As several recent surveys, including our own Capital Confidence Barometer, have shown, there is a heightened perception of risk for both the investing community and those executives charged with running our largest companies. This risk is comprised of many different strands: geopolitical, financial, regulatory, and even medical. It is important that we can recognise and appreciate these risks; but equally important that we react appropriately in the face of each and not overreact.
Everything is down – or is it?
With the International Monetary Fund again downgrading global economic expectations it could lead people to think all is doom and gloom. And yet, as Mr. Olivier Blanchard, Director of the IMF Research Department said, “I have always been a bit skeptical [sic] of this world growth number. In this case, I think it is potentially misleading in the sense that it hides different evolutions across different countries, and more so now, I think, than in the recent past. You have some countries which have recovered or nearly recovered, and then you have others which are still very much struggling. So, one needs to go and look at it more or less country by country.”
The same could easily be said of recent volatility in equity markets, outflows from various asset groups, downward pressures on most commodities and energy prices, and big swings in exchange rates.
With the S&P 500 at an all-time high less than a month ago, and the FTSE 100 at similar levels, the recent slide in equities, outflows from high yield, and a steep fall in oil may appear to be an overreaction to a recent stream of bad news, including the above downgrade, poor German industrial results, and increasing concerns about Ebola. These news releases are negative, but in and of themselves not enough to cause such a slide.
However, is it the disconnection between various data releases that is causing this overreaction, combined with the overhanging bogeyman of QE and rate hikes? As we get a suggestion that Chinese growth may be slowing, this causes the oil benchmarks to fall, which eases inflationary pressures in the US and UK, which pushes rate hikes out a few more months, but increases deflationary pressures in the Eurozone, which are then offset by a falling Euro, with the stronger Dollar making oil more expensive for companies in the Euro-bloc, which increases the likelihood of full-blown QE in the area, which drives down the Euro against the Dollar and Sterling, which impacts export earnings……..you get the point. Investors have had a very easy ride since immediately post GFC. They now have to learn about looking at fundamentals again, and this is causing quite a bit of the current volatility. There will be asset classes that appreciate in value over the coming months, just as there will be sectors and countries which will outperform. The key is to understand which ones, and just as importantly, why.
Psephology gets it wrong, which makes it more interesting
In the olden days calling the results of forthcoming elections was quite simple. Pollsters would appear on TV and tell us that such and such a party or politician was due to win. Not any longer. With the rise of different forms of media and a diversity of forums for political discourse, the forecasting of electoral results has become much harder. The recent first round of voting in the race to be the next President of Brazil was a good example of the current trend. Ms. Marina Silva was expected by many to win the first round, with incumbent President Dilma Rousseff expected to come second. What actually happened was Mr. Aecio Neves came second, behind President Rousseff, with Ms. Silva a distant third. Mr. Neves, a pro-business candidate from the centre-right, will face a final run-off with President Rousseff on October 26th. Current polls suggest it is too close to call. This, I suspect, is the answer psephologists may be giving quite often in the near future, especially closer to home next May.
The geopolitical ramifications of the coming UK election will make the post Referendum questions seem risible in comparison. While we may not get the pre-election guidance we have been used to we will certainly be interested in the eventual outcome.
3Q earnings season: will it be like 1Q or 2Q?
3Q earnings season in the US kicked off with Alcoa reporting another strong set of results. This would make it seem like a rerun of 2Q reporting, where US corporates overwhelmingly reported strong numbers (unlike in the UK and Eurozone, which were mixed). However, we will have to wait and see how the full reporting season goes, in the US as well as UK and Euroland, before deciding if there is also a disconnect between corporates and the economy. With the US economy less exposed to foreign markets than the S&P 500 (US exports 13.5% of GDP; S&P 500 foreign earnings 46.3% of revenue) it may be that we will have to dig a little deeper to understand where corporate earnings are pointing to a particular form of risk.
Not one size fits all
It was good to see Jean Tirole awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for 2014. His work on how to control overly powerful corporations’ in modern economies, especially his understanding that each solution must be specific to the sector and particular circumstances, has influence wherever regulators take an interest is such matters.
With the tide of mega-mergers set to continue (with discussed and discounted and rumoured bids in consumer products and mining among others), and the associated regulatory risks such deals entail, Mr. Tirole can expect some extra royalties from his many books, especially The Theory of Corporate Finance, to add to his well-deserved prize money.