
best.
Commodities meanwhile have displayed abnormal price behaviour. While oil prices – as represented by WTI
-- have swung violently from highs of $97 in the middle of 2014 to lows of less than $50 in Q1 this year, the
gold price has flat-lined during the same period, despite a rising US dollar. Although demand/supply
imbalances have been attributed as the main factor behind this, there are also geopolitical forces at work
that have swayed momentum in the commodity space. This also means that traditional measures of
correlation have not worked as expected, and we expect this to continue as long as central banks continue
to print money, thereby resulting in divergent fortunes for many economies.
Happy Investing!
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