Last week was a very poor week for equity investors. Around the world, there were signs of slowing growth: weak data from China; multiple downgrades of global oil demand accompanied by further declines in prices; more stringent collateral requirements in China; and renewed angst over European politics. The dichotomy between the US and other countries was sharply represented this week by fund flows, with US exchange-traded funds gathering $2.5 billion of inflows, while those in Europe saw $1.6 billion of outflows. It was a particularly poor week for equity investors in Europe, led by the Greek stock exchange, as there is potential for the Syriza Party to triumph in a series of presidential elections, which start on 17th December. The Greek stock market plunged 18.6% on the week, and Greek bonds sold off. Other equity markets in Europe were also weak as the potential risk to global growth suggested by the declining oil price led to people fleeing those markets in anticipation of earnings downgrades.
In spite of a still-resilient economy, US assets are demonstrating that they’re not immune to the global slowdown. The S&P 500 traded down to a five-week low, with technology and energy leading the way down. Volatility, as measured by the VIX index, rose above the 20 threshold for the first time since October. This increase in volatility was consistent with the further widening of credit spreads, which are now at their highest level since June 2013. The sell-off in high yield has been largely driven by growing concern over energy issuers. Indeed, since the OPEC meeting at the end of November – when no cut in the quota was suggested – we’ve seen the spread on energy stocks rise by 260 basis points. The oil price is the central topic of the moment. Is it the canary in the coal mine, warning us about global growth declining, or is it actually a stimulus to global growth? It’s probably a bit of both in that we’re seeing reductions in energy intensity in a number of countries (China, in particular), but we would expect there to be some activity boost from consumers, who are now finding it cheaper to fill up at the pump. And that is the dilemma that investors find themselves in, because bond markets are rallying strongly: last week, US 10-year Treasuries touched 208, which is the lowest level in over a year, and government bond markets in Europe also rallied.
Another big event of the week was the re-election of Prime Minister Shinzo Abe in Japan; the market will now be looking for an acceleration of institutional and structural reform over the next few months. However, it must be said that investors are a bit nervous as we head into year end. A couple of important things to look out for this week: firstly, as mentioned, there will be a Greek parliamentary vote for a new president, the final round of which will be held on. If the Syriza Party should prevail, we will need answers to the following questions: will they pull out of the euro? (They’ve said that they will not.) Will they renegotiate or ignore Greece’s International Monetary Fund payments and loans? (In terms of austerity, almost certainly, yes.) And would that be a crack in the eurozone’s recovery? Our view is that while there are some extreme parties in Europe, this is an unusual case, because Greece has suffered more than most in terms of the aftermath of the crash. The decline in European assets has as much to do with the falling oil price and the time of year, but there are concerns that the Greek presidential election will set off a kind of snowball effect. The other thing that spooked people about Europe last week was the relatively small take-up of the European Central Bank (ECB)’s targeted long-term refinancing operations. Investors still hope for quantitative easing involving sovereign-bond purchases by the ECB in the first quarter of 2015. Otherwise, as we head into year-end, Wednesday will be an important day, with the Federal Open Market Committee’s last meeting of the year. All eyes will be on the language of their statements regarding, specifically, whether they remove the reference to not changing rates for a “considerable” amount of time. Also, purchasing managers’ indices across Europe will give us a sense of how flat that economy is.
There is a hangover from this party; it’s being felt in high-yield markets & leveraged-loan markets most of all
It’s important, with regards to economic policy, to look beyond the stream of economic releases and remind ourselves that this is the time of year when markets tend to trade quite thinly. The only major issue that people are having difficulty with is the decline in the oil price. We can see this if we look at stock market indices again, because much of the decline in those indices and the widening in spreads is down to the energy sector. And the question that people want to look into as we move into next year is: has there been a lot of bad lending to energy companies that will impact our capital markets and our banking ratios? The answer is: there probably has been a lot of bad lending, because the oil price has been remarkably stable at a very high level for three years, which set off an increase in global exploration and production. So there is a hangover from this party; it’s being felt in the high-yield markets and the leveraged-loans markets most of all, and in the equity markets in terms of downgrading earnings forecasts for energy companies. But there are bright spots as well: this fall in energy prices is essentially a tax cut for consumers, and as we move into the new year, we feel that investors will start to look at the positive side of the coin as well, and will almost certainly be looking to bargain-hunt in equity markets.