18 Feb Boom & Gloom: January 2016
Our view of the investment markets
This table reflects our view of the relevant assets, based on expected performance. After the recent strong rally in US bonds we have changed our view of the asset from buy to hold. We retain our overweight in precious metals where we favour platinum.
Drivers of the global markets
A couple of phrases have kept popping up the media over the past month: bear market, fast money, leverage and hedge funds.
So, what is driving the global markets?
Oil has been a critical driver of the market. The global oversupply has been the key driver of sentiment in the crude oil market since Saudi Arabia started a price war to squeeze the higher cost producers out of the market. The negative sentiment reached a peak in January, driven by huge expansion in the short positions of the oil derivative market.
The graph below plots the ETF short, long and net position, and the Brent oil price. Note the price movement as the short positions increase and get squeezed out as the price appreciates and the long positions spike toward month end.
The correlation between the oil price and high yield bonds has been increasing as risk appetite dissipates. This is partly due to the oil price’s exposure to the energy and materials sectors. We see a similar trend between oil and inflation expectations, inflation expectations have been retracing in line with the fall in the oil price, particularly since mid-2015.
The Chinese market
The second driver of global markets has been the Chinese market, especially the Yuan and capital flows. After years of strengthening, the Yuan has started weakening with the slowdown in the Chinese market (against a very strong dollar).
The weak Chinese growth numbers and sell-off of the equity market has led to a strong outflow of capital. The involvement of fast money added velocity to the market sell-off.
Fast leveraged money drove the Shanghai stock exchange to extreme highs, only before seen in the hype before the great recession of 2008.
Where does this leave us in a global context?
- Fast money and leverage are here to stay. In times of uncertainty we will see higher levels of volatility due to the effect of leverage and fast money.
- Global markets have reacted aggressively to the strong sell-off in oil and it will take time to adjust. Sharp CapEx and operational expenditure cuts have dampened markets. The positive effect of cheaper oil is still to be seen as the consumer, especially in the US, is biased to saving.
- The slowdown in China drove commodity prices down, aided by cheaper energy. Excess capacity in Chinese production disrupted global markets and is exporting deflation.
- The drivers discussed above have led the market to question the US Federal Reserve interest rate hike in December 2015, and have lowered the probability of hikes going forward. This has led to a correction in the US dollar over the past week or two, thus helping to stabilise commodity prices and driving safe haven assets like gold in the Japanese Yen.
- Looking forward, we believe that the dollar could sell off slightly more as the market digests slower interest rate increases in the US. This will be positive for US growth but will impact European export negatively, which has been aided by the weak euro over the past years. European consumer sentiment is still improving, leading us to believe that domestically-focused businesses should do well.
Total return to 31/01/2016, in domestic currency
Total return to 31/01/2016
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