August angst, September…..?

Takeaways: So much for the summer break! Deal frenzy, spectacular market dives and the odd rebound. In modern sporting parlance, we can take the positives: earnings resilience, US recovery and a continuing M&A boom. However, it’s hard to escape the shift in mood. The last month has highlighted (again) how much market confidence is still based on the support of central banks and a strong Chinese growth narrative. What’s different is that China looks like more of an enigma than ever, whilst central banks appear to hold less of a whip hand over markets – and the biggest look set to take their stabilisers away.

Whilst we wait to see if the global economy can pedal fast enough to regain equilibrium, companies can expect a wobbly period of uncertainty feeding into contract delays with demand, currency and price fluctuations that will throw up winners as well as losers.

Goodbye August Angst…

August Asset PerformanceThe August asset performance chart (left) barely scratches the surface of a remarkable month. For equity markets, there’s a roll call of ‘worst since’ the crash or 2011/2. Oil prices were up overall, but only after a rollercoaster that included a dive to a six year low and 25%+ rebound in just three sessions! Gold prices were up – when the music stopped – but this wasn’t part of the normal flight to safety you’d expect when equities go haywire. US Treasuries just crept into positive territory and Bunds dipped.

These mixed signals from the markets in many ways highlight the mixed signals from the relevant authorities and the increasing confused outlook that look set to typify September  – and possibly beyond.

Conflicting narratives

Analysis by Gabriel Sterne of Oxford Economics for fastFT shows that ‘Black Monday’ hit advanced economy equity markets harder (13%) than recent shocks, such as the mid-2013 tapering tantrum (8%). So far this is relative small fry against Eurozone crisis (15%), dotcom burst (40%) and global financial crisis (50%), but it would be premature to say this period has played out.

Markets continue to fluctuate, with three positive narrative strands providing periodic backstops. The first is a continued faith in earnings recovery driven by continuing evidence of a modest, but still resilient economic recovery in the Eurozone and more robust growth in the UK and US. Eurozone unemployment fell to a three and a half year low of 10.9% in July. The US economy rebounded more than expected in Q2. UK exports have finally picked up. This suggests that earnings have the potential to maintain a positive momentum. Excluding the energy drag, S&P 500 EPS growth would be +7.8% in the same period.

Linked to this narrative, is the continuing boom in M&A, where US volumes and values already exceed 2014. The final component is a belief in China’s economy to avoid a disorderly decline, linked to the ability and willingness to of the authorities provide support where necessary – as per last week’s interest rate cut. Fitch Ratings are just one agency that has come out in the last week to say ‘Black Monday’ was ‘likely overdone’.

But – and you knew there was one – the doubts that sparked the sell off this August are developing deeper roots – all of which have the potential to insidiously undermine the foundations of the narrative above. As Albert Gallo, at RBS noted last week, much of the post-crisis recovery is predicated on faith in the central bankers not necessarily to re-start growth, but at the very least to set the tone. If China can’t manage this, who can? This doubt feeds into the increasing uncertainty surrounding the next move for Chinese authorities, how far they will deviate from the path of rebalancing and market reform – and the long-term consequences if they do pull back.

Plus, crucially,  there is a  dawning realisation that 6-7% growth in China is likely to be as good as it gets for a long time. This isn’t a blip, a dip in the cycle or a period to ride out. This is a long-term adjustment that the global economy – and individual companies – will need to make. Reading the statements of major car companies, plant & machinery, luxury goods companies you get the sense of how much this is the end of an era, especially for mature sectors, where Chinese offset slower growth elsewhere.

This is – of course – already playing out in many areas of the global economy. World trade contracted at its fastest pace since the financial crisis in H1 and this slowdown is visible in country and company fortunes. Canada contracted in Q2. South Korean exports fell by 14.7% in August. Australia only grew by 0.2% in Q2. Likely candidates for FTSE 100 and mid-250 relegation – Weir, Premier Farnell, Lonmin – are global trade victims, making way for candidates primarily from disruptive & new industries –   e.g. IT security provider Sophos Group, asthma drug maker Circassia Pharmaceuticals and peer-to-peer lender P2P Global Investments. Periods like this can create odd winners, like Premier League clubs ‘saving’ up to £85m due to a weak Euro in the latest transfer window…if ‘the term saving’ can ever be applied here….!

The cherry on the cake of this building confusion and uncertainty is, of course, the on-going Fed ‘will they won’t they’ saga. The latest comments coming out of Jacksons Hole from Federal Reserve representatives sounded reasonably hawkish and US data is mostly positive. But ‘mostly’ isn’t entirely and this week’s manufacturing data will play to the ‘doves’ – if global market fluctuations aren’t enough to make them pause. The odds of about 40-60 in favour of holding in September sounds about right, but we have a few rollercoaster weeks of data to go including the now immensely significant non-farm payrolls on Friday.

…hello ‘susceptible’ September…

So, as for September’s moniker, ‘susceptible’ seems apt to start with….

Going back to that recent volatility in oil prices, Brent Crude’s three-day 25% recovery from its six-year low in mid-August came on the basis of two arguably very slight tightening signals from US supply data and OPEC, only for the price to fall by 9% on 1 September. That yo-yo sounds about par for September’s course. It’s a month where nerves will be frayed and confidence finely balanced. One piece of data could dramatically tip the balance between bull and bear as markets try to work out if the global economy really can pedal fast enough to offset Chinese and Fed inspired wobbles. It’s all up for grabs.

All of which makes it very tough to make predictions – but we’re ready to give it a go. Look out for our expectations for rest of 2015 in the next few weeks. A preview in a few words: volatile, divergent, costly…..