Investment markets and key developments over the past week
Shares have had a volatile start to the year, first falling sharply, then rebounding before coming off again in the US and Europe on Friday. It seems shares were left with a bit of a “hangover” from the Santa Claus rally through the second half of December and so worries about the fall in oil prices, Greece and Europe along with weak US wages growth and uncertainty about the ECB have led to a volatile ride at the start of the year. Over the last week US shares fell 0.6%, Eurozone shares fell 3.1% and Japanese shares fell 1.5% but Australian shares rose 0.5% and Chinese shares gained 1.6%. Of these markets, only Australian and Chinese shares are up year to date. Bond yields are generally down year to date reflecting expectations that the falling oil price will weigh on inflation. Oil and metal prices have continued to fall, with the global oil price falling below $US50/barrel for the first time since 2009. However, the $A is up slightly on expectations that weak US wages growth will delay Fed monetary tightening.
The period ahead sees more event risk regarding the impact on energy producers from falling oil prices, Greece and the Eurozone and the Fed’s gradual move towards a rate hike. Looking at each of these:
- The oil price collapse is a big negative for energy producers and its reasonable to expect some sort of blow up there, but its unlikely to cause major systemic problems globally or in Australia and more broadly the stimulatory impact of the 50% fall in oil prices over the last year on global and Australian growth (likely to be around 0.7%) is expected to ultimately dominate.
- Uncertainty about a Grexit (Greek exit) from the Euro has returned ahead of Greece’s January 25th election with left wing Syriza leading in the polls. This uncertainty could linger for a while yet, particularly if the election does not result in a government as occurred in May 2012, necessitating another vote. However, a Grexit is not the threat it was several years ago: while Syriza is ahead its lead is small and it will be unlikely to get enough support to govern on its own; secondly its anti-Euro rhetoric has been toned down as it realises that most Greeks want to stay in the Euro suggesting if it does win it would ultimately seek a deal with the Troika (the ECB, Eurozone and IMF that now own 80% of Greek debt); other peripheral countries (Portugal, Ireland, Spain) are now in much better shape and hence are less vulnerable to any contagion that may flow from a Grexit; and finally the defence mechanisms in Europe are now far stronger with a strong bailout fund, a banking union and a far more aggressive ECB committed to doing “whatever it takes” to preserve the Euro.
- The broader issue in Europe is deflation with headline inflation going negative in December and growth indicators remaining soft. Fortunately, the ECB looks set to widen its quantitative easing program with a letter from President Draghi indicating that it may include sovereign bond buying. However, uncertainty is intense with reports that an ECB staff briefing only focussed on a €500bn program causing some consternation as it would be below market expectations. However, it would be wrong to read too much into this as some reports also suggest open ended QE was considered in the briefing and, even if it is just €500bn initially, Draghi could indicate that it will be extended if needed. Quite clearly investors are nervous ahead of the ECB’s January 22 meeting, but I think it likely that the ECB will deliver a decent quantitative easing program.
- The Fed is likely to confirm at is January 28 meeting that it will remain patient in moving to raise interest rates and that it will be dependent on further improvement in the US economy providing confidence that inflation will eventually rise back to target. Our base case is for a June rate hike, but soft December wages growth clearly indicates that the risks are skewed towards a later tightening.
While we see each of these “events” turning out ok, they all nevertheless have the potential to create short term turbulence in markets.
Full update, click here: Weekly Market Update – 9 January 2015