MACROSCOPE
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Global financial markets starting 2016 where they ended in 2014

For equity markets, it’s like 2015 never happened although buys and sells abound

PUBLISHED : Tuesday, 29 December, 2015, 7:00am
UPDATED : Tuesday, 29 December, 2015, 7:00am

One of my favourite economic cartoons begins in a trading room full of happy faces speaking on the phone saying, “BUY, BUY!” to each other. Suddenly someone hears the word “Bye”. Someone else picks up “Bye Bye”, and the cartoon ends with a sea of gloomy faces winding each other up by shouting “SELL, SELL!”

Investment markets in 2015 saw sizable changes of sentiment every couple of months, but nevertheless markets seem likely to close the year largely where they began. The US S&P 500 index is flat on the year while the European markets are up nearly 10 per cent in local terms, though around break even in US dollar terms. In a sense, 2016 begins much as 2014 ended in terms of the economic and financial fundamentals - as if 2015 barely existed.

Those of us in the markets spent much of 2015 gazing at our navels; focusing on the trees rather than the forest.

Would tiny Greece bring down the global economy? Would the Fed raise rates by the smallest amount in March, September or next year? Are falling oil prices good news or bad?

We even lived through the remarkable event of the first US interest rate rise in nearly a decade, and despite that, it appears that the underlying economic trends from 2014 remain largely intact.

Conditions to expand business and the economy in 2016 are (like 2014) very advantageous, with low interest rates, low input costs (commodities and oil), low inflation, helpful government policies, muted wage inflation, and automation that is reducing labour costs.

Those of us in the markets spent much of 2015 gazing at our navels; focusing on the trees rather than the forest...The underlying fundamentals in early 2016 look as positive as they did at the end of 2014

So things should not change much as we enter 2016, with expectations of a sluggish US market hampered by a strong US dollar, even if it is not appreciating as it did in 2014-5. The European markets should start to reflect the recovery of economic growth.

China will renew its multi-year struggle with growth, which has not been helped by the relative lack of stimulus from the authorities.

The oil price dividend will flow over oil importing markets such as a good deal of Europe, Southeast Asia, India, and Japan, that will many times counteract any tightening from interest rate rises. In 2014, we saw a dramatic 55 per cent fall in the oil price from the highs, and since May 2015 oil has suffered a further 44 per cent slump.

The choked flow of petrodollars to Brazil, Saudi Arabia, Russia, Venezuela and others will bring an unwelcome austerity to those countries.

Most analysts are suggesting two or perhaps three more interest rate rises in the next year and if the Fed plays its cards right, each one will seem less worrying to the market than the last. But history tells us that rising rates are not popular with investors as they encourage people to sell the bond market and that often has a knock on effect on the equity market.

Could that lead to significant deleveraging, with many people reducing their loans just a little to compensate for just a little rise in interest rates? That could lead to a spiral of selling to raise cash, causing significant falls in all markets from stocks to bonds to property.

The money would then scurry into safe haven assets, pushing up the US dollar, the Swiss Franc, and gold. Industry starts to lose confidence, becomes conservative, and unemployment rises, slowing down economic growth and leading us towards a harsh winter. The markets with their characteristic flakiness start crying, “sell sell!”

A key skill of investment is to see through this noise and to draw conclusions about what the real economy is doing rather than being led by the short-term news as in 2015. The underlying fundamentals in early 2016 look as positive as they did at the end of 2014, with the advantage that the first interest rate rise is behind us and the markets have had a year to consolidate.

It does not seem likely that we are going to see a rapid departure from current trends in the first six months of next year. This cycle – elongated and debt filled as it is, has not yet run its course.

And it looks like things are likely to get better before they get worse. However we are already some eight years into this cycle so the best mantra for investors in 2016 will be - as always - to “expect the unexpected”.

Richard Harris is chief executive of Port Shelter Investment Management

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