By ROBERT HARLEY 29/10/2010
Global equity markets continued their rise into October. Earnings releases for the quarter have been strong: to date over 70% of the companies that have reported have beaten expectations. However against the backdrop of positive news at the corporate level, economic indicators for the world’s largest economy, the US, still appear mixed.
Indeed part of the rise in markets (both equity and bond markets) has arguably been fuelled by the prospect of a second round of quantitative easing (QE) led by the U.S. Federal Reserve. Goldman Sachs estimate that $1 trillion of QE is already priced into markets. Ultimately the aim of this measure would be to rekindle a lack-lustre US recovery. However, it is very much open to debate whether it will have any real impact on economic activity in an environment where there is already plenty of liquidity and demand for credit remains subdued even at low interest rates. If this is the case the benefit of any wealth effect from rising asset prices could be also short lived.
Against this backdrop, in his latest Investment Outlook, Bill Gross joint CEO at Pimco, one of the world’s largest bond managers, cautions against the outlook for global bonds when central banks print money. Year to date we have shifted some of our exposure in quality bonds both to other assets and to higher yielding bonds. Whilst we don’t see bond yields under immediate pressure, we share Gross’s concerns and are likely to continue shifting our weighting in favour of less interest rate sensitive securities. At some point interest rates must normalise from current extraordinarily low levels.
At the G20 summit in Korea competitive currency devaluations were top of the agenda. The outcome from these discussions was not surprisingly fairly wishy-washy: “an agreement to reduce excessive trade imbalances, with indicative guidelines being agreed at a later stage.” We don’t see this preventing on-going unilateral action by countries to protect currency competiveness and expect tensions to remain.
Nearer to home the publication of the Comprehensive Spending Review received lots of press coverage although there was little change from the first release in June of this year. UK Q3 GDP data surprised on the upside, leading some commentators to suggest that QE by the Bank of England might be shelved. However, closer inspection of GDP data suggests this was lead by deferred contracts in the construction space whilst consumer spending remains muted. The Bank may wait to see what the U.S. does.