Standard Life Investments - Q2 2016 Global Review

In Brief

• Investors endure another volatile quarter
• The UK's vote to leave the EU leads to a marked sell-off
• the US Federal Reserve takes a more dovish stance on interest rates
• Bond yields hit historic lows
• The Real estate sector also had a difficult second quarter

Global Review

Concerns about the global economy, the direction of US Federal Reserve monetary policy and the UK’s EU referendum debate were the main talking points this quarter. Equity markets were volatile for much of the review period. Economic data from the US and China remained mixed, although the Eurozone continues on the road to recovery thanks in part to ongoing accommodative monetary policy from the European Central Bank (ECB). Perhaps the biggest event was the UK’s vote on 23 June to leave the EU. Markets across the world sold-off and bond yields fell in response, although many have regained their poise. Meanwhile, it was a strong quarter for most commodities, with the oil price climbing on supply disruptions. There was also a halt in the rise of the dollar.

Sentiment towards UK equities was dominated by the prospect, and eventually the outcome, of the country’s referendum on EU membership. With macroeconomic concerns driving investor positioning as much as bottom-up company fundamentals, volatility remained heightened in the lead up to the vote. This was especially true in June when investors grew increasingly sensitive to opinion polls that suggested the result was likely to be extremely close. However, the ‘leave’ vote, when it arrived, still came as a shock and ushered in a period of intense upheaval in UK risk assets.

Q2 was a mixed bag for US investors. First-quarter GDP was revised higher to 0.8% on a seasonally adjusted annual rate, although the June non-farm payrolls numbers were well below expectations. This, combined with uncertainty emanating from the UK’s referendum vote, saw the US Federal Reserve adopt a more dovish stance on rates. This position was cemented when the vote favoured the ‘leave’ campaign. The dollar and equity markets dropped in response; however, the latter staged a mini recovery over the closing days of the quarter.

Over April and May, European economic data was broadly mixed, while the health of the Italian banking system, the looming UK referendum on EU membership and US interest rate speculation were key influences of investor sentiment. While this still formed an uncertain backdrop, European equities were able to make positive progress. However, this trend went sharply into reverse at the end of June as markets sold-off aggressively in response to the surprise ‘leave’ result of the UK’s EU referendum. The uncertainty over the economic and political impact on the rest of the EU engendered by the vote poured cold water on risk appetite.

Japanese equities had a bumpy quarter, as a sharp increase in the yen put pressure on the country’s exporters. The Bank of Japan’s decision not to launch any further stimulus measures at its April meeting further dented sentiment. Meanwhile, the UK’s EU referendum result saw shares retreat and investors flock to the yen for its safe-haven status. There were some bright spots, however, including Prime Minster Abe’s decision to postpone hiking the consumption tax until October 2019 and a recovery in the oil price.

Asian markets, like most around the world, had a volatile quarter. The period started well on expectations of further Chinese economic stimulus and hopes that US rate increases would be postponed. Commodities, both metals and oil, continued to strengthen. Thereafter, sentiment soured on disappointing results for a number of Asian exporters. Markets took this as a sign to lock-in profits. However, as the quarter came to an end, markets tumbled after the UK’s surprise vote to leave the EU. This, though, does increase the likelihood of further monetary and fiscal stimulus as governments look to minimise the fallout.

Risk appetite slowly began to return in April and yields for gilts, Treasuries and bunds all rose as a result. However, this changed when May’s US non-farm payrolls report (for April) disappointed expectations, increasing the prospect of a further delay to a Federal Reserve rate hike. In the UK, polling surrounding the EU referendum began to hint that a ‘remain’ vote was not a guaranteed outcome and this sparked a gradual flight-to-quality, which supported UK gilts. When the ‘leave’ result was eventually announced, it sent shockwaves through global markets and yields fell dramatically.

At the beginning of the quarter, commodity prices stabilised, which provided a boost to risk appetite. In the UK and Europe, investors were comforted by the ECB’s planned purchase of corporate bonds, which provided support to spreads. In June, the UK’s EU referendum result was met mostly with surprise by investors and credit spreads dramatically widened, while sterling plummeted against the US dollar. However, by the end of the period, credit spreads had mostly recovered, as investors adopted a ‘wait-and-see’ approach to the market uncertainties.

UK commercial real estate endured a difficult second quarter, with slowing capital and rental value growth resulting in moderating total returns. Investment decisions were also put on hold ahead of the EU referendum, putting further downward pressure on capital values. The investment hiatus reportedly had most impact on Central London. Following the referendum, investors delayed a significant amount of transactions or cancelled them due to heightened uncertainty.