US interest rates are now on hold for at least another month and bond yields are set to rise only slowly at best. This means investors will continue looking for other ways to generate income in their portfolios.
Seeds of doubt in the outlook for the global economy may have been sown by the Federal Reserve’s (Fed’s) decision this month to keep US rates at their current record low. And the most recent bout of jitters in equity markets may have been exacerbated by weakness in the latest index of manufacturing activity in China.
We still believe that these fears are overblown. As we’ve noted in recent editions of Global Markets Weekly, the Chinese economy is still growing at an enviable pace of over 6% per year. It has a highly competitive manufacturing sector, strong domestic incomes and spending and lots of room for government and central bank stimulus.
Furthermore, the Fed’s decision was in line with our long-held view that rates wouldn’t need to rise until late this year at the earliest. We still think the US economy is strong enough to warrant a gradual rise over the coming year (see our 18 September Wealth Watch for more detail).
Major government bond markets have rallied recently as growth scares have resurfaced. At the same time, equity markets are factoring in substantial dividend cuts in the automotive sector in the wake of the costly Volkswagen emissions scandal.
We think this provides a good opportunity to shift some of our exposure away from expensive government bonds towards other forms of income. Conditions are favourable to get income from dividends,which now look even cheaper compared to bonds.
We also continue to like UK commercial property and see high-yield bonds as a better source of risk-adjusted income than higher-quality, but overly expensive, government debt and investment-grade corporate bonds.
Key data & events this week
|Tuesday||Eurozone business and consumer sentiment; US and UK consumer confidence; UK mortgage approvals|
|Thursday||Global manufacturing PMIs|
|Friday||US jobs data|
Keeping an eye on emerging markets
It’s been a rough month for emerging market equities. The MSCI Emerging Markets Index fell by 14% between the beginning of August and the low point. In fact, it hasn’t been this low since it was climbing its way out from the depths of the global financial crisis in 2009. All this might suggest that we should be following the rest of the market and cutting our losses. But we take another view.
Much of the fall has been currency-based, hitting commodity producers – typically in Latin America – the hardest. These markets may be due for a rebound if the exchange situation changes, when we could see an improvement. Manufacturing countries have fared better and fallen less severely. In South Korea and Taiwan, for example, valuations are being sustained by demand in the developed economies for the consumer goods they produce.
While there’s a risk that emerging markets could fall further, we’re still positive on risk assets in general and we don’t think this is the time to sell. Instead, we’re maintaining our positions for now and looking more closely at regional allocations.
Low supply + high demand = rising UK house prices
The latest RICS UK housing data show that limited supply is holding back the number of both transactions and new instructions. Meanwhile, the property website Rightmove pointed to a lack of properties on the market and cheap borrowing as key drivers behind the biggest September advance in UK house prices in its own index in 13 years.
When UK rates do eventually rise, which we think will be sometime next year, the increases look set to be gradual and limited. That should keep a lid on mortgage payments and support continued demand from buyers. With supplies likely to remain limited and demand holding up, we see room for UK house prices to continue rising.
Developed government bonds expensive
Yields on government bonds are at historic lows, making them an expensive source of income.
Euro dividend yields better than bonds
We think that dividend yields on European shares are attractive relative to global government bonds.
EM manufacturers weathering storm
Within the emergingmarkets, manufacturing-based countries like South Korea are outperforming commodity producers like Brazil.
UK housing surveys still pointing
Tight supply, high demand and low interest rates mean that UK house prices are likely to keep rising.
Developed and Emerging Equity Markets
Performance (%tr, local) As of: 25 September 2015 Current -1W -1M -3M YTD 14 Developed Equity (MSCI) 1,217.5 -1.5 1.6 -9.3 -2.8 10.4 FTSE All Share 3,361 -0.1 0.6 -8.6 -2.1 1.2 FTSE 100 6,109 0.1 0.6 -9.4 -4.1 0.7 S&P 500 1,931 -1.4 3.6 -7.7 -4.8 13.7 Nasdaq Composite 4,687 -2.9 4.1 -8.1 0.2 14.8 DJ EuroStoxx 326.0 -1.6 -2.6 -12.2 4.6 5.0 Nikkei 225 17,881 -1.1 0.5 -13.7 3.4 9.0 Hang Seng 21,186 -3.3 -0.4 -21.0 -7.4 5.5 Emerging Equity (MSCI) 43,933 -3.3 2.0 -13.1 -7.0 5.6 BRIC (MSCI) 476.2 -3.5 0.9 -17.8 -7.0 5.8
10-Year Bond Yields
Change (basis points) As of: 25 September 2015 Current -1W -1M -3M YTD 14 US Treasuries 2.17 4 3 -22 -1 -83 UK Gilts 1.84 0 -6 -30 9 -128 German Bunds 0.65 -2 -10 -21 11 -140 Japanese Government Bonds 0.33 1 -5 -13 0 -41
Performance (%) As of: 25 September 2015 Current -1W -1M -3M YTD 2014 Commodities (TR) 178.3 0.9 2.6 -12.3 -15.2 -17.0 Brent Crude Price (Spot) 47.3 0.0 12.8 -21.8 -13.6 -50.3 Gold Bullion (Spot) 1144 0.7 0.8 -2.5 -3.5 -1.8 Industrial Metals (TR) 194.3 -3.4 -0.9 -14.4 -22.0 -6.9
Current Inflation (%) Interest Rate Forecasts (%) Rate Announcement Next Date
Current Dec '15 (F) Mar '16 (F) United States (Fed Funds) 0.2 0.25 0.50 0.50 28 October United Kingdom (Base Rate) 0.0 0.50 0.50 0.50 8 October eurozone (Repo Rate) 0.1 0.05 0.05 0.05 22 October Japan (Call Rates) 0.2 0.10 0.10 0.10 7 October