Bernanke Clarifies Policy; Bond Prices Rise

in Market Commentary by

Market Digest – Week Ending 7/19

Gains were modest relative to last week, but virtually every major asset class ended in positive territory. In congressional testimony, Bernanke provided further clarity on bond purchases, helping persuade investors the Fed would remain accommodative. This resulting fall in short and intermediate term rates lifted bond prices. Foreign and domestic stocks also increased, as did gold and most commodities. The dollar weakened.

Weekly Returns:
S&P 500: 1,692 (+0.7%)
FTSE All-World ex-US: (+1.4%)
US 10 Year Treasury Yield: 2.48% (-0.10%)
Gold: $1,295 (+0.9%)
USD/EUR: $1.314 (+0.5%)

Major Events:

  • Monday – Citigroup reported a 42% jump in profit, beating consensus estimates.
  • Tuesday – US industrial output increased more than expected on strong automobile sales and lean inventories.
  • Wednesday – In congressional testimony, Ben Bernanke said the tapering of asset purchases is “by no means on a preset course”.
  • Wednesday – The International Monetary Fund warned China on its capital account liberalization, stressing a need for caution.
  • Thursday – Detroit filed for bankruptcy protection in the nation’s largest ever municipal case.
  • Thursday – With a lack of shareholder support, Dell delayed voting on the $24.4 billion buyout by Michael Dell and private-equity firm Silver Lake.
  • Friday – China’s central bank announced it will eliminate certain interest rate controls, a key step towards financial market reform.

Our Take:

This week the IMF warned China on its plans for capital account liberalization (i.e. deregulating and further opening financial markets). Specifically, they stated a more gradual approach would help prevent shocks to nation’s financial system and economy. It’s always encouraging to see China embrace more market-oriented reforms, but we agree this transition should be a cautious one.

As part of these new reforms, foreign investors will gain greater access to China, and Chinese investors will gain greater access to foreign markets. While both are good, the latter could seriously impact growth if poorly executed. With few viable alternatives, Chinese investors have long turned to real estate as their primary form of investment and store of wealth. These speculative investments have fueled skyrocketing home prices across major cities, with many large condo complexes sold, yet completely vacant. There was a period of pullback in 2012, but prices have since resumed their upward march. The resulting rise in wealth has helped drive consumer spending and economic growth.

But if the Chinese were suddenly offered unlimited access to foreign markets, a potentially lucrative and easier alternative to real estate, the nation’s property bubble could burst. This would place significant downward pressure on household wealth, and virtually derail the government’s transition to a consumption based economy. As such, the government will need to take a more cautious, measured approach to these reforms so as not to choke of growth. So far this appears to be the case. Just today the central bank announced it is eliminating curbs on interest rates, but left the floor in place on mortgage lending—a move designed to prevent further speculation in real estate.

 

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Brendan Erne, CFA
Brendan Erne serves as the Portfolio Management Team Leader with Personal Capital Advisors. He has over 15 years of industry experience, spanning almost all levels of the investment process, including several years at Fisher Investments as an equity analyst covering the Technology and Telecommunications sectors. He also co-managed a large cap growth portfolio and co-authored Fisher Investments on Technology, published by John Wiley & Sons. Brendan is a CFA charterholder.

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