Investment markets are being driven by two trends, as bonds predict a gloomy outlook of low growth, but optimistic equities surge into a bull market.
The FTSE 100 closed above 6,282 this week, a rise of more than 20 per cent from the low of 5,537 it touched on 11 February.
A bull run’s a promising sign, but it’s at odds with the depression of bond yields, where a flurry of demand has pushed down the return from bonds and simultaneously raised their prices. In the UK, a gilt maturing in 2018 traded with a negative yield, part of a broader trend where $11.7 trillion of global bonds give investors negative yields. Unilever, Sanofi and Allianz have all issued zero coupon bonds with next to nothing yields.
“In the past year people have reacted with amazement to what bonds are doing,” says Jim Cielinski, global head of fixed income at Columbia Threadneedle Investments.
Typically, bond yields heading downwards is a sign an economy isn’t doing well. Taken at face value, “we have priced out the notion that central banks will raise rates or that there will be inflation”, Cielinksi says, adding that this assumption has been applied by investors looking ahead into the future.
Investors look at what’s going on in the market for signals as to what’s coming next, and at the moment the picture looks muddied. Traditional signals aren’t clear.
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It’s expectations of more market-boosting QE that has driven share prices up. Bank of England governor Mark Carney is thought to be poised to add an extra $250bn in QE when the minutes of the monetary policy committee meeting are announced on Thursday. He is also expected to cut interest rates to a new history-making low of 0.25 per cent, known as “easing” monetary policy.
“Easier monetary policy and previous periods of QE have been rewarded by the equity market. The extra liquidity has found its way into the stock market,” says Dean Turner, UK economist at UBS Wealth Management.
That’s great in one sense, but the bigger work of QE has been to distort market signals. In this vein, the rise in the FTSE 100 isn’t necessarily positive, but nor are bond yields at these levels foreboding doom. Since QE and pension regulation are driving demand for bonds, their price depression says little about the future outlook. “In this TINA, or ‘there is no alternative’ market, investors are being pushed into risk assets regardless,” says Peter Toogood, investment director of City Financial. “Bull market territory sounds jolly exciting but the index is below the level it was a year ago and in January 2000.”
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In the UK, movements in the FTSE 250 are probably a better signal to watch. “The FTSE 250 is down 4 per cent since the referendum. It’s probably more instructive of what is going on… It’s likely to be hit by a weaker UK economy,” says Turner.
It remains to be seen how the UK will fare post-Brexit, but there are some signs of hope. “Before walking into Brexit, the UK economy was bumping along quite nicely. So an extended spell of lower interest rates for longer should be supportive of the consumer economy,” says Bryn Jones, head of fixed income at Rathbones.
“Of course, a great deal of unanswered questions remain about life post-Brexit. I suspect there may be some fiscal stimulus through corporate tax cuts to help keep businesses in the UK, which again is something that is helping to keep the FTSE elevated.”