Equities
US equities are supported by
- a weak dollar (supporting multinational exports – see below)
- a deregulation of industry under President Donald Trump making it ‘easier for firms to do business’
- a return to global growth
- a recent cut in the corporate tax rate from 35% to 20% (i.e. increasing corporate profitability)
- a strong set of 3rd quarter results from major technology firms e.g. Amazon/Google
US equity markets (S&P 500, Dow Jones Industrial Average and the technology focussed NASDAQ) are at all-time highs with all indices performing exceptionally strongly in 2017 up 20 – 30%.
What are the risks to continued stock market strength?
- An unexpected spurt of US inflation
- A Chinese growth wobble
- Renewed European political drama
- That Central Banks and bond markets combine to push up the cost of debt i.e. higher bond yields and higher interest rates. All Central Banks wish to ‘normalise’ monetary policy i.e. get their economies off the current emergency ultra- low levels of interest rates associated with the financial crisis. Why?
Current accommodative monetary policy is inflationary despite the global absence of inflation right now. If we had another financial crisis monetary authorities would have no room to respond (by lowering interest rates) if rates start at current super low levels! The current US ‘Fed Funds’ benchmark interest rate is 1.25% – the average Fed Funds rate over the last 40 years is 5.95%!
Fixed Income
Bond yields remain super low looking at the last 30 years with 10 year bond yields:
- Germany 0.45% (Yield-To-Maturity)
- UK 1.20%
- US 2.40%
Most market forecasters are calling for a rise in yields this year e.g. US 10-year yield up to 2.75%. Remember – yields rise / prices fall resulting in losses for bondholders.
Foreign Exchange
2017 was a tough year for the US dollar as US growth, inflation and interest rate hikes were all on the low end of expectations. The US Dollar Trade Weighted Index (a weighted average of the foreign exchange value of the U.S. dollar against the currencies of a broad group of major U.S. trading partners) fell over 6% last year and the markets start the year in dollar negative mood.
A rebounding Euro currently on the back of rebounding Eurozone growth is a significant contribution to this trend.
Commodities
Oil – Brent crude has topped $68 a barrel for the first time since 2015 and is within touching distance of levels not seen since oil fell from $100 a barrel. Oil is supported by the return to world growth and reduced supply from the ongoing OPEC/Russia production cut agreement.
5 factors that will determine the 2018 oil price
- Iran and rising geopolitical risks with Iran the third largest producer in OPEC producing 3.8 million barrels a day.
- US shale and non-OPEC supply: Will this supply grow faster than oil consumption?
- Demand and the world economy
- OPEC and Russia Strategy: Will the production cut alliance stay intact?
- Hedge Funds: This group has record bullish positions in oil. Will this group remain buyers or sellers of the commodity?
MiFID Special
The biggest shake up in European financial markets was instigated on January 1st when a huge piece of regulation – MiFID 2 (Markets in Financial Instruments Directive) – came into effect. Banks and brokers have been working for two years to comply with the 1.7 million paragraphs of the regulation. Major banks have hired a couple of hundred people each to comply with, and be ready for, the January 1st deadline.
A couple of key themes
Price Transparency to promote fairer markets so clients receive fair prices. Prices of bonds, shares, derivatives will need to be disclosed to all a bank’s customers both before and after a trade not just kept private between one client and a bank and ‘kept secret’ as it were.
Research Unbundling: Currently banks produce significant financial market research (bond ,stock, FX, macroeconomic analysis and recommendations). Banks provide this free to asset managers who then conduct trades with the bank in return. Very cosy!
Under MiFID 2 banks will have to charge asset managers for all research and the former will trade with banks independent of any research relationships.
Implications: A number of Tier 2 banks will probably stop producing research as asset managers won’t pay them for it. Asset Managers may do more of their own research.
Prices one month ago in brackets
Equities
S&P 500: 2720 (2640)
Nasdaq: 7070 (6850)
FTSE 100: 7700 (7300)
Bonds – 10 Year Government Yields
US 2.45 (2.35)%
EU 0.38 (0.45)%
GB 1.30 ( 1.30)%
Foreign Exchange
EUR/USD 1.2000 (1900 – 1 euro buys 1.1900 dollars)
GBP/USD 1.3500 (1.3500 – 1 pound buys 1.3500 dollars)
Commodities
OIL: Brent: 68.00 (62.00 – dollars per barrel)
GOLD: 1315 (1280 – dollars per ounce)
Receive fortnightly Market Update notifications by ‘Following’ Opening City Doors on LinkedIn