Stockwatch: Why markets look well-supported

Equities remain in overall bullish form, affirming the base-case I advanced a couple of months ago - about attractive dividend yields in a low interest rate scenario.

Lately there has been a wobble, after the US Federal Reserve indicated it could raise interest rates again this June, against expectations for no such action then. This needs following for its potential effect on emerging markets, but the likelihood only of a 0.25% increase in the federal funds rate won't alter the appeal of equities (with adequate cash flow-supporting dividends).

The upward march in oil prices continues to encourage risk-taking. Few shocks have appeared among companies reporting in the UK and US. Brexit campaigners increasingly struggle to convince wary voters that 'leave' is no treacherous step in the dark. So, barring surprise bad news, markets look supported.

US interest rate rise: mind the wider risks

Consensus was that dovish talk from Janet Yellen, chair of the Federal Reserve Board, implied scant chance of another rate rise since last December. Minutes from the April board meeting then suggested June could in fact see another rise, if only another 0.25% from the current range of 0.25% to 0.5%.

The Fed may be prioritising the US economy, but monetary tightening will be felt more widelyThe dilemma - as I explained in April's macro piece - is the US labour market tightening even as some economic numbers slow, i.e. "stagflation", risks making it tricky to normalise monetary policy. GDP and durable goods orders are weak, yet consumer spending and the housing market are doing well enough to meet the Fed's criteria to raise rates from historically very low levels.

Mind the risk for emerging markets with substantial dollar debts - especially in Latin America, Asia and South Africa - also given the dollar is liable to strengthen with rate rises. The Fed may be prioritising the US economy, but the extent of interdependency nowadays means monetary tightening will be felt more widely - potentially also to reverberate on the US.

Pessimists note the yield curve - i.e. the difference between short-term and long-term US Treasury bond yields - is very narrow at 0.92%, half its level of two years ago and generally a negative for economic growth.

Yet this may be explained by short-term yields rising in expectations the Fed is now on a rate-raising path, while long-term yields have fallen as foreign buyers of US Treasury bonds avoid negative returns in their own countries.

Oil price reaches $50 a barrel

The story has shifted from a production glut to "outages" (supply disruptions) and US inventories falling sharply, with far less incentive for traders to go 'short'.

Mind that Saudi Arabia and Iran have indicated they will keep increasing exports, with Iran defiant of any production freeze - so fundamentals may yet check the oil market's bullish tone. And if Iran goes its own way, what chance for discipline around a freeze among other OPEC numbers? Their history of co-operation has rarely been good.

Long/short trading on margin is exacerbating near-term trends, helping volatility continueThe psychologically significant $50 mark is also liable to encourage US shale producers, thereby boosting supply. There really needs to be more evidence of global demand, i.e. economic recovery, to sustain oil's rally, but the latest Chinese data, for example, shows state-owned firms' 2016 profits down and debts up - that is, credit-fuelled growth having hit diminishing returns. Oil has risen despite the fundamentals looking cautious, but at some point reality catches up.

The longer term may still offer upside. With oil & gas discoveries down to the lowest level since 1952 as exploration is pared back, Morgan Stanley posits that, on current trends, only two-thirds of demand will be met by 2030 - and assuming only very modest demand as a result of global warming.

Such a timescale is highly conjectural, given the scope for alternative energies to develop, but it captures a long-term case for buying oil exploration and production stocks on the dips created by excess supply. Long/short trading on margin is exacerbating near-term trends, another reason for volatility to continue and present opportunities.

EU referendum to revive sterling and boost stocks

It's a rumbustious debate, yet not enough Brits appear to have the stomach for the "step in the dark" that Brexit represents economically. A recent poll suggests 55% of voters back 'remain' versus 42% for 'leave', but you can discount the polls to sense 'leave' campaigners are anyway struggling to fully counter the risks that 'remain' portrays.

Sterling and UK equities will likely gain a modest reprieve closer to 23 June, with a relief rally thereafterA broadly conservative British mindset is unlikely to engage with such a route, despite social concerns over immigration and its pressure on housing and public services. The majority won't risk jobs, lifestyles and sterling's spending power abroad to make a go of it. This is my belief - despite intending to vote 'leave' because a new future outside the EU is what I'd prefer Britain to create.

Since the consensus in the financial community favours Remain, the likely scenario is for sterling/UK equities to gain modest reprieve closer to 23 June, with a relief rally thereafter. Voting can always mock predictions, but I'd not fret about Brexit and a leadership crisis in the government happening.

Renewed yuan weakness: a genuine risk issue?

Conspiracy theorists have alighted on the yuan/renminbi's latest fix of 6.5693 versus the US dollar being the weakest since March 2011, as if the Chinese are devaluing their currency to make exports more competitive.

Beggar-thy-neighbour devaluations will follow, a downwards spiral into deflation, they suggest. Part of the problem is this term "fix", which comes across deviously, despite being simply a reference point around which the currency can trade 2% higher or lower.

The Chinese central bank is also taking into account US dollar strength after US new home sales rose the fastest since early 2008; the dollar is an important reference point in the bank's goal to make the yuan more internationalised and market-based.

It's going to need a more vivid "black swan" to upset the case for equitiesThat is consistent with the Chinese currency joining the IMF's special drawing rights basket, as it evolves as an international power. I'd put more emphasis on risks with the Chinese authorities renewing debt-driven infrastructure spending as a means to sustaining economic growth rates.

A conspiracy theory to take more seriously, perhaps, is to what extent yuan weakness represents capital flight in fear of economic crisis - although action is being taken against banks facilitating this against the law.

So the macro context essentially continues as I have portrayed it in the last two end-of-month pieces: broadly encouraging, yet with scope for jitters when events surprise. It's going to need a more vivid "black swan" to upset the case for equities.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.