3% is not enough

The FTSE 100 regained nearly a third of last week’s losses on Monday, as the outcome of the Crimean referendum came as no surprise. It would have been very tempting for traders to come into Monday morning, positioned for a continued negative reaction by equities to the current uncertainties. As we often point out in these blogs, markets tend to move in a manner designed to give traders the most pain, and I would not be surprised if that was not the case on Monday. Whether this will be a short-term relief rally or a more sustained recovery is yet to be seen. 

Monday’s economic news will have helped boost equity markets. Firstly Moody’s, the credit rating agency, confirmed they believe the Chinese economy will grow between 7% and 7.5% in 2014 and 2015. Secondly, Eurozone year on year inflation for February was confirmed at 0.7%, 0.1% below the previous estimate. As we commented yesterday, this will see further pressure being put on the ECB to expand its balance sheet. In America, Industrial Production for February grew at 0.6% against an expectation of 0.2%. This report increases the possibility the Fed will taper by another $10bn on Wednesday. We have often argued that the ECB will probably introduce their own QE as the Fed tapers. This scenario looks a little more probable after today’s news. 

House builders in the UK and US were in the news on Monday. The UK names rising sharply as the Chancellor confirmed ahead of Wednesday’s budget, his intension to extend the help-to-buy scheme until 2020. In the US, the monthly house builder’s sentiment index for March rose slightly after falling sharply in February. 

Finally, there was an interesting article in the FT’s fund manager section, on Monday. The London Pension Fund Authority announced it has sold virtually its entire portfolio of UK gilts. The proportion of gilts held in a typical pension fund has grown substantially over the years, to the point that it can make up at least half of the overall portfolio. This was very different 30 years ago as fund managers held up to 80% of the portfolio in equities, as they saw this as the best way to protect capital over the long term in an inflationary environment. The fund manager was quoted saying “a 3% rate of return before inflation means we are not able to pay the pensions”.

If this trend of moving out of gilts continues, it will have two consequences. One the demand for gilts will go down, yields will increase as the governments ability to borrow in the market will become harder, as investors will want greater returns for their investment. Secondly, demand for other asset classes will increase, one of which is the equity market.

Posted on March 18, 2014 .