Andrew Miller: Spillovers need not be destabilising

As we enter the final third of 2013, we continue to see the prospective tapering of quantitative easing (QE) by the Federal Reserve

Andrew Miller
Andrew Miller

As we enter the final third of 2013, we continue to see the prospective tapering of quantitative easing (QE) by the Federal Reserve – and perhaps even the limitations of ‘forward guidance’ in the US and Europe – as a welcome step on the road to monetary normalisation. The move strengthens the argument that economic growth is not dependent on central bank support.

August, traditionally a time of holiday, is nowadays associated with volatility in asset prices as political events intersect with markets.

Although not extreme by the standards of previous years, August 2013 has still been a time of notable flux – a reminder of the interrelatedness of politics, the global economy and financial markets.

The weakness in emerging-market returns highlights the far-reaching effects of the Federal Reserve’s quantitative easing program.

On a six-month comparison, emerging-market bonds have fallen by 9%, the biggest drop since late 2008, and the third biggest decrease since the mid-1990s.

Yet corporate balance sheets and economic fundamentals are, in general, much stronger than in 1998. As a result, and in our view, emerging-market assets are cheaper than they were, however, we still prefer developed stocks (and bonds). Several high-profile countries have disappointed, and emerging markets generally are sensitive to further portfolio outflows triggered by that monetary normalisation.

Across advanced economies, UK and US bond yields have been strikingly correlated (to a degree that Bank of England governor Mark Carney might be expected to protest), but Japanese and (on average) eurozone bond yields have so far de-coupled significantly from the US moves – a sign that, for these markets, investors are paying heed to local conditions and central banks.

The rise in bond yields has been accompanied by a rise in some – but not all – commodity prices. Since early May, iron ore and steel prices have sharply rebounded, while oil prices have risen by 10-17%. Yet wheat prices have fallen by 5-15%, coal prices by 9% and US natural gas prices by 11%.

The recovery in metal prices appears linked to improved confidence in China (borne out by import demand).

Meanwhile, the rise in energy prices relates more to a risk premium associated with political tensions in the Middle East and North Africa.

When the dust settles, we expect stocks to outperform further. We can see the possibility of a short-term rally in bonds, and renewed nerves in stocks – perhaps as the German election on 22 September looms closer.

However, we would use this as an opportunity for under-invested portfolios to rebalance towards stocks, both tactically and strategically.

We doubt the election result will fan the still-smouldering euro crisis back into flame.

:: Andrew Miller is a director of Barclays Wealth and Investment Management in Newcastle

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