Castlefield's Market Insight - May 2015

The first quarter of 2015 saw further gains across equity markets as investors responded to the combination of stabilising energy markets and a European Central Bank (ECB) clearly set on implementing policy moves to avert the threat of widespread deflation. This latter point is particularly crucial given the continued pressures in the Eurozone periphery, where ratios of government debt to GDP remain elevated and where the risk of a generalised and widespread fall in prices is something the ECB is determined to try and avoid. Initial signs have been that market participants have reacted favourably to the size and scope of the ECB’s action, albeit the fact remains that Eurozone governments must play their part too as regards implementing stimulatory policy, rather than simply relying on the ECB.

Here in the UK, interest rates and our own quantitative easing programme remain at the levels prevailing for a number of years now. The apparent move nearer to an initial rise in interest rates given the improvement in employment data and wage growth has been questioned anew given the energy-induced drop in the inflation rate. This potential delay has been favourably received by equity investors, while the moves in the Eurozone have further boosted sentiment given the importance of the region to the UK as a trading partner. This more sanguine environment has come despite the continuing headlines about a potential Greek exit from the single currency.

One of the most notable developments over the past couple of years has been the importance of currencies as a means of policy transmission for many of the major sovereigns. Devaluing one’s currency has often been seen in financial history as a means to an end, even as far back as the Roman Empire when the silver content in its coins shrank from 100% to 0% in little over a century. In modern times, Japan has explicitly set out to weaken the Yen as part of the ‘Abenomics’ strategy, whilst the ECB is likewise striving to achieve a weakening of the Euro in order to boost competitiveness in the region. Other nations such as Switzerland and the USA have seen their currencies strengthen significantly with their perceived “safe haven” status a major driver of demand for the currency (and ironically Japan’s currency had strengthened in such a fashion previously, hurting business for its exporters and leading directly to the move described above).

In fact, one of the most notable developments over the period involved the Swiss Franc and the unexpected decision to remove the ceiling imposed on the currency against the Euro. This ceiling – set at a level of 1.20 Francs per Euro – had been in place for some three-and-a-half years as a response to the sudden and sharp appreciation of the currency at the height of the Eurozone debt crisis in the summer of 2011. It was a policy being pursued with the “utmost determination” given the desire to prevent further damage to its exporters’ competitiveness; however, with the ECB clearly hinting that it was to launch its quantitative easing programme there was a risk of substantial new inflows into Swiss assets, which could have forced even greater intervention from the Swiss National Bank (SNB). The key here is the financial cost to the SNB of maintaining this policy that was being suffered had reached the stage where a further worsening could not be justified. The result was one of the most stunning days in currency markets, with the removal of the ceiling seeing the Swiss Franc strengthen as much as 39% against both the Euro and the US dollar intra-day. There were also large moves observed against other major currencies such as Sterling. What became apparent as the day unfolded was that despite the FX market being one of the most liquid and freely-tradable asset classes available, many participants were unable to trade at the prices apparently shown on screen. Over the following days, a number of FX broking houses went out of business as a result of losses incurred by these moves, as it quickly became apparent that some people had become complacent in assuming that the Swiss position would not change. The financial markets are a great leveller in that regard, with an old adage about trying to pick up pennies in front of a steamroller brought home to roost. Not engaging in such speculative activity is the best way to avoid such losses!

Finally, no-one can avoid the impending General Election. Still shaping up to be closely and bitterly contested, the outcome is unclear and markets never like uncertainty. It would therefore be no surprise if UK equities make little progress before the outcome is known and investors can anticipate the policy outlook for the next few years. Whether the UK ends up committed (or not) to a referendum on Europe will be perhaps the most important issue.

The divestment campaign continues apace, with many leading global universities and institutions either committing to selling their shares in oil & gas extractive companies, or at the least investigating whether they should do so. This indicates that the wider investment community is catching up with what our clients have recognised for many years, namely that climate change cannot be ignored.

One of the results of the sharp fall in the oil price was that ethical funds avoiding exposure to the sector saw favourable performance. This reinforces the point that investing in such areas risks both environmental and financial costs.

Moving away from the market discussion, the wind of positive change continues to blow in many corners of the world. In particular, the movement to divest from fossil fuel investments has gathered rapid pace, boosted by President Obama speaking on legislating to tackle climate change. Senior management at oil and gas production companies have remained unflinchingly unconcerned (at least publicly) about the threat to their businesses, with heads firmly buried in the sand. They can’t see that the tide is turning against them. Of course, it isn’t all good news here, with the UK government continuing to row back on support for renewable energy sources whilst bending over backwards to promote shale energy production. But the most important point is that these industries are growing, and fast. Elsewhere, pressure continues to be applied to companies to pay the Living Wage to all employees. These are significant steps forward.