Market rally in first half of year ends on volatile note

After a volatile month, global stock markets stabilised last week.

The MSCI All Country World Index rose 1.3 percent last week, partially recovering the previous week's 3.2 percent loss that had been driven by concerns of a tapering of bond purchases by the Federal Reserve.

For the entire month of June, the MSCI All Country World Index was down 3.1 percent. That cut its gain for the first half of the year to 4.7 percent.

Among the major stock markets, Japan's was the only one to have gained in June. It was also the best-performing stock market among major stock markets for the first half of the year.

MSCI index performance
	Local currency (percent)		US dollars (percent)
	June	1H 2013	June	1H 2013
USA	-1.50	12.50	-1.50	12.50
Japan	0.01	32.59	1.66	15.41
UK	-5.58	5.16	-5.54	-1.88
Germany	-4.50	1.85	-4.21	0.42
France	-5.40	2.68	-5.11	1.23
Hong Kong	-5.73	-2.86	-5.65	-2.93

In line with the rebound in stock markets, government bonds also recovered last week. The US 10-Treasury yield fell four basis points to 2.49 percent last week after having risen 40 basis points the previous week.

In his latest investment outlook published last week, William Gross described the recent market volatility as a case of market panic in response to the Federal Reserve's announcement of a likely tapering of its bond purchases. Investors had taken on too much risk and leverage. As they tried to adjust their positions in response to the Fed's announcement, selling begat more selling, hence the sharp fall in bond prices.

However, Gross advised bond investors not to jump ship now. He thinks that continued low economic growth and inflation will probably prevent the Fed from tapering its bond purchases. He also thinks that the 10-year Treasury should be yielding 2.20 percent, somewhat lower than at present.

In contrast to Gross, John Hussman says in his latest market comment today that a reduction in the pace of the Fed’s bond purchases is likely in the next few months. While he also sees little inflation in the near term, he says that inflation risks will become larger in the back half of this decade. He says that the current pace of purchases increases the risk of systemic disruption and financial distortion as well as the difficulty of eventually normalising monetary policy.

Still, Hussman thinks that Treasury bonds remain worthwhile investments. He thinks that weak economic growth and the lack of immediate inflation pressures will likely dissuade the Fed from selling its bond holdings and also keep short-term rates near zero for a very long time. This in turn is expected to support demand for medium and long-term Treasury debt.

However, Hussman is not as optimistic for stocks and corporate bonds. He thinks that the risk premiums for these assets have already become too thin. He says that stock market internals in particular have broken down “decisively” and that “this may be the highest level investors will see on the S&P 500 for quite some time”.