Things that go bump in the night


It’s a curious thing. Why do some people like the feeling of being scared while others don’t? One only needs to consider the growing hype surrounding Halloween to see the commercial value we put on being scared.

Which got us thinking. A bit like the investment landscape, investors can have very different objectives. Some may be thrill seekers while others may be more risk averse. Which is why risk assessment is a key part of our investment process.

On a long-term view China appears to be a reasonable story, but have current share valuations become devolved from reality and is it a possible horror story in the making? Up over 125% in the last year, the approximate size of the Shanghai Composite Index is now estimated to be a staggering £3.5trillion. This is roughly equivalent to the combined aggregate values of the FTSE 100 at an estimated £1.9trillion and Euro Stoxx 50 at an estimated £1.6trillion, both with numerous long established businesses. The Shanghai Composite’s median price-to –earnings ratio, has reached 75, yet the index is still 25% off its 2007 peak.

While the UK stock market is itself not without scare stories, generally the level of reporting disclosure and due diligence provides investors with a fair degree of security, when making investment decisions. It is interesting to note therefore the extreme volatility of some Chinese growth stocks. For example Hanergy Thin Film Power Group plunged 45% in a day, wiping $18bn off its market value after a six fold increase in the previous 12 months. Its chairman failed to turn up for the AGM! Goldin Financial, which had risen over 350%, collapsed 43% in a day, wiping $16bn off its value. Stratospheric valuations of technology start-ups and new business models? Haven’t we been here before?

We could all awake to things that go bump in the night.

What have we been watching?

European markets remained sensitive to news stories from Greece ahead of the next IMF repayment due on the 5th June. Apart from Greece and its creditors agreeing on the need for a quick deal on the repayments due, it appears that little progress was actually achieved over the weekend.

e83dec2e-e9c5-4758-8d47-9156e9236308
In the UK, a survey by the CBI revealed retailer confidence at the highest level since 1988. The hoped for upward revision of Q1 GDP failed to materialise with growth of just 0.3%. This backward looking data didn’t really have any material impact on the market but does highlight, once again, the challenge for the UK in re-balancing the economy. That said, with a Conservative majority Government now in place, the outlook for the second half of 2015 should be more favourable.

d531b9ab-e558-43f7-a52c-9edc30c5eb40
In the USA, Q1 GDP was revised downwards although this had been widely anticipated by economists. Durable goods orders slipped slightly in April but key non-defence capital goods spending increased. In addition, the Conference Board’s measure of US consumer confidence improved further in May while US new home sales grew more than expected. This data was viewed as re-assuring after the raft of soft economic data and suggests that US Q2 GDP and that for Q3 is on a much firmer footing. Not surprisingly, the US Dollar continued to strengthen as the data increased the likelihood of a first interest rate hike from the Fed in September.

Japan Flag
Japanese stocks remained at a fifteen year high even though the BoJ policy meeting revealed that some committee members felt that inflation would not meet the central bank’s target in the 2017 fiscal year.

China Flag

 

In China, the Shanghai Composite Index was propelled to a seven year high in response to Beijing’s plans to seek private investment in $300bn of infrastructure projects and the opening of Hong Kong registered funds to Chinese investors. Official data remains mixed with PMI readings for May showing manufacturing edging up to a six month high while the services sector remains at its lowest level since 2008.

Oil Drum
Oil drifted lower as the US Dollar continued to strengthen. This week sees the latest OPEC meeting which, is unlikely to see any change in stance given Saudi Arabia’s current commitment to production. Brent 12 month futures continued to trade around $66.

Finally, we have all become accustomed to central bank support for the global economy or Quantitative Easing but what happens when this ends? Well, first clues from the Bank of Japan. It has been putting aside 25% of its annual profits, equivalent to about Y200bn, from its monetary easing programme. This is because it estimates that, if it were to raise interest rates from zero to 3% which, would be consistent with its longer term 2% inflation target that it could possibly suffer several trillion yen a year in operating losses.

This is a reminder, should one be needed that when interest rates rise, someone, somewhere takes the pain. No wonder the US Fed is being so careful with its guidance for the path of US interest rates. While future rises may be gradual, when the US interest rate cycle turns global investors will need to be careful.

Full version