As we head towards the end of the first half investors seem to be approaching the second half of 2015 with a distinct degree of caution and trepidation. When stock markets have recorded the sort of mixed and in some cases meagre to negative returns for a six month period, one has to ask the question as to whether there is any meaningful investor appetite left to lift equities higher. At the same time FX markets have had a very turbulent first half, which looks set to continue in the months ahead when looking at what the economic and political calendar has in store.
When looking back briefly at the first half we can rest assured that it was not in the slightest bit short of impactful events. The year started with a bang as equity market volatility remained high after spiking towards the end of 2014, leading to large oscillations in global indices and FX market volatility sky rocketed after the Black Swan event that was the Swiss National Bank’s removal of its currency ceiling against the euro. Since then, apart from a pullback in February, FX volatility has remained at heightened levels due to not only considerable geopolitical uncertainty, but economic uncertainty as well, whereas equity market volatility has fallen from the highs of earlier in the year.
In respect to returns, as mentioned these are very mixed so far for 2015. UK and US national benchmarks are as good as flat, European benchmarks positive due to the impetus from the European Central Bank’s quantitative easing program and more recently renewed optimism of a deal for Greece, although their impressive gains have dwindled somewhat in the second quarter, Indian stocks are largely negative and the only real standout is the Shanghai Composite seeing over a 40% gain so far. In the FX world the dollar has added to the impressive returns it made in the latter part of 2014, with the dollar index up over 5% year to date and the majority of those gains coming at the expense of the yen and euro. It’s not just the dollar that has benefitted from euro weakness with sterling up 8% against the single currency and the pound has held its own against the mighty US dollar, up just over 1% year to date.
Whilst the first half shows a very mixed picture when it comes to returns across asset classes, it suggests bifurcation amongst investors and indicates a wide ranging concern about what the second half has in store. There are three major issues casting a long shadow over the rest of this year with the first being the ongoing Greece saga, the second being the continuing slowdown in China and the third is the US Federal Reserve’s approach to raising interest rates from their all-time historical low. All have been hotly debated throughout the year intensifying as we reach breaking point.
Let’s look at the Greece issue first as it finally looks as though it is going to be thrown yet another a lifeline by the EU and other creditors as the outcome from this week’s negotiations is expected to see the release of €7.2 billion to shore up the country’s finances through the summer. Investors are showing relief with equity markets bouncing, but even if a deal is agreed, it then has to be ratified by the Greek parliament who have of course been voted in on an anti-austerity ticket, so this is just one of the high hurdles needed to be overcome. Ultimately though a deal would be a short-term fix that only buys Greece a few more months’ time before we will see the problem resurface. Without some sort of debt restructuring a bailout resolution will mean prolonging of what is widely being accepted as inevitable and in the eyes of many investors when Greece does finally leave the euro, such a break-up further down the line should be more manageable. A default and resultant Grexit will cause much short-term pain, but is potentially better in the long run for Greece and its creditors as now contagion risk is less than it was three years ago. The only problem with the latter scenario, which is the reason why there has been so much time and resource vested in negotiations, is that it means an end to a single currency project that was never supposed to fail and if it’s alright for one member to see an end to austerity whilst having their outstanding debts written off, then other members such as Spain, Portugal, Ireland and even Italy will be asking why isn’t it the same for them. Either way the financial markets are becoming more and more accepting of whatever the outcome of these negotiations, the main reason why they are seen by so many as being inconsequential is because a Grexit remains firmly on the cards.
China’s stock market is currently in the midst of a ferocious bull market with many arguing it’s now a bubble set to burst spectacularly as growth for the world’s second largest economy has been slowing over the past five years, more so in the past twelve months. China’s real growth is reputedly half of its officially reported 7% GDP rate and when you speak to investors in the City many are seriously worried about the rate with which its economy is slowing. On top of this you have a property market built on unstable foundations and a debt mountain that would make Greece or the UK’s look like a mole hill. It is little wonder that the Federal Reserve has been vocal in citing the slowdown in Asia as a worry. There’s been a saying in financial markets that if the US sneezes then the rest of the world catches a cold, but you could quite easily apply the same to China now.
As if these two issues weren’t enough of a headache for there’s the other issue of having to deal with the commencement of central bank monetary tightening, the other major conundrum faced by investors for the remainder of 2015. Whilst a few central banks around the globe continue to ease monetary policy, for example earlier in the year the European Central Bank introduced its long awaited quantitative easing program and more recently the Bank of Korea, Reserve Bank of Australia and Reserve Bank of New Zealand cut their interest rates, the Federal Reserve and Bank of England are getting twitchy trigger fingers to commence hiking.
Whilst we are still some way off those first rate rises with question marks over whether even the Federal Reserve moves this year or in 2016, investors, businesses and consumers have been used to ultra-low interest rates for years and are nervous about monetary tightening. The Federal Reserve is significant because any rising of interest rates has ramifications beyond the shores of the US, in particular emerging markets as it makes their debt, much of it dollar denominated, more expensive. We saw the potential of an emerging market rout back in 2013 when the Fed commenced the tapering of its quantitative easing and even though most emerging market currencies have depreciated considerably since then, the trend could easily continue as this time these economies not only have to deal with the prospect of more expensive debt, they have to do so at a time when many countries across the globe are seeing growth stall. This combination has the potential to make their currencies depreciate even further against the dollar, making their debt problems worse.
Ultimately, the world is going to find interest rate hikes hard to stomach as we’ve been used to near zero rates in many major developed economies for almost seven years. At least we can be safe to assume that when rate hikes do come, they are likely to be gradual rather than precipitous, with the tightening cycle for the Fed expected to peak around 3.00% towards the end of 2017. But this may not be enough to put investors’ minds at rest during the remainder of 2015.