RMG Wealth’s Stewart Richardson sees a week of mixed messages in the market
Stewart Richardson, chief investment officer at RMG Wealth, sees a need for more tactical trading in the short term as markets have given off mixed signals.
It feels like the equity markets have become very choppy indeed. The outcome of the Italian election has obviously muddied the waters and the poor data from Europe this week (with the possible exception of Germany…what’s new!) certainly does not help. European equities are leading the way lower (down 0.5% this week, down 2.5% in February and flat year to date) with the US and UK performing much better.
At the end of last week, the EU downgraded its forecast for zone-wide growth this year to -0.3% from their previous forecast of 0.1%. That may not be big news, but any change to the forecasts from the ECB when they meet next week would be. In particular, the ECB is forecasting inflation to be well below their mandated target at 1.4% in 2014. There is a risk that this forecast is nudged a bit lower along with lower growth forecasts. With the ECB mandate for inflation to be at or just below 2%, we have to wonder how they are going to achieve this target.
Frankly, we have to believe that they are going to either cut rates and/or start printing money; if not this month, then probably quite soon. Perhaps the main reaction to an easier ECB will be euro weakness and yet perhaps lower interest rates without QE will not be enough to generate any upside in equities. The reality is that the ECB balance sheet is shrinking (as banks repay LTRO money) which is the exact opposite of the FED and therefore it is perhaps no surprise that European equities are struggling in comparison.
Ben Bernanke presented his semi-annual testimony to lawmakers on Tuesday and Wednesday. He did nothing to dissuade bullish traders from bidding stocks higher mid-week, although Thursday and Friday were much more choppy. For the week, major US indices were mostly positive with the Dow Industrials leading the way. Now that we have had another Bernanke booster, markets may need some robust employment data next week to generate further gains. Our view on US equities is that they look more attractive than European equities in the short term with modest growth and money printing being better than negative growth and relatively tight monetary policy.
Elsewhere, 10 year bond yields were lower last week. The 10 year US Treasury yield fell by 12 basis points with the equivalent in Germany down 15 basis points and in the UK down 21 basis points (whoever would have thought the UK downgrade from Moodys would be a positive for the Gilt market?). In our view, the lower yield environment is very much a result of weak economic growth, and we note therefore that it is somewhat strange that both bonds and equities rose in the same week (at least in the US and UK). Can both markets be right? Probably not, and we suspect that the bond market is right and the equity markets will succumb at some point to the weak economic environment.
Last week we highlighted gold as being possibly oversold and definitely under-loved. Despite continued promises from Bernanke of excessive money printing, gold cannot pick itself up off the floor. Even signs of trouble in the eurozone were not enough to encourage traders to buy some gold. How times have changed – remember two years or so when gold was a beneficiary of both central bank largesse and eurozone instability!
FX markets continue to be lively with sterling continuing its decline as more Bank of England officials trash the currency (talk of negative interest rates etc…) and the dollar benefitting from cyclical assets underperforming and perhaps a bit of safe haven buying, what with the Vix index up by 10%. So much for the dollar falling as the Fed prints.
So to sum up, we finish a week when equities were mostly higher (although Europe did edge lower), bonds were higher and the US dollar was higher. Certainly an unusual combination. Regarding risk assets, equity volatility rose by 10% and yet gold was lower. Overall, a number of mixed messages this week and with the ECB and the Bank of England meeting next week, we can expect more of the same.
With markets seemingly moving into a more choppy environment, we suspect that a more tactical trading strategy will be the order of the day. We intend to trade from the bearish side in Europe (both equities and currency) and the bullish side in the US and UK equity markets. In FX, the US dollar should be stronger against most currencies and we look for opportunities to be bearish on the yen and sterling. We continue to trade from the bullish side in gold and we suspect that bond markets will edge higher in the short term (even if they represent poor value in the long term).