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27 April 2015

Who would have believed that a new asset class would spring up, called ‘negative-yield bonds’. It should be an oxymoron – but tell that to the European sovereign bond market, where at the end of the March quarter, about 30% of the securities on issue showed negative yield.

Paying to lend money? Huh?

‘Negative yield’ means the bondholders are paying the issuing government to hold their money. The bonds guarantee losses for buyers who hold them to maturity. Why would a rational investor do this? Only because they expect the yield to go further into the negative – that is, the securities to appreciate in price before the investor sells them to a bigger fool, before they come due. A decline in global inflation means holders of negative-yield bonds can expect prices to rise (slowly) in the future.

Even German bonds – the top-rated debt in the Euro zone and the bloc's benchmark – offer negative yields out to maturities of five years. (Just after quarter’s end, Switzerland became the first sovereign to issue ten-year debt at negative yield.)

Although bond yields grinding lower is nothing new in bond markets, the dive below the break-even line of European bonds in the first quarter came on the back of the long-awaited announcement of sovereign quantitative easing (QE) in the Eurozone. Indeed, monetary easing is in vogue; more than 20 central banks cut rates during the first quarter, the Reserve Bank of Australia (RBA) included. Bonds are still in bubble territory and prices can’t be sustained. All bond market participants are well aware that the US Federal Reserve grows ever-closer to lifting rates, with the economic data to decide just when that happens.

Frozenomics returns, US lacklustre

On that score, the quarter revealed that the US economy grew at an annual 2.2% in the final quarter of 2014, but plenty of economists fear some of that momentum dissipated in the first quarter of this year. Non-farm payrolls added only 126,000 new jobs in March, down from a downwardly revised number of 264,000 in February, and the first time that US jobs growth did not beat 200,000 since February 2014.

Not only was the March US employment report a disappointment, other data, notably durable goods orders and retail sales, was also anaemic. However, as occurred a year ago, there was an element of ‘Frozenomics’ in reading the March quarter tealeaves, because some fairly extreme winter weather weighed on US economic activity in the quarter. The US economy is still expected to be the engine of global growth in 2015.

‘Grexit’ fears weigh on Europe

Politics dominated the European outlook early in 2015, after a coalition of radical left-wing parties – known as Syriza – won power in a snap election in Greece. Syriza promised to re-negotiate Greece’s crippling debt, which immediately put the country at odds with the rest of the Eurozone, which saw that as default and grounds for expulsion from the Eurozone (the so-called ‘Grexit’).

With debt talks at an impasse and Greece’s status as an EU member hanging by a thread at the end of the quarter, there was a danger that investors might have missed the clear signs of economic recovery – albeit modest – across the Eurozone, helped by lower oil prices, a weakening euro and improved confidence on the back of the Zone’s stimulus program. EU bulwark Germany again led the economic recovery, posting in March the fastest increase in private sector activity since May 2011, while France slowed, but unambiguous good news for the Eurozone came from Spain where there is very positive momentum in that economy.

The Organisation for Economic Cooperation and Development (OECD) lifted its growth forecasts for the Eurozone, and now expects an expansion of 1.4% in 2015 and 2% in 2016. By comparison, it expects the US economy to grow by 3.1% this year, easing to 3.0% in 2016.

China slows, Japan exhibits life

In Asia, the news of the quarter was the People's Bank of China’s (PBOC) unexpected rate cut in February, just three months after a previous piece of rate surgery. That implied slower growth, led by the country's cooling property market, and this was borne when China's official first quarter growth slowed to 7% annualised, down from 7.3% posted in the December quarter, and the slowest pace since the global financial crisis in 2009. However, economists see the PBOC as having plenty of ammunition – and willingness – to stimulate the Chinese economy further.

In Japan, the Bank of Japan’s ‘kitchen sink’ approach to economic stimulus brought dividends, but not quite the hoped-for robust recovery. However, Japanese shares continued to rise on the back of healthy corporate earnings.

Market round-up

Global sharemarkets were mainly positive for the quarter, with European equities the stand-out. US stocks posted modest returns in the March quarter, with the S&P 500 Composite Index managing a 1% rise, while the Dow Jones Industrial Average edged ahead by 0.3%. The star index was the Nasdaq Composite, which put on almost 4% and pushed through the 5,000-point level for the first time since 2000.

Despite the headline difficulties with Greece demonstrating the stock markets are easily rattled, European stocks surged ahead over the quarter, bolstered by improving economic data, falling energy prices, a weaker Euro and the European Central Bank’s aggressive stimulus program. Most European markets showed double-digit gains for the quarter, in many cases seeing some of the best quarterly returns in years.

After a slight dip in January, Australian shares had a strong quarter as investors flocked to the nation’s high-yielding stocks in the wake of the RBA’s February interest rate cut. The interim (December 2014) reporting season was characterised by dividend payout expectations being either met, at worst, or exceeded. The big four banks drove the quarter’s 8.7% rise in the S&P/ASX 200 Index, all showing double-digit gains. With the low interest rate environment likely to prevail for some time, the local market is poised to benefit from increased takeover activity and a continuation of domestic investors’ hunt for yield – in particular, the increasingly influential self-managed super funds (SMSF) contingent.

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