The FTSE-100 index climbed to 6,840 towards the end of May representing its highest level for five years.

Cause for Optimism

This rally was largely driven by economic stimulus programmes undertaken by central banks around the world in order to boost growth. As central banks have injected money into financial markets, known as ‘Quantitative Easing’ (‘QE’), the return on government bonds has fallen to unprecedented levels. This has resulted in institutions having large amounts of cash to invest and turning in many cases to equities so as to target higher returns. Another boost for markets came from better than expected figures from the US where consumer confidence and unemployment figures have started to show encouraging signs of improvement.

Market Volatility and Sell-Off

However, markets were quickly brought back down to Earth in June as prices tumbled 10% over a period of just five weeks, further demonstrating the volatility that continues to characterise the investment climate. The sell-off in markets was based on fears of a credit crunch and slowing growth in China, as well as talk of a reduction in the QE by the US Federal Reserve sooner than expected.

Turbulence continued to affect many emerging markets with news of riots taking place in Brazil and Turkey bringing political instability. Alongside this, the Indian Rupee recently sank to an all-time low against the US dollar.

At the end of June, the Federal Reserve Board Chairman, Ben Bernanke, announced that the Fed may taper its quantitative easing bond-buying strategy by next year. You could be excused for thinking this was a positive sign of economic recovery, however, the news represented a level of uncertainty which did not sit well with the markets. It remains to be seen how the Bank of England will react once Mark Carney picks up the reins in July.

There was also cause for concern in China as fears of a credit crunch emerged following a tougher economic approach from the new premier, as well as the lowest period of growth in China for almost 30 years. China represents the world’s second largest economy and as a result, any dips are felt in markets worldwide.

Europe also remained in the spotlight as weak growth data and largely poor employment figures continued to cast a shadow over the Eurozone. Alongside these factors, June traditionally represents a bearish month as fund managers are less active resulting in generally lower trading volumes.

Markets

The table below shows the performance of key global markets in local currency terms, US dollars, and UK sterling terms, including dividends re-invested between 1^st April and 30^th June:

In local currency terms, Japan has once again outperformed other indexes, the US showed a small gain whilst the UK showed a small loss of 2%. Hong Kong demonstrated the largest losses with Europe showing no change. However, it must be remembered that currency has played a significant role over Q2 as in Q1 which makes the gains in Japan seem a little less impressive.

Outlook for July to September 2013 (Q3 2013)

Looking ahead with cautious optimism over the coming months, in our view markets do not appear ‘over-priced’ at current levels and there are some selective buying opportunities on a medium-term view. Even if the market remains flat, dividend yields alone offer the potential for income in excess of cash deposits and keeping pace with inflation. Investment markets are likely to remain volatile throughout the next quarter as the global economy continues its slow route to recovery.

Despite the recent dip in markets, the general outlook is still positive. The Eurozone appears to be stabilising and a reduction in unemployment figures in Spain is a welcome sign. Whilst one eye should be kept on developments in America and the emerging markets, there are reasons to be optimistic with regard to our own economy. Recent British manufacturing data showed the strongest period of growth for two years. There were also encouraging signs of growth in the retail and construction sectors. Further to this, the housing market also seems to be picking up with mortgage approvals hitting their highest level in May since December 2009. The service sector too, which accounts for almost 75% of the UK economy, increased at the fastest rate for more than a year.

Markets tend to over-react and this may be the case with the recent market falls on the back of Bernanke’s recent announcement concerning QE in the US. He has stated that the US Federal Reserve will only cease to stimulate the US economy once unemployment figures reach 6.5%; and it is unclear when this target will be met.

An example of a market which has performed particularly well of late is Japan. The Japanese economy responded positively to president Abe’s economic stimulus to counteract deflation which resulted in a $103 billion stimulus package and the appointment of a Bank of Japan governor who has targeted 2% inflation per year. 

Our Approach

We expect that investors will continue to regain trust in the markets which should eventually bring stability. However, it will not all be plain sailing, as we have seen with recent speculation concerning QE in the US; there will be bumps along the way, bringing continued volatility. Portfolios will require careful monitoring.

This means that there will be a continued search for yield as investors rotate out of low yielding cash and bonds and into equities. Whilst the timing is impossible to predict, this should inevitably support equities, pushing prices higher. However, bonds should not be readily dismissed either in our view – they continue to offer essential diversification to portfolios and provide valuable income.

With interest rates likely to remain low for some time to come, UK equities and funds, which give exposure to Asia and other emerging markets, appear to offer the most attractive prospects for longer-term growth after the recent market correction.

Following Mark Carney’s recent appointment as Governor of the Bank of England, it will be interesting to see what changes are made in order to focus on growing our economy and help ensure future financial stability.

Our approach will be to help our clients benefit from equity returns and target sustainable dividends, whilst continuing with our diligent research and analysis to highlight attractive investment opportunities and mitigate risk as far as possible.

[Matthew Clark, Milford & Dormor Financial Planning Financial Planners Ltd, 3 July 2013]

Please note, our Investment Commentary is our view of markets and does not constitute investment advice. If you would like investment advice on your individual circumstances, please do not hesitate to get in touch.