Climbing the Wall of Worry in 2017
The term “climbing the wall of worry” has been used in many pieces of commentary from other fund managers, and market commenters over the past 6 months; but at no time is it more fitting than right now. We have seen share markets in the US reach record levels with the Dow Jones Industrial Index reaching an amazing 20,000 points; which is a return since the bottom of the GFC in 2008 of 303% or 14.87% p.a. At the time of writing this, the markets continue to trade around the 20,000 mark, which we (and many commentators) see as unsustainable and potentially an alarm bell for the top to a market cycle.
Source: Google Finance, Yahoo Finance, MSN Money
So if the markets are heading up, what is the “worry” about?
The first point of worry should come as no surprise. President Trump has shown that he is abrasive and aggressive in implementing his policy, and how he deals with his so called allies. There has been enough published on him in the media already so we will take a break this month and focus on other areas of concern.
The next brick in the wall of worry is increasing interest rates around the globe on the back of increasing inflation pressures. We are seeing both global and local bond yields (return to maturity) increase in line with rising rates in the US the Europe. This has seen bond prices fall around the world, as the markets price in a developed world moving into a higher inflationary and interest rate environment. As discussed last month this is also translating into increasing mortgage rates in New Zealand, but to date, the larger movement (c.+1.0%) has only been seen in the 5-year mortgage rates.
Source: Bloomberg Finance, DB Global Markets Research
China’s rising debt levels, coupled with rising finance costs and a slowing property market is another brick in the wall of worry. China’s growth is continuing to slow as the cost of producing goods in China increases. China’s rising cost of goods has also increased global inflationary pressures as the cost of goods produced in China has started increasing for the first time in many years. Lastly, tensions between China and the US are continuing to escalate, and the addition of President Trump to this equation may be the spark that is required to spark off this political powder keg.
Looking to the UK we have concern around the impact of Brexit, or the United Kingdom’s (UK’s) departure from the European Union (EU), which is predicted to commence in the first ¼ of this year, when Teresa May (UK Prime Minster) finally implements article 50 of the EU agreement to commence discussions with the EU around the UK’s exit. This is likely to lead to some pretty nasty, and public negotiations around the penalty fee the EU will charge for their departure, and the ability of the UK to continue to trade with the EU post their departure.
Moving to the EU itself we see a French election which, like Brexit and Trump, may be closer than expected, and Marine Le Pen, President of the French National Front party, and a staunch anti-European Union advocate, may come to power, and force a referendum on if France should also leave the EU. Will we see a “Frexit” next?
Staying with the EU we also have an election in Germany in September this year, with Germany’s current Chancellor, Angela Merkel, likely to face stiff competition from the newly elected leader of the centre-left Social Democrats, Martin Schultz. Germany has been the leading backer of the European Central Bank (ECB) for some time now, which the majority of German’s are now questioning the sustainability of moving forward. Add to this that the German public, as with other member states of the EU, are quickly becoming less supportive of the open borders policy that is dictated by the members of the EU, and we can see that the chance of the German public voting for change may be high.
Lastly, we look to Japan to round out the “Wall of Worry”. The Bank of Japan (BoJ) has continued to pump unprecedented levels of stimulus into their economy via quantitative easing. At present they are pumping in just under US$100 billion of new capital per month in an effort to keep interest rates low and increase inflation in their economy. They have confirmed that they will support the bond market by purchasing Japanese bonds to keep the 10-year Japanese bond rate at 0%, and have also supported the share market via investing directly into it and buying shares to support and increase share prices. This has led to the BoJ now owning more than 50% of the Nikkei exchange traded fund (ETF) market.
Quantitative Easing Since 2008
Source: Inv Trust Ass, BoJ, Haver Analytics, DB Global Markets Research
These are a few of examples of the bricks that make up the wall of worry that the markets are currently climbing. We continue to watch this unfold with building concern for the markets, and continue to recommend clients maintain conservative positioning in their portfolios, and use managers that can move to protect their clients from any dramatic downside movement.
Will 2017 be the year of the correction?
No one knows the answer to this question, and just as there are reasons not to invest there are reasons to stay invested. We are seeing a lot of positive data out of the US and Europe with unemployment rates falling, deflationary concerns diminishing and the volatility index staying at low levels not seen since 2006.
We are also seeing accelerating growth globally, as shown below with the Purchasing Managers Index showing that the world is growing well. The PMI index shows if an economy is in growth or contraction, with a result above 50 meaning the economy is growing and below 50 meaning contraction.
Source: IHSM, JPM, Haver Analytics, DB Global Markets Research
6-month global index performance – ending 31st January 2017
Source: FE Analytics, Craigs IP Research