The Lowdown on Markets to 11th December
World Markets at a Glance
In this week’s issue
- Global equity markets suffer from a weakening crude oil price and currency disturbance.
- As uncertainty returns to the market’s volatility rises in the form of the CBOE Vix Index.
- The price of crude oil retreats by almost 13 per cent to reach its lowest level in 7 years.
- Whilst commodity prices have tumbled throughout the year there are winners and losers.
- The Chinese unveil a new index to gauge the level of their currency against others.
- This week’s focus will now turn to the Federal Reserve Banks decision on US interest rates.
What does this mean for the markets and asset classes?
“Stock markets react to weaker oil prices and further currency disturbance”
It was a difficult week for equity markets as concerns mounted over the extreme drop in the price of crude oil, concerns that the Chinese authorities might devalue the renminbi again, and reports that investors have been selling out of high yield bond funds in anticipation of a Fed interest rate hike this week. This in turn, generated a wave of volatility which saw the CBOE Vix Index, rise by 63 per cent over the five day trading period. Certainty, the next few trading days are likely to see markets react to the Fed’s decision; however, it would seem that risk assets have already anticipated that they will announce their first interest rate hike in a decade.
“The oil industry does experience booms and busts, history has taught us that”
Looking over the events of last week it was very apparent that the markets became very nervous over the extent that the price of crude oil fell, indeed, it retreated by nearly 13 per cent over the week reaching a level not seen in 7 years. Obviously, the oil industry does experience booms and busts, history has taught us that, however, the recent collapse in the oil price is its deepest since the 1990’s which is a concerning.
Certainly, we have seen corporate earnings for many of these companies fall dramatically in recent times, after making record profits in previous years. In turn, this has led to the decommissioning of nearly two thirds of the oil rigs, with a sharp cut in investment and production. More than 200,000 oil workers have lost their jobs and manufacturing of drilling and production equipment has fallen sharply. Indeed, we have even seen the Gulf pull out some US$19 billion from some of the largest Sovereign Wealth funds as they have been forced to raid their portfolios as the crude oil price has tumbled.
“Some investment bankers, and commodity analysts believe that the price of Brent Crude Oil will fall below US$30 a barrel”
Clearly, this has led to some concern that it will be many years before we see the price of oil back up to anything like US$100 a barrel. Indeed, some investment bankers, and commodity analysts believe that the price of Brent Crude Oil will fall below US$30 a barrel sometime in 2016, particularly, if we see oil inventories continue to rise as supply outstrips demand, and when Iran begins to add to the supply glut when their sanction is lifted sometime next year.
Clearly, there are winners and losers when we experience volatile price movements in either oil or commodities, indeed, any motorist, or home owner, will eventually benefit from the pump or tank, as the prices of petrol, heating oil or natural gas prices begin to fall. Equally, this means that many households spend less on utility costs and more on other consumer products. Likewise, for those countries that are oil importers, such as Japan, China, South Korea and India will be beneficiaries of the recent collapse in the price. In the same way, companies that are in sectors such as consumer discretionary, airlines, transportation and automobiles should reap the benefits from weaker prices.
“There are winners and losers when we experience volatile price movements in either oil or commodities”
Similarly, those that export oil such as Venezuela, Iran, Nigeria, Ecuador, Brazil and Russia are just a few petro states that suffer from weakening oil prices, which in turn, have severe ramifications for their economies and can therefore create political disturbances. Even countries such as the United States can suffer as regions such as Alaska, North Dakota, Texas, Oklahoma, and Louisiana being to hurt from the effects of lower oil prices.
Arguably, this year’s fallout in the commodity markets has caused some real serious anxieties in the markets, given that it might be a signal that there is a serious slowdown in global demand and that any economic benefit from cheaper costs for consumers and businesses might be counteracted by the cutting of investment and loss of jobs in the resources sector.
Turning towards another area of indecisiveness is in the foreign exchange market whereby we have seen currencies in the emerging markets suffer from the uncertainties of any future Federal Reserve Bank decisions and the potential problems that this might create if the US dollar were to strengthen excessively, as the cost of borrowing rises, and in turn, creates an emerging market crisis.
“Before the Chinese devalued their currency in August the renminbi was trading close to the US dollar”
Clearly, this seems to be weighing heavily on the minds of the Chinese authorities [PBOC] as they try to slowly loosen the renminbi’s peg against the US dollar, particularly, since the PBOC feel very uncomfortable with US monetary policy. Obviously, before the Chinese devalued their currency in August the renminbi was trading close to the US dollar dragging their exchange rate higher with the appreciating dollar.
Understandably, any appreciation of the renminbi is increasingly at odds with the weakening Chinese economy as it hurts their exports, therefore, what the authorities decided to do last week was to create a new FX index, or in simple terms, to create a basket of currencies so at to monitor the competiveness of each of these countries goods and services against the Chinese currency.
Obviously, this had an immediate effect on many of the emerging market currencies, as speculation mounted that any forward weakness in the Chinese renminbi might encourage other policy makers in developing countries to weaken off their currencies, which it turn, could escalate into a further period of “currency wars” around the world. Unquestionably as we have seen in 2015, central bank monetary policies have continually manipulated currency markets and it would not be a surprise to see this tactic continued throughout 2016.
“The focus will now firmly turn towards the Federal Reserve Bank”
And so as we enter this week, the focus will now firmly turn towards the Federal Reserve Bank, and whether they think it now appropriate to raise US interest rates. Certainly, the Fed fund futures are predicting a rate rise, given that the US economy is doing fairly well, unemployment continues to fall and the fear of deflation has subsided. However, what might still be problematic for the US central bank are the global economic uncertainties that are still being created outside of the United States and what affects they might have on their economy in 2016.
Regrettably, the impact from the recent weaker oil price, uncertainties surrounding the weakening Chinese economy, and any forthcoming monetary tightening in the US seems to have already taken its toll on the markets; therefore, most professional investors are unconcerned about the outcome of this week. However, they are showing some concerns about the possibilities of further rate hikes in 2016 and how aggressive the Fed might become over time.
Indeed, looking back since the financial crisis, every central bank that has tightened have had to subsequently retreat, therefore, there is more than a chance that if the global economy weakens through harmful forces and the US economy falters then the Fed might need to undo any interest rate increase they have implemented, in fact, a mild recession in the US cannot be ruled out over the next 12 to 18 months.
With just a few trading days left in 2015, and the “Santa Claus Rally”, seemingly rather elusive, we now need to focus our minds towards next year’s investment themes both strategically, and perhaps more importantly tactically, Clearly, as we have experienced this year central bank policies are likely to continue affecting market sentiment, especially as they diverge, and of course, the returns that might be achieved through the various asset classes as events unfold.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum, he worked within a larger asset managers, primarily as an Investment Director with Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Committee.
This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed.
Investment Quorum is authorised and regulated by the Financial Conduct Authority .
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