There have been two particularly notable surprises so far this year that have affected markets.
The first was the situation in Ukraine as Russia effectively annexed Crimea and raised the threat of a more aggressive advance into eastern Ukraine. Recent events have now led the markets to believe that this risk has been reduced following Russia’s declaration that it has no interest in the Ukraine beyond Crimea which provided a positive backdrop for equities.
The other big surprise of the year so far came from China, where the economic data was persistently weaker than expected. Maybe that in itself was not so shocking, as many pundits had already drawn attention to the build up of debt and the tricky transition from an economy fuelled by investment to one built on consumption.
The real surprise, perhaps, was the yuan, which investors, particularly the more speculative variety who tend to leverage their trades with borrowed funds, had come to see as a one-way appreciating bet. The Chinese government decided to “re-educate” the market with around a 3% fall in the currency relative to the dollar. This fall might not sound dramatic, but we are now in a position where the yuan is worth less than it was a year earlier against the dollar for the first time since 1994.
That is a huge statement by the People’s Bank of China, especially as it has imposed severe pain on many Chinese companies who have been using spare cash and borrowed funds to play this “carry trade”. Indeed, much of the trade had the yen on the other side, as that was deemed to be the one-way depreciation bet. So not only has this policy change unsettled domestic Chinese companies, it has also put a spanner in the works of “Abenomics”, given that yen depreciation is a key component of Japan’s policy to create more inflation and growth.
It is also worth mentioning that there been $38bn worth of IPOs worldwide so far this year, which is twice the value of the same period in 2013. Positively, it is a sign of the confidence of both companies and investors. Negatively, high levels of IPOs have been associated with market peaks, as investors lower their quality thresholds in the rush to get involved in the “next big thing” and unscrupulous issuers take advantage of this to market more speculative ventures. Matters might not be extreme just yet, but the valuations that have been ascribed to, for example, AO World (already listed), Just Eat and King Digital are eye-watering. Of course, some of these companies will go on to become the new category killers, the Amazons and eBays of the future, but it’s worth also remembering that even great businesses can become hideously overvalued and markets can be unforgiving of any that disappoint.
In the US, the Federal Reserve reversed their decision to tie future interest rate rises specifically to the unemployment rate, instead promising to take into account a “wide range of information”, including labour market conditions, inflation expectations and financial markets, which effectively means they can do pretty much what they want.
However for now they said that “a highly accommodative stance of monetary policy remains appropriate”. That didn’t stop them reducing the monthly purchases of bonds by another $10bn to $55bn, which was also entirely as expected.
At a domestic level, the headline announcement during the budget was the decision by the Chancellor to liberalise the pension market by removing the need for defined contribution pension holders to buy an annuity. The current regime taxes cash withdrawals (above the initial tax-free allowance) at 55%.
The new regime now means pension holders can withdraw capital from their pensions at their marginal income level. This will clearly encourage a significant number of pensioners to release cash from their pension’s via draw-downs.