With widespread civil disorder in London and other English cities at the start of the week attracting most of one’s attention, the continuing drama in investment markets seemed almost trivial. However a second, tumultuous week for markets means that although August is just twelve days old, the MSCI All Countries World Sterling Total Return Index is already down 9.2%, and is now down 10.5% in 2011, with Emerging Markets down 15.6% year to date.
The headlines were dominated by the fall- out from S&P’s credit downgrade of the United States late on the previous Friday, and by the announcement of eurozone and ECB commitment to buying Italian and Spanish bonds in response to the sharply rising yields of the previous week. Prime Minister Berlusconi announced he was bringing forward planned austerity measures, Italian and Spanish bonds were duly bought by the ECB and yields fell.
However European concerns have not gone away and, in a febrile atmosphere, after Germany’s Commerzbank reported a massive write down of its Greek sovereign debt holdings, fears of French government and French bank solvency spiked before dissipating by the end of the week. Discussions between Chancellor Merkel and President Sarkozy continue this week.
Bill Clinton’s 1992 presidential campaign slogan was “It’s the economy, stupid”, and it is the prospective path of economic growth which has drawn the attention of investors, and it is stock markets which have taken the brunt of their concerns. The Federal Reserve announced on Wednesday that it will keep rates close to zero for at least two more years, citing economic weakness, and restating its preparedness to use other policy tools, by implication QE3, to respond to a worsening economy.
The twelve days of August have seen a remarkable surge in risk aversion and in volatility. Despite a credit downgrade the US 10 year yield fell over the week from 2.57% to 2.26% as investors voted with their feet and demonstrated the safe harbour status of the US. Gold leapt to new highs, ending 5.5% up on the week. The VIX index, measuring the implied volatility of S&P 500 index options, reached 48 on Monday 8th, it’s highest since May 2010, before closing the week on 36.
As the dust settles somewhat, investors can consider a landscape where the developed world offers low interest rates for the foreseeable future, and indeed negative real rates, whilst bond markets offer ten year nominal returns of 2.3% in the US, 2.5% in the UK, 2.3% in Germany and 1% in Japan.
By contrast equity markets currently – absent any significant downgrades to profit forecasts – offer very attractive earnings and, particularly, dividend yields, with the UK stock market yielding 3.6%, the US on 2.1%, and the German and French markets offering yields above 4%.
Issued by: Rupert Caldecott, CIO of the Global Asset Allocation Team, Dalton Strategic Partnership LLP, an investment management boutique in London founded in 2003 by the late Andrew Dalton