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Markets had a mixed month in December, a feature for much of 2014, and missed out on an anticipated ‘Santa rally’ in the run-up to the end of the year in spite of a further fall in the price of oil, disruptive but broadly positive, and strong economic data from the US.
The cost of a barrel of Brent oil dropped further over the month from $70 to $57, half its level of $115 in June and now at the lowest for five years. While such a fall will both reduce supply as oil companies cut back on exploration and stimulate demand, in the short-term there may be further weakness as Saudi Arabia in particular is happy to maintain production to put the squeeze on the higher-cost producers, many of whom also have to at least maintain volumes to sustain revenues. A concern is that the considerable strain on countries that rely on oil revenues, such as Russia and Nigeria, will prompt political unrest and unwelcome diversions. By contrast it is usually a sharp rise in oil prices rather than a fall that presages problems for the world economy; lower energy costs boost consumer demand and have a dampening effect on inflation, which allows central banks to be more accommodating in their approach.
This is particularly the case in the US where the figure for GDP growth in the third quarter of 2014 was again revised upwards, from 3.9% to an impressive rate of 5.0%, the fastest since 2003. This follows growth of 4.6% in the second quarter, although that reflected in part a recovery from a drop in the first quarter when the weather was atrocious and companies cut inventories. The main driver of this growth is consumer demand, stimulated by the increased spending power that lower energy bills provides and by growing wages in a strong jobs market. While the estimated real increase in median income in the first eleven months of 2014 was just 1.2% this was better than in the previous two years. Non-farm employment has been growing strongly and the rate of unemployment has dropped to 5.8%, in part due to a longer-term trend of lower labour participation as the population ages. Yet in spite of the strength of the economy inflation remains subdued: the Federal Reserve does not expect it to rise to its target level of 2% before 2018. The Fed has adjusted its stance on when it may raise interest rates by saying now that it will be patient; the expectation is that the first rise will be around the middle of the year, and this has contributed to the strength of the US Dollar.
In the UK campaigning for the general election in May has started with a focus on the economy and the NHS, with immigration and the relationship with the European Union also key topics. If the book-makers are as accurate as they were for the Scottish referendum then the outlook is quite uncertain, as the odds indicate there will be no clear-cut winner either outright or in coalition. The Chancellor in his autumn statement on 3rd December found some interesting new policies, on stamp duty in particular, but the government is constrained by the persistent structural budget deficit, with income tax revenue lower than forecast. While corporate investment should be reasonably robust, much will hinge on the strength of consumer demand as the housing market slows and as the PPI compensation diminishes. Economic growth is not as robust as before and inflation remains minimal, such that there is unlikely to be a rise in interest rates from the Bank of England in the first half of 2015 and any increase will be gradual.
In the eurozone there have been renewed fears of a crisis following political developments in Greece, although both opinion polls and the stated opinions of the Syriza left wing party suggest that the fears may be overdone. Germany, the prime mover on the Continent, appears more willing to contemplate a Greek exit from the euro although still reluctant to countenance an easing of monetary or fiscal policies. With inflation (at a headline 0.3% or a core 0.7%) still much lower than its target of 2%, the European Central Bank is moving closer to a substantial programme of asset purchases through quantitative easing which if it is to expand its balance sheet as intended to its previous size of €3 trillion in 2012 would be a controversial purchase of sovereign bonds.
In Japan Shinzo Abe’s Liberal Democratic Party with its coalition partner won decisively the snap election called for 12th December, although the low turnout indicated a lack of enthusiasm for a vote nominally to sanction the logical deferral of a second rise in the consumption tax to 2017 after the dire impact of the first one in April 2014. The government announced at the end of the month an emergency stimulus package worth ¥3.5 trillion, designed to boost real GDP by up to 0.8% in 2015- 16. It will make it harder for the country to reduce its high level of public debt, which stands at some 245% of GDP and the currency is likely to stay under pressure. The main attraction in Japan lies in individual companies and the benefits of the improving returns on investment and to shareholders.
In China lower energy prices will provide a considerable boost to an economy that was slowing although still forecast to have grown at over 7% in 2014 and to achieve a similar rate in 2015. While the data is perhaps questionable any rate of growth above 5% is still significant for what is now on the IMF’s calculation the world’s largest economy on a purchasing power parity (PPP) basis. It thus dislodges the US, which had assumed the mantle from the UK back in 1872, although on a per capita basis there is still more to do. How well the Chinese government manages the further transition to a consumer-driven economy will be a crucial factor in the world outlook; the Shanghai stock market is certainly exuberant at present. Reduced demand for commodities from China and the strength of the US$ have weighed against a number of emerging markets.
Over the course of December the FTSE 100 index fell by 2.3% to close at 6566, giving a return for the calendar year of -2.7%; mid-sized and smaller companies have done a little better with the FTSE 250 index up 1.5% in the month to give a positive return for the year of 0.9% and the FTSE SmallCap index flat in December and down 1.4% for the year. In the US the S&P 500 slipped 0.4% in the month but still managed a rise of 11.4% for the whole of 2014 and the technology-oriented NASDAQ index was up 13.4%; the Russell 2000 index for mid-sized companies, by contrast, was up in the month but only by 3.5% for the year. In Europe the EURO STOXX 50 index was 3.2% lower in the month to give a return for the year of 1.2%; in Japan the Nikkei 225 index was flat and up an annual 7.2%; and the MSCI Emerging Markets index fell by 4.8% to give -4.6% for 2014. Bond yields mostly fell again in the month and the UK 10-year gilt moved from 1.93% to 1.76%; the FTSE Gilts All Stocks index delivered a return of 10% in the year, which was hardly anticipated at the start of it.
Sterling was little changed against the US dollar at a rate of $1.56:£, although 6% weaker for the year while against the euro it strengthened to €1.29:£, up 7% for the year. The price of gold rose by 1.5% to $1185 per troy ounce although it was down for a second successive year, albeit by only 1.7%.
2015 is likely to be an interesting and challenging year, but a productive one.
Julian Cooke – Investment Director 5th January 2015
All views are the authors own and do not represent those of SG Financial Services Limited.
DISCLAIMER: Any forecasts, figures, opinions or investment techniques and strategies set out, unless otherwise stated, are Vintage Asset Management’s own. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. They may be subject to change without reference or notification to you. The views contained herein are not to be taken as an advice or recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate and investors may not get back the full amount invested.
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