Market Bulletin - Minus signs?
Last week’s continued market volatility reflected an array of fears but positives remained – investors should not be swayed.
Last week, stock markets continued to flash red, pushing some of the world’s leading indices close to bear territory (defined as 20% below the previous peak). The S&P 500 fell 1.3% last week, while the FTSE 100 was down 2.4%, although a welcome bounce on Friday trimmed the losses.
Commentators and market participants alike struggled to agree on a first cause: oil, banks, China, global growth and interest rates were all offered up as possible drivers of the dip.
Yet to underline the extreme nature of current short-term volatility, and the need for investors to ignore it, early trading this week told a very different tale: the Nikkei rose more than 7% (buoyed by a weaker yen and despite news of worse-than-expected economic performance in the fourth quarter) while both the FTSE 100 and S&P 500 were on a sharp upward trajectory at the time of writing.
The reality is that stock movements in 2016 have been very far from mirroring global growth dynamics – or even the broad corporate outlook. Instead, a few familiar fears have led markets to decouple from economic fundamentals. The trend is nothing new and, as this week’s opening goes to show, it is rarely a permanent phenomenon.
“January’s stock market swings have continued into February,” commented Luke Chappell of BlackRock. “Although the US is experiencing slower growth, following a period of economic recovery since the financial crisis, we expect US consumer spending to remain resilient, aided by lower oil prices. We do not expect this slowdown to turn into a recession.”
Last week Janet Yellen, chair of the US Federal Reserve, struck a cautious note when speaking to Congress, although she said that the Federal Reserve remained committed to a path of gradual rate rises. She pointed to troubles in China and unsupportive financial markets as providing significant risks.
“These developments, if they prove persistent, could weigh on the outlook for economic activity and the labour market, although declines in longer-term interest rates and oil prices provide some offset,” she said.
It was the kind of sober analysis typical of central bankers, but it was also a helpful corrective to the market’s current tendency to view the economic glass as half-empty. An analysis of money and credit data released last week by Capital Economics showed that the world is unlikely to be facing an economic downturn. Moreover, last week there were a few data releases that indicate global growth remains on track.
In the US, weekly jobless claims fell to 269,000 in the week ending 6 February, far lower than the expected 281,000, indicating that the country’s job market is holding steady in the face of turmoil elsewhere in the world. US retail sales, announced on Friday, were up 0.2% in January – above expectations. The eurozone economy grew 1.5% in 2015 as a whole, significantly up from 0.9% in 2014. India announced economic growth of 7.3% in the fourth quarter of 2015 – even allowing for a suspected statistical fiddle, the country is on a very encouraging growth trajectory.
One of the most significant fears on markets is the state of the financial sector – and memories of what troubles in the sector meant for the global economy back in 2008. Following poor earnings results, a number of leading banks’ stocks have fallen by 20–30% in 2016; and last week it was reported that Deutsche Bank, Germany’s largest bank, was looking to buy back several billion dollars’ worth of its debt. Yet markets may have been overreacting: on Friday, US bank shares had their strongest day since 2011 and Deutsche Bank rose 12.1%.
“Markets are ignoring the fundamental improvement in bank balance sheets – we do not believe that there is any solvency or liquidity risk in the top-tier banks,” said Paul Causer of Invesco Perpetual. “Price moves are not distinguishing between strong or weak banks and do not reflect fundamentals. BNP [Paribas], ING and Intesa, for example, have just announced increased dividends, for which regulatory approval was required and granted.”
Indeed, among the reasons that banks are being attacked are the increased capital safeguards introduced by regulators, which have encouraged banks to keep their borrowing at lower levels.
“Banks are struggling a bit as a consequence of banking regulations – because it’s so expensive for them to run big loan books, liquidity has deteriorated,” said George Luckraft of AXA Framlington. “Deutsche has unwound much of its book [i.e. reduced its lending]. But everyone is wrongly over-interpreting these developments as signals that something deeper is wrong.”
There can be no certainty about the short-term direction of markets, which are likely to remain volatile. The key for investors is to avoid being swept up by the current storm and to continue to keep in mind both longer-term goals and the wider economic picture.
Last week, Sweden’s central bank moved interest rates from -0.35% to -0.5%, adding further impetus to the negative rates momentum gathering around the world. There is increasing expectation that the Bank of Japan and European Central Bank will aid markets by extending their own forays into negative rates.
Japan currently seems to need that helping hand more than most. Last week the Nikkei 225 dropped a hefty 11.1% on a number of related concerns, but then made up most of the loss again on Monday. A strengthening yen has been undoing the good work of quantitative easing and could pose a major challenge to the health of the country’s export companies. This week, however, the yen started to fall once again.
Haruhiko Kuroda, Japan’s central banker, may have a soul mate in the form of his European counterpart Mario Draghi, who was dubbed ‘Super Mario’ for his success in introducing a radical programme of quantitative easing – despite the constraints of European politics. Last week the FTSEurofirst fell 4.0%, as concerns about banks continued to tell.
Such falls can imply some kind of banking crisis, yet European banks are in a fundamentally different state today than they were in 2008. One of the ECB’s roles is to provide ‘emergency overnight lending’ to European banks which need liquidity. Daily loan requirements last week were in the tens of millions of euros – on Tuesday, they spiked to €127 million. In 2008, however, daily loan highs reached some €25 billion – adding weight to the view that comparisons between then and now are somewhat misplaced
“Balance sheets are considerably stronger now,” said Paul Causer of Invesco Perpetual. “We do not believe that we are back in a banking crisis. Recent moves do not reflect any fundamental decline in bank solvency or the liquidity of the region’s largest banks. With equity valuations back at levels not seen since 2012 and tier 1 debt [which regulators view as fundamental to a bank’s financial strength] now offering double-digit yields, we are seeing more opportunity than we have for several years.”
Slipping and sliding
Oil provided another potential negative on markets last week. The price of Brent crude flirted with a dip below $30 a barrel, before enjoying a surge on Friday that took it to around $33. The supply glut remains the chief issue for oil companies, although it benefits both industrial and retail consumers. In the long term, rising demand will not allow oil to remain so cheap, but the price of a barrel may yet fall further before it rises.
As with oil, so it is with many of the other worries currently stalking markets; a combination of short-term factors and excessive market panic is driving prices lower. In the meantime, global (and Chinese) growth continues, banks are in a much better state than they were before the crisis, and global oil demand is not about to stop rising.
There are plenty of minus signs in markets at the moment that might concern investors, but they are not proof of negative economic fundamentals. Investors should focus on the big picture, and wait for the storm to pass.
AXA Framlington, BlackRock and Invesco Perpetual are fund managers for St. James’s Place.
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