While You Were Sleeping: Asian Developments Loom for Financial Markets
Markets Reach Record Highs
Equity markets crawled slowly higher last week, with both the S&P 500 and Dow Jones Industrial Average reaching new highs to end the week. The S&P 500 and the Dow Jones closed above 1,800 and 16,000, respectively, for the first time amid Janet Yellen’s imminent confirmation as the next Chairman of the Federal Reserve. The Senate banking committee approved her nomination late last week, sending her now for approval by the full Senate.
The Fed took center stage amid discussions about Ms. Yellen and the release of minutes from October’s FOMC meeting. The transcripts captured investors’ interest, in particular, as the group’s discussions hinted at the long-awaited taper in coming months: “Many members stressed the data-dependent nature of the current asset purchase program, and some pointed out that, if economic conditions warranted, the Committee could decide to slow the pace of purchases at one of its next few meetings.” With that said, most of the FOMC characterized economic growth in the second half of 2013 as weaker than anticipated, but maintain their more optimistic projections for 2014.
A flurry of economic data was released last week, spanning inflation, housing, and consumer-related sectors. Overall, the data was positive, although some key concerns persist.
On the inflation front, the consumer and producer indices indicate a significant lack of pricing pressure. Both of the headline indices declined in October, mostly as a result of softer energy prices. Core levels, which strip out food and energy, were also muted, at 0.1% and 0.2% for the consumer and producer measures, respectively.
The key takeaway from last week’s inflation data is that the Fed still has a clear runway for quantitative easing should it so desire. With an inherent lack of money velocity in the economy, additional dollars being pumped into the system have not yet led to greater inflation.
Retail sales were the positive surprise last week, increasing 0.4% in October. Economists have expected little to no increase in the measure, owing to decreased consumer confidence in the wake of the near-debt default and budget debacle in Washington. The report served as a reminder that consumer sentiment and confidence reports are only so helpful in gauging spending behavior.
The prior month was also revised slightly higher for retail sales, from an initial reading of -0.1% to 0.0% in September. Part of the monthly swings were caused by motor vehicle sales, which rebounded from a contraction of 1.2% in September to a gain of 1.3% in October. Gasoline sales were weak, however, declining 0.6% in the month.
The housing market took another hit last month, as existing home sales fell 3.2% to a seasonally adjusted annualized rate of 5.12 million sales. This is down from a rate of 5.29 million in September, and 5.39 million in August. Sales declines were observed across the country, suggesting that broader macroeconomic factors are at work. Although mortgage rates have eased recently, the back up in rates and relatively tight supply in 2013 are believed to be a headwind for the market. Ongoing labor market sluggishness is also an impediment.
While You Were Sleeping; Asian Developments Loom for Financial Markets
Amid all the Fed talk dominating airwaves and headlines, a few key developments occurred overseas last week that could shape financial markets significantly in the quarters ahead.
The first was in Japan, where a long-awaited decision by a government-appointed panel could structurally shift the make-up of large institutional portfolios. The group was designed to evaluate the asset allocation methodologies of the country’s largest pension fund, the $1.21 trillion Government Pension Investment Fund (GPIF). The thought is that any move by GPIF could have implications for other large institutional plans in the country.
Japan’s pension funds are significant holders of Japanese government bonds (JGB’s), and viewed by some as the crucial lynchpin holding that $8.4 trillion market together. The impact of any structural allocation shift by these entities is significant; Towers Watson estimated that Japanese pension fund assets totaled $3.7 trillion in 2012. That same study found that Japanese pensions have by far the highest bond allocation of their major global counterparts, save the Netherlands, at approximately 55% of assets.
Global Pension Allocations 2012
Source: Towers Watson
The Chairman of the panel, Takatoshi Ito, an economist and professor at Tokyo University, released the final recommendations last week. That report suggested that GPIF further reduce its holdings of domestic fixed income from its current target of 60% in favor of riskier, more diversifying assets. This includes investments in REITs, real estate, infrastructure, venture capital, private equity, and commodities. The recommendations are based partially on the assumption that Abenomics will be effective and that the country will enter a prolonged inflationary environment.
Source: Pensions & Investments
For many investors, the structural shift out of JGBs implies spillover effects for the country’s equity markets. Despite the robust gains already witnessed in Japanese equity markets this year, some market participants believe that Japanese stocks will be further fueled by this historic transition by the country’s long dormant pension plans.
Game changing news also arrived out of China during the week, although it too fell under the radar. As part of the announced reforms emerging from last week’s Communist party congress, the head of China’s central bank announced that the country will stop its practice of intervening in currency markets. China has long been accused of keeping the renminbi artificially low to help support its massive export apparatus. In recent years the country has been more responsive to the criticism, gradually allowing the currency to appreciate against the US dollar.
According to the Financial Times, some experts question the immediate impact of any such announcement. They note that China tends not to engage in any dramatic, sudden policy. Any loosening of the renminbi will likely occur in a more controlled, gradual fashion. Still, the implications for financial markets and global economics are indeed significant should the world’s second largest economy fully liberalize its currency. The US could find its export economy, for example, more competitive on the global stage should the renminbi move to a floating rate mechanism. Investors in Chinese equity markets would also enjoy the tailwinds of foreign currency appreciation, as just another such example.
As we wrap up the final month of 2013, investors should keep an eye on international developments that could impact their portfolios in 2014. Although events in Washington and chatter about the Federal Reserve have dominated the financial dialogue over the last few months, potential risks and opportunities outside of the US are bubbling beneath the surface. Investors would be wise not to ignore them.
The Week Ahead
There is more housing market data to digest this week, in the form of housing starts, the FHFA Housing Price Index, and the Case-Shiller HPI. Consumer confidence and durable goods orders are also on tap in the holiday-shortened week. Financial markets are closed Thursday for Thanksgiving and close early on Friday.
Outside of the US, a spate of economic data in Japan and Europe are due for release, including the UK’s GDP and Japanese inflation, unemployment, and industrial production. Manufacturing data from China is scheduled for the weekend.
Central bank activity is concentrated in emerging markets this week, with policy decisions expected from Israel, Hungary, Brazil, Thailand, and Colombia.
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