Global financial markets were dominated by worries in August, so government bonds were in very strong demand and equities were out of favour, mostly because of data suggesting the US was at risk.
However, confidence improved in September as the data indicated only a modest US slowdown, and the pattern reversed, with equities rallying strongly and bonds selling off. The story of global economic recovery is still intact, underpinned in particular by very strong growth in the major emerging markets, supporting growth-linked assets.
Fixed Income Review: Yields Creep up from Historic Lows
Renewed worries in August about the economic outlook, particularly in the US, led to a remarkable surge of nervous "safe haven" money into government bonds. The benchmark 10-year US Treasury bond was yielding less than 2.5% by the end of August, and there were other dramatically low yields from euro zone 10-year bonds (2.8%) and UK gilts (2.9%). Japanese bond yields--already extremely low--went down further still, with 10-year debt reaching a low of just under 0.9 %.
In September, however, a recovery in confidence about the global outlook led to a reversal of the trend, and government bond yields rose, although yields are still very low by historical standards. Corporate bond yields followed a similar pattern, US corporate yields reaching a low of under 4.5% by the beginning of September, but rising since to 4.7%.
Fixed Income Outlook: Higher Yields On the Cards
The current low levels of bond yields make some sense from some perspectives. Cash is offering little or nothing in most markets, and short-term interest rates will be staying low in many markets for some considerable time.
The US Federal Reserve's latest statement mentions "exceptionally low levels for the federal funds rate for an extended period". It's not surprising as a result that yield-seeking investors have been forced into the bond markets by default.
The role of bonds as insurance against economic or financial system setbacks also has a certain logic, particularly as no one can be sure that the global financial crisis is well and truly dead. (For example, the credit spreads that Greece, in particular, but also Portugal and Ireland have to pay on their debt have continued to rise in recent weeks.) Equally, though, yield levels appear to have been driven to unsustainably low levels on any mainstream evaluation of the economic outlook.
In the US, forecasters in The Wall Street Journal's latest poll expect inflation to rise to 1.8 % by the end of 2011, and US 10-year Treasury yields to rise with it to 3.8%. A sensible assessment is that higher bond yields, and lower bond prices, are on the cards for many markets.
Equities Review: Restoring Confidence
There was a marked change in sentiment in global stock markets over the past month. The MSCI World Index was weak in the second half of August on the back of renewed fears about the global and (especially) US economic outlook, but recovered strongly in September as confidence improved. The net result is that world shares were up 5.9% over the past month in overseas currency terms.
The improved sentiment flowed through to nearly all the major markets. The US was up 6.3% (S&P 500), Europe up 6.1% (MSCI Europe), and Japan up 2.5% (Topix). Asia, Eastern Europe, and Latin America all contributed to a 4.2% increase on the MSCI Emerging Markets Index. The odd market out in an otherwise strong month was China, where the Shanghai Composite Index was down 1.9%.
Equities Outlook: Growing Too Slow, Growing Too Fast
The key issue for global stock markets over the past month was the perceived outlook for the US economy. Two issues in particular had investors worried: consumer spending; the labour market.
Retail sales in the US had fallen in June, prompting fears that household retrenching could imperil the economic recovery, and these fears were aggravated by what was happening to new claims for unemployment benefits. These are usually averaged over four weeks to take out volatility: on that basis, new claims had been more or less stable since March, but had then risen in July and August. This raised concerns that the US labour market was turning softer, or even presaging a double-dip recession.
In recent weeks, however, both sources of concern have eased. US retail sales picked up in July and again in August, ahead of forecasters' expectations. The level of initial jobless claims has also headed down again, and even though it is not yet back down to where it started, fears of a weakening labour market have eased considerably. The Fed's assessment in its latest policy statement was that "the pace of recovery in output and employment has slowed in recent months" but that it also expected the recovery to continue ("a gradual return to higher levels of resource utilisation").
Other forecasters agree with this picture of a continuing recovery but at a pace less rapid than previously thought. The Wall Street Journal’s September poll of forecasters expected US GDP growth of 2.5% this year (down from 2.9% in the August poll), and 2.8% next year (down from 2.9%).
World stock markets in short have been through a US-focused exercise of reassessing expectations.
On the US front, while not as strong as originally hoped for, the recovery is ongoing, and elsewhere the global economy is in good shape, particularly in the larger emerging markets. In Asia, indeed, the issue for policymakers has been how to cope with what might be unsustainably fast growth.
A secondary worry for investors over the past month had been the scale of any potential slowdown in Chinese growth as the government tried to cool its pace, but latest industrial production figures (up 13.9% year-on-year in August) have allayed concerns for now.
India shows a similar picture--the central bank aiming to rein in extremely fast growth. Industrial production in July was up 13.8% on a year earlier.
Although there may still be risks to some of the slower-growing economies of the Organisation for Economic Cooperation and Development (OECD), overall the outlook for economic activity globally remains positive for international shares.
Property Review: Listed Property Delivers
Global listed property delivered on all fronts over the past month but there were quite marked variations among the regional markets, with strong performances from Europe (ex-UK), the US, Asia and, to a lesser extent, the UK. Japan was the worst off while, in the smaller markets, the global financial crisis continued to take its toll on, for instance, Greek property share prices.
Property Outlook: The Other Side of the Bond Coin
Global property should continue to benefit from improved investor confidence over the economic outlook. But the asset class has also been one of the beneficiaries of investors desperate for income in a world where cash in the bank and government bonds offer poor yields. This is helping the asset class now, but bond yields are likely to rise from their unusually low current levels and, when that happens, global property is likely to struggle to retain its support.
The sector also remains difficult to summarise. Conditions range from still-depressed markets with large distressed property overhangs (some of the peripheral eurozone economies), through to overheated markets where local authorities are trying to rein in prices (China, Hong Kong, Singapore).
Performance periods refer to the month and three months to September 22, 2010. This is an edited version of an article that originally appeared on Morningstar.com.au, a sister site of Morningstar.co.uk.
