Unhappy New Year for Markets
A distinctly nasty and to us unexpectedly severe fall in the markets has come early in the new year. The FTSE 100 finished at 5804 on Friday 15th January and the S&P 500 1880, down 7% and 8% respectively since the end of 2015. Almost unnoticed there has been a little offset for sterling investors in the US and Europe, with the pound falling by 3.5% against the dollar and 3.8% against the euro. But what has gone wrong for stock markets?
Oil conquers all
The headlines have all been about China and the oil price; the latter at $29 a barrel has fallen by 22.5% in dollar terms since 31st December, an astonishing decline given the extent to which it had already fallen in 2015. The new year opened with further weakness reported in Chinese factory activity and there has been a mounting sense of hysteria about the state of the Chinese economy, not helped by incoherent responses by the authorities. This has fed into the oil price decline story, which although linked to Chinese weakness, seems to have taken on a life of its own. Hedge fund traders are surely to the fore in this oil market activity, given the volatility in the price.
So, although there is essentially nothing new in these twin concerns of China and commodities, they have taken on an intensity which may of itself be damaging, if persistently gloom ridden headlines damage fragile confidence. In this respect it may not help to have the Chancellor talking about ‘dangerous cocktails’ as he did earlier in the month.
Of course, aside from the effect on consumer confidence, there does come a point where an oil price that stays low for the long term does real damage; this is because of the knock on effects of companies going bust, the loss of stock market value and an embedding of a deflationary mindset. So how low will the price go and will it stay down?
What is the outlook?
Speaking to an oil industry insider in September, he thought that sufficient supply would have been choked off by April 2016 to ensure some stability in the price but he may have been talking his own book. Commentators remain divided; the FT on 13th January gave space to both the bear and the bull view. The former was basically that the US shale revolution had altered the supply dynamics of the oil industry at the same time as technological developments were steadily reducing demand for oil as a share of GDP. On the bull side – ‘there is a very low buffer of spare sustainable capacity – at around 1% – and a high level of unexpected supply outages, of which Libya is the single biggest piece’. Also Chinese oil demand is still growing – at over 6% in 2015.
You take your pick but the bears certainly have the momentum and the price may have to get even worse before it improves.
But what about the winners?
The strange thing about all this is that, despite the fact that there are clear winners from a low oil price, the stock market does not seem to be giving much credit to them; or to the significant boost to global demand from increased consumer real income all over the world, even in the UK with its high tax on petrol, where prices are beginning to fall below £1 a litre. Admittedly, geopolitical worries – centred around the Middle East – have also intensified with tension between Saudi and Iran and a series of terrorist incidents.
But it is not as if the recent corporate news has been all bad. Of the 130 or so companies we follow, we have had 14 third quarter or Christmas trading statements so far this year; putting aside the (presumably) temporary effect of unseasonably warm weather on clothing retailers, the majority have been quite positive in their outlook and reports of their quarterly and Christmas trading. Mergers & Acquisitions, usually good news for the market, abound, with Sainsburys showing interest in Home Retail Group and BT completing its acquisition of EE, for example.
We are sorry we have got it wrong so far by favouring equities in 2016 but we don’t think this is the time to panic. Investors in the miners such as Rio Tinto and oil and gas majors Shell and BP (like us) have had it particularly rough and it may get worse over the approaching year end reporting season. Ignore the headlines about reported losses – these will be huge as companies write off the cost of investments which cannot be justified at current prices – the real story will be about cash flow and dividends. The market is pricing in pretty severe dividend cuts already so we don’t think this is the time to jump ship; providing, of course, your portfolio is well diversified in other areas.
It is likely to continue to be a bumpy ride from here and the energy sectors will undoubtedly cast a pall over the results season which kicks off at the end of the month. But, if they can peer through the general gloom, with a weaker sterling, lower energy input prices (although with hedging in place these may take some time to work through) and potentially stronger consumer demand, companies from other sectors may just be able to be a little positive. We need some good news!