Global equities reached an eight week high this week. In the way this works now, this is partly because of some good news and also because of some bad news that becomes good news because it’s raised hopes for further/continued stimulus. While we all ponder how on earth we got into this confused state, here are six charts that we think explain the story so far. The early-2016 selloff was obviously overdone, but this rally remains a cautious one. Perhaps it’s because there’s more than usual up in the air and really no-one knows what count as ‘good’ news anymore. Combine this with the rapidity of structural change, data that isn’t all that it seems on first glance and it can be tough to get a firm handle on asset prices. Still, any respite is useful and we expect to see more companies active in the market if calm prevails.
- Safety first?
It’s hard to attribute much conviction to recent market rallies when gold and bunds remain the highest performing assets in 2016. Gold and global government bonds are having their best start to a year since 1980 and 1993 respectively. Japan has sold 10-year bonds with a yield below zero for the first time at auction. German 5-year bunds recently auctioned at an average yield of minus 0.36%, another record low.
Of course there’s a great deal going on here. Bund prices in particular are the sum of so many hopes and fears, including concerns about deflation and the chances of more ECB action next week. The latter is likely, but the bund market now appears to be indicating that it doesn’t expect Eurozone inflation to reach 1% for more than five years. This feels somewhat overdone, since even a mild commodity price rally should take prices this high. But, these are markets of extremes in a world still full of uncertainty. It’s no surprise we have such a demand for safety – even in a supposed rally.
- Perkier commodities?
The rally in equities seems to be at least partly inspired by rising metal prices, which have been quietly staging a steady recovery. Copper prices are at their highest level in four months, with zinc and nickel staging similar improvements and investors placing increasing bets on recovery. This week, the head of Glencore indicated that he thought prices may have bottomed, and the company’s order book into China – which consumes over 40% of copper – was strong. A metal price rebound was inevitable once markets moved on from the idea of imminent global recession. China’s also been offering some encouragement. Central bank governor Zhou Xiaochuan, said last week that Beijing “still has some monetary policy space and multiple policy instruments”. This always rallies mining shares.
Nevertheless, uncertainty remains around China’s path and Moody’s recently cut its outlook on the country to negative from stable. It feels like the market needs a catalyst to take this much further. And we come back to oil, which has remained above $35 for a whole week for the first time this year; but Brent Crude is still only at $37 with continuing concerns about investment at this level. UBS estimates that amongst its global coverage universe of 89 major integrated, E&P and emerging market oil & gas companies, capex will fall by 44% over 2014-16. In their words: “The scale of the decline in investment perhaps provides some insight into why a fall in the oil price isn’t as unequivocally positive for the global economy as had been thought.” A thought we’ve had too…
- Trading places?
How does this commodity rally fit in with charts showing the value of world trade falling in 2015 for the first time since the financial crisis? The first thing to note is that the data isn’t as bad as it looks on first glance. The fall in value reflects a collapse in the dollar price of goods sold for export abroad – which is hardly surprising given the collapse in the price of oil & other dollar denominated commodities. Measured in volume terms, world trade looks healthier, although undeniably the pace has slowed. We could attribute this to well-worn reasons like slower demand from China and await the pickup in demand here – or elsewhere. But it’s also worth thinking about structural changes.
The impact of the digital economy, from automation to 3D printing that has clear implications for the trade in goods and globalisation. According to McKinsey, by the end of 2016 companies and individuals will send 20 times more data across borders than they did in 2008. Meanwhile, supply chains are shortening. Chinese companies are producing more components in house. We don’t want to overplay the ONS figures out last week that show that consumers are consuming less “stuff” – at least in volume terms; but it’s obviously true there is more consumption of ephemeral and free resources in our leisure time. Free online newspapers, free videos, free social media all on our phones that are TV, stereo, computer and window to the world. It’s not that none of this activity has a value, but it’s a harder to define value – for economists and companies.
- What no profit warnings?
The rise in UK equities might also have been helped by the fact that UK companies haven’t been issuing profit warnings anywhere near the rate they were before Christmas, when the fall in company expectations neatly presaged the market slump. Again we’d caution a straight line reading of this, since – as the chart shows – UK earnings expectations have taken thumping since mid to late 2015 – especially in the first two months of this year.
Substantial downgrades in energy and materials account for some of the downgrade in hopes, which is probably one reason why less exposed Eurozone markets have seen smaller downgrades. Although, earnings struggles are certainly not limited to these sectors. The recent EY ITEM Club report on consumer spending paints a relatively healthy picture for the consumer in 2015-2016; but consumer facing companies are struggling to turn this into improved profits as consumer expectations on price and service rise.
- Beware ‘falling angels’?
It’s a measure of the nuanced picture that debt markets remain firmly back on the agenda. Stress in the oil & gas sector has shone a light on “fallen angels” – companies moving from investment to non-investment grade – which hit their highest level in 2015 since 2009. But what really matters here isn’t so much the absolute number as the market’s ability to absorb newly made HY debt.
As with so much these days, we’re reaching a bit into the dark. We have a market that’s been on the one hand been tightened by regulation since the financial crisis, but also has a thirst for ever diminishing yields that seen some investment-grade portfolio managers add BB rated buckets to their funds. Tesco’s bonds rallied after their downgrade. Distressed PE dry powder is also the highest over the past decade at US$85b. What does become more testing is when companies are in unloved sectors like oil & gas or fall below BB. Plus there’s always the refinancing conversation, especially if the borrower is long-used to conditions offered to investment-grade buyers.
- Divergence (back) on?
The US Economic Surprise Index compiled by Citigroup has jumped to the highest level since November as surveys outpace expectations depressed by recession fears at the start of year. In the US – at least – economic expectations have recovered the ground lost by early-2016 worries. But it’s not like the last two months never happened. You can see pockets of lingering concern and further monetary loosening is rising up the agenda elsewhere. The ECB look set to act next week. Expectations for the first UK rate increase have moved out to 2017 – beyond expectations for the ECB in some markets. It’s hard to determine cause and effect between market worries and poor UK survey results, but either way we’re divergence on again…