Andrew Miller: Mixed messages from the markets

Equity markets in both the UK and continental Europe have put in an impressively resilient performance over recent weeks – helped in part by voters

Andrew Miller
Andrew Miller

Recent market activity has seen equity and fixed income markets witnessing the same events but seemingly coming to divergent conclusions on what they might mean for developed markets.

Equity markets in both the UK and continental Europe have put in an impressively resilient performance over recent weeks – helped in part by voters.

In the end – in spite of some fairly hysterical media commentary – European parliamentary elections played out much as we expected.

The euro crisis will no doubt continue to smoulder while the political and fiscal architecture for the euro remains only partially built. However, we see the weight of history and the lack of credible alternatives forcing the project unevenly forward from here. European parliamentary elections have done nothing to change this view. In this context, we still see European equities, alongside those in the US, as a good place for investors to take selected risk. Earnings headroom remains greatest in Europe, even if the latest earnings season provided little evidence of it.

A weaker currency may help the corporate sector at the margin given its globally well-diversified revenue footprint relative to the US equity market.

To this end, June may see the European Central Bank actually start to follow through on its promise to do “whatever it takes” – a change in language in its most recent statement, suggesting that it is no longer happy with medium-term inflation expectations, may indicate that a negative deposit rate and/or some form of targeted liquidity operation are coming our way.

This is all in the context of a still fairly sluggish economic recovery, albeit not far from trend, as evidenced by May’s business confidence data.

So far this year, Japanese equities have provided a fairly brutal reminder of why we prefer to sit on the fence.

To date, Japanese authorities have deployed headline-grabbing monetary and fiscal measures in their attempts to shake the country out of its economic torpor.

There were some signs of life in the first-quarter’s GDP data, however, the bottom-up reform and liberalisation that we would need to see before comfortably taking an active position on the market, remains largely absent.

In the US, data released last month signalled a pickup in economic activity.

Housing starts and building permits surged, and leading indicators pointed to a second-quarter bounce.

First-quarter earnings results echoed the same refrain, exceeding expectations in both the large and small- and mid-cap sectors.

The unemployment rate dropped to the lowest level since the start of the recession, and inflation hit the Federal Reserve’s elusive 2% target. Consumer and business confidence ticked upward as a result.

In response, US equities moved to new all-time highs, while 10-year Treasury yields remained largely unmoved at around 2.5%.

With yields flat to falling in May, US fixed income performance continued to confound consensus expectations.

We hesitate to make a tactical call on exactly when the government bond market will cease to defy valuation gravity, however, our very small suggested strategic weight should tell investors that we do not believe this will be the case for long and investors should lower their fixed income portfolio durations.

Andrew Miller, regional director for Barclays Wealth and Investment Management in Newcastle

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