Eurofirst 300 Index -6.61%; German 10-Year Yield 0.57%; EUR/USD $1.131; Brent Oil $44.73
Global equity markets sold off sharply last week, with many of the major equity indices experiencing the worst weekly declines since 2011. A plethora of factors are being blamed, commodity prices plunging, turmoil in China, the loss of momentum in the global recovery – confirmed by dismal purchasing managers’ survey data last week – and investors fretting about the possibility of the US Federal Reserve raising interest rates this year.
These are all themes I have discussed over the last six months, they have been widely known for some time but largely ignored by investors. However, a sudden shift in sentiment, the tipping point being the Yuan devaluation, has brought them all into stark focus at once. The equity market sell-off has intensified as market participants have looked for the exits at once, a familiar occurrence in financial markets.
US ‘fear index’ records largest weekly increase ever….
The much quoted CBOE Volatility Index (VIX), the so-called ‘fear index’, a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices, recorded the largest weekly increase ever, up more than 118% to 28. The index has been hovering near record lows for some time, a sign of complacency among investors which I’ve highlighted previously.
Many equity indices suffered worst weekly declines since 2011…..
The sell-off in equity markets intensified on Friday to cap off a miserable week for equity market investors. In Europe, the FTSE Eurofirst 300 closed down –6.61% for the week; the German DAX index was one of the worst performers, falling -7.83%.
In the US, the S&P 500 index fell -5.77% while the tech-heavy NASDAQ Composite fell -6.78%. Many of the market darlings, priced for perfection, have seen their shares prices slashed over the last month. The largest of them all, Apple, has fallen -20% since July 20th.
In Asia, Japan’s Nikkei 225 index fell -5.28%, while China’s Shanghai Composite Index of mainland shares fell -11.54%. I continue to see investing in mainland Chinese equities as the equivalent of riding a moped in that part of the world, extremely dangerous!
Oil prices hit the lowest level since March 2009…..
It has been a tough time for commodity investors, commodity producers and companies leveraged to these markets. After staging a comeback in March, the rally in oil prices proved to be short lived with the price of a barrel of Brent Crude oil falling by around a third since May. Even worse, the price has dropped by -60% since June 2014.
The game changer in the oil markets was the surprise decision by OPEC not to cut production in November of last year, a move many expected to support prices after Brent Oil dropped from $115 a barrel to circa $75. However, instead they choose to maintain production levels, a signal of their willingness to accept lower market prices in their price war with the US shale industry. The question is how low will they let it go before intervening?
Figure 1: Spot Price of a barrel of Brent Crude Oil (Source: Reuters)
While oil attracts most of the attention given its central role in the world economy and high weighting in the commodity indices, but we are seeing a decline across the board in commodities, a cause for concern on the deflation front. These could prompt further easing on the central bank front.
I maintain my view from earlier in the year regarding the movement in oil prices. “The macro impact of the oil price decline is debatable but moves of this magnitude over such a short time period in any financial asset can be inherently destabilising; one lesson from the last crisis is that market participants can underestimate the contagion effect from what is perceived as a relatively small part of the market, think sub-prime mortgages!”
Demand for perceived ‘safe-haven’ assets…..
Amidst the sell-off in global equity markets, demand for perceived ‘safe-haven’ assets pushed the prices of core government bonds higher. With yields move inversely to prices, the German 10-year bond yield declined 9bps to 0.57%. The US 10-year treasury yield fell 15bps to 2.05% while the UK 10-year government bond yield moved down 17bps to 1.83%.
Gold has also moved back into favour in recent weeks as volatility has picked up, the price per troy ounce rising 3.87% last week to $1,159, and up 7% since August 5th.
On the currency front the Euro moved higher as risk aversion set in, a by-product of its funding currency status, rising 1.83% against the US dollar to $1.131, the highest level in two months. The emerging market currencies remain under pressure after China’s move to devalue the Yuan and the continued slide in commodity prices.
European equity markets have opened sharply lower this morning following a sell-off in Asia overnight; China’s Shanghai Composite Index of mainland shares fell a further -8.49%. The index is now down -37.86% from the closing high in June of 5,166.35. It looks like it might be another challenging week for equity markets, as they await some reassuring words from the all-important central banks.
On the macro front this week there are a number of important reports for investors to focus on. It is a relatively quiet week in Europe, but there are a number of key reports from Germany including the final estimate of second quarter GDP and the preliminary inflation rate for August.
In the US, all eyes will be on the durable goods report Wednesday and the second estimate of Q2 GDP growth on Thursday. The first estimate showed the US economy grew at an annual rate of 2.3% in the second quarter, slightly below expectations. An upgrade would increase the likelihood of the Fed moving this year on a rate hike, while a downgrade would add to concern over the global slowdown. Still, a downgrade could be a classic case of “bad news is good news” for the market, with rate hikes pushed out till next year.
There is a raft of economic data from Japan on Friday which should provide an update on the progress of Shinzo Abe’s reflation strategy, with reports on retail sales, unemployment and consumer price inflation. There is a sense that the ‘Abe effect’ is waning, with calls for faster structural reform and more aggressive monetary policy from the Bank of Japan.
On the monetary policy front, a number of US Fed Governors will be giving speeches, with markets looking for signs that an interest rate increase will be further delayed. The annual symposium held in Jackson Hole, Wyoming will begin on Thursday, with central bankers, policymakers and academics meeting away from the demands of their everyday work to discuss this year’s topic “Inflation Dynamics and Monetary Policy”. However, the most important central banker of all, the Fed’s Chairwoman Janet Yellen, won’t be in attendance.
Away from the market noise, it’s all about Monday night football again this week. After two scrappy wins in the first two games of the season, Liverpool face a real test tonight at the North London Library, aka the Emirates, against Arsenal. I’ll be in the Clock end tonight, surrounded by the ‘oh so quiet’ Gooners, cheering on Big Ben and the Reds. #YNWA