Graduate Market Update

Equities 

US equities had a very strong 2017 (up circa 25%) and led all global equity markets higher accordingly. This ‘bull run’ continued in the first few weeks of 2018 (US stock markets up 6%) based on a ‘goldilocks’ scenario

  • The return of US and global growth (US GDP is running at just below 3% per annum)
  • Subdued inflation (below the central bank desired 2% growth rate)                                             
  • A weaker dollar (down approximately 10% since Trump was elected 14 months ago) thus helping US exports
  • Only gradually rising interest rates with the US Federal Reserve making three 0.25% increases in the key ‘Federal Funds‘ (‘Fed Funds’) rate with market expectations of three more gradual 0.25% interest rate rises in 2018.

All this on a Trump ‘action plan’ of lower taxes (Corporation Tax was cut from 35% to 21%), increased infrastructure spending and less restrictive industry regulation.

Such a ‘goldilocks’ scenario  led to US and global equity indices having an exceptional 2017.

Fixed Income/Interest Rates

In the past 10 days the mood has changed and equity indices have come off their all-time highs.

Of major concern is the rise in the level of interest rates in the US depicted by US Government (Treasury) bond yields. In particular, the US 10-year Treasury spent most of last year close to a 2.30/2.40 yield-to-maturity / annual rate of return. Since the beginning of January we have seen a  sharp rise to 2.70% YTM – a rise of 0.30% or 30 basis points.

Market participants fear that the great ‘bull’ market in bonds that has seen yields fall from 11-13% 30 years ago to the lows of 1-2% 18 months ago may well be over – remember yield falls equal price rises.

Higher bond yields are a problem for equity markets for two reasons:

  • Government bond yields depict the base level for corporate bond borrowing costs e.g. If IBM borrows at 0.80% above the 10-year Treasury yield then if the latter moves to 3.20% all of a sudden IBM is paying 4% borrowing costs – very high by recent standards. The cost of financing affects corporate profitability and therefore the attractiveness of stocks.
  • Any fund manager making an investment decision last year had to choose between equities, which had not risen too much, in an accelerating economy and bonds which paid 1.75-2.00% yields. Buying equities was an easy decision. Should bond yields move to 4% they could look pretty attractive versus equities which look ‘very frothy’ on current valuations.

The direction and the magnitude of change of (US) bond market yields over the next few weeks/months will be critical for global equity markets!

Commodities

Commodity prices generally remain high in a world returning to global growth. Oil is trading at just below $70 per barrel – its highest for 3 years. The agreement between OPEC (led by Saudi Arabia) and Russia to cut production – an agreement which has been in place since November 2016 – seems to be having the desired effect!

 

Prices from 1 month ago in brackets

Equities

S&P 500: 2825 (2770))

Nasdaq: 7400 (7070)

FTSE 100: 7600 (7700)

Bonds – 10 Year Government Yields

US 2.70% (2.40%)

EU 0.63% (0.45%)

GB 1.50% (1.20%)

Foreign Exchange 

EUR/USD  1.2400 (1.2000)  (1 euro buys 1.2400 dollars)

GBP/USD  1.4100 (1.3500)  (1 pound buys 1.4100 dollars)

Commodities

OIL: Brent: 68.50 (68.00) – (dollars per barrel)

GOLD: 1345 (1315)  (dollars per ounce)

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About Paul McCormick

Paul McCormick is the founder of Opening City Doors and is a Financial Market Specialist having worked for several leading Investment Banks and financial technology institutions additionally.He therefore provides a unique insight, and unusually broad perspective, into the opportunities available in London Financial Markets and related sectors and how to launch your career in the ‘City’.