Asset Allocator: April 2015: A busy period for markets!

In his latest Asset Allocator post, David Stevenson provides his predictions for what he views as a busy period within the market with oil, macro challenges in Europe and the upcoming election in the UK dominating proceedings.

 The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes no responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear. 


ASSET ALLOCATOR: APRIL 2015

13/04/15- A BUSY PERIOD FOR MARKETS

 

Readers of these regular articles will know that I usually take a fairly strategic, sanguine view about the art of investing – in simple terms, I’m very cautious about in any sense trying to time markets. But even I think the time has come for more tactical, opportunist investors to tread cautiously – markets are looking a little frothy to me and I sense we may be in for a turbulent summer. 

It’s important to first say that I am not for one minute joining the growing legion of equity bears who think we are just one step away from a global economic meltdown. My own core view is that the slowing growth rates that are increasingly evident in both the US and the UK aren’t harbingers of a new global recession. Yes, US corporate earnings growth is slowing down. Yes, the UK export sector is having a tough time. It’s also indisputably true that UK national growth is currently being sustained by consumer spending, partly financed through increased levels of debt and lower savings. 

All of these powerful drivers are present and of concern. But I think this bearish picture somehow assumes that growth is always linear (upwards) and never bumpy!

Growth scares happen, and my own suspicion is that this summer we’ll (yet again) see another uptick in fear and panic, followed by a quietening of the fears towards the end of the year. 

The Eurozone expansion, helped along by Euro devaluation and its own version of QE is going to make a huge difference as will the steady growth in Japanese industrial output. I also think that US corporate momentum will pick up later in the year as those declining energy and commodity prices feed through into the bottom line. Crucially I also think that the Chinese government will be keen to pump up growth in the second half of 2015. 

At the policy level I also think we’re moving into a fairly predictable behavioural pattern, involving a battle between global investors and central bankers. At some point every year for the last three years we’ve seen a taper tantrum. Central banks threaten to withdraw support, and investors react through increased market turbulence. The chart below from the Financial Times website shows the VFTSE measure of FTSE 100 turbulence or volatility since 2012. You can see periodic hikes in volatility frequently connected to some concern about QE and deflation/inflation. 

 

 

 

 

 

 

 

 

Source: http://markets.ft.com/research/Markets/Tearsheets/Summary?s=VFTSE:AEX 

My own guess is that current softening in demand at the global level will be aggravated by three particular short term volatility pumps – even lower oil prices, Greece leaving the Eurozone and UK volatility post an election. I’ll explore each in short detail below but the overall impact will be obvious – fear levels for investors will intensify, market turbulence will increase, and central banks will switch to a reassuring mode and delay interest rate rises (again!). Core economic data will then emerge at some point post summer that will suggest that fears of a global recession are largely misplaced and investors will feel cheerful again.

Obviously all of this conjecture is entirely irrelevant if you are a long term strategic investor – as I am. Frankly I couldn’t give a damn what central banks might think will happen next. What matters is the price we’re paying for financial assets and the expectations of long term growth. But many investors – for varying reasons – do take a more tactical approach and they might be concerned about an uptick in market volatility. 

If you are one of these more tactically inclined investors I’d suggest watching out for three key factors – oil, Greece and the UK. 

Let’s starts with oil.  My own core view is that despite being very long (bullish) energy equities, oil has not found a sensible market clearing price. With the OPEC summit fast approaching in June I wouldn’t be remotely confident that the Saudi’s have ‘done enough’ to reduce global supply. In particular I’d take great care in examining rig statistics coming out of North America – the Saudi’s want to see a massive drop in horizontal drilling rig deployment. A recent note from analysts at Goldman Sachs suggests that this is very, very far from happening. 

Goldman Sachs analysts Damien Courvalin last week told his investors that their research has discovered that “the current US oil rig count points to US crude oil inventories rising again during this coming Fall’s refinery turnarounds. Further, given the gradual impact of highgrading, productivity gains, the return of uncompleted wells and front-loaded shale well decline rates, we expect that US production growth will remain too high in 2H15 and 2016 at the current rig count and as a result of the constraint of the export ban”. 

The Goldman’s analysts conclude that “while the decline in the US rig count has been faster than we expected, it remains insufficient in our view. The recent stabilization in the rig count therefore leaves us reiterating our forecast that prices need to remain low in coming months to achieve a sufficient and sustainable slowdown in US production growth. Admittedly, US producers have responded more aggressively than we had expected by slashing capex and activity at a 1Q average WTI price of $49/bbl (vs. our 1Q $46/bbl forecast). We view this as creating modest upside to our price forecast of $40/bbl over the next three months, however from a level perspective and not a path perspective. Our work on the outlook for US production in 2016 in turn leaves risk to our $65/bbl forecast as skewed to the downside”. 

Personally I’d go a lot further than this GS analysis and suggest that we need to see oil prices slip below $40 a barrel before we see any meaningful long term decline in oil supply, especially in North America – with a possible low of $20 before the summer is out. 

My next concern is Greece. Having long believed that the Greek government didn’t actually want to precipitate an exit from the Eurozone, in the last few weeks I’ve been quietly changing my view. The current socialist government is clearly not going to so early in the game entirely ignore its resounding electoral mandate for an end to austerity. I’m also increasingly puzzled by how the EU Troika can possibly allow anything that isn’t a massive climb down for the Greek government in front of its electorate. Add to all this, I’m also a little disturbed by the harsh rhetoric deployed by both sides – a tactic that doesn’t seem to be a very productive way to negotiate such an important settlement.

Crucially many hedge fund managers have told me that they are very concerned that both the ECB and the Greek central bank are making very advanced, practical plans for a currency separation. I hope that all this ‘bad blood’ is just war game planning and that sense will prevail but I’m not sure that will be the case anymore. Both sides seem to be pushing themselves into a corner. Just a few months ago I would have put the chances of a Greek exit – a Grexit – at less than 20%, whereas now I’d suggest it’s closer to 50%, and creeping inexorably higher by the day. Put bluntly a whole series of repayments will be needed in the next two months and unless a new deal is in place, technical default is looking an inevitability. 

Turning to the UK, the macro risks are vastly diminished compared to our Agean cousins. Despite the rampant rhetoric of the general election campaign, the main parties are not in fact a million miles apart in their policies about fiscal responsibility and business policy. There are differences between the parties – big ones that matter – but they’re not irreconcilable. Some investors I’ve spoken to at the international level admit to being cagey about Labour plans for instance but no one is seriously suggesting that a big sell off will result from a Labour win. What is concerning investors though is the lack of a government mandate and a general reluctance post-election to confront difficult structural issues – a worry that could apply to all the parties! Investors can usually be reconciled to most major party manifesto platforms but they’ll be deeply un-nerved by zombie minority governments forced to soldier on while the UK slides into acrimony and constitutional uncertainty 

Investors will be especially worried about the UK’s deep structural imbalances i.e our worsening balance of payments and accelerating levels of consumer debts. I think Paul Jackson at Ossiam captures this concern very well in the following observation – “in many ways, the UK is looking more and more like the sort of badly managed and imbalanced economies that the British would have called “Bongo-bongo land”. A domestic counterpart to the disequilibrium represented by external imbalances is the reliance on an ever rising housing market (encouraged by the current government’s emphasis on boosting demand rather than supply, thereby benefitting its home-owning core support group). The BoE might be about to hike rates but short term uncertainties and long term disequilibria suggest sterling may have to go lower”.

I’m willing to speculate that we could see a nasty run on sterling before 2015 is out, with foreign investors aggressive sellers of UK government debt. The timing of this move could be dreadful, with political uncertainty legion and the Bank of England desperate to increase interest rates as local inflation rates start to increase following what in effect would be a sterling devaluation.

So, stepping back from all of these factors I think there’s plenty of room for being concerned in the short term i.e the remainder of spring and summer 2015. I think we are in a growth scare and common sense will return to the markets later in the year but in the meantime I think we all need to act cautiously and carefully. If I were a tactical investor I’d be looking to take some risk of the table and sit tight for buying opportunities to emerge.

 


The content of Asset Allocator is provided by David Stevenson, an independent financial journalist. The views expressed in this page are those of David Stevenson only, and Societe Generale takes no responsibility for his views. The views expressed are David Stevenson's views as of the date of publication only. Neither David Stevenson nor Societe Generale accepts any liability arising from investment decisions you may make for your own account. This material is intended to give general information only and is not to be construed as investment advice. The investments mentioned may not be suitable for everybody and you should ensure that you fully understand the investment you intend to make before making an investment. Links to external websites are not operated by or affiliated with Societe Generale. While we aim to point you to useful external websites, we cannot be responsible for their content or accuracy. Societe Generale takes  responsibility for the views expressed on any external websites or any liability arising from investment decisions you may make. You should seek professional advice if any of the content of this page is unclear.

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