Uncertainty - "No-one likes that"

Monday, 14th December 2015 09:24 - by David Harbage

After a gloomy week for global equity markets (the FTSE100 index fell 4.6% to 5,952.78, the Dow Jones shed 3.3% and the German DAX lost 3.8%), it might help to take a hard look at what has spooked investors. And the 'bottom line' is that the prime news - that the price of oil fell, by another 12% - represents a positive development for all consumers, if not the owner/producers of the commodity.

That OPEC (the Organisation of the Petroleum Exporting Countries) decided to maintain, rather than cut, its daily production means that the current surplus will continue to grow. Moreover OPEC reported that, in November 2015, its members were pumping oil at the fastest rate since 2012. Not surprising then, that Brent crude fell below US$38 per barrel, and the equity valuations of BP and Royal Dutch Shell collapsed by a further 13 and 75 pence to 338p and 1460p respectively on Friday. Energy analysts will wonder how much further the price of oil can fall, while macro commentators will be concerned that global demand and GDP (reflecting total economic activity) is lower than generally perceived. Sub $30 and 3% in 2016 are typical of the respective numbers being bandied about by the more pessimistic; prompting some to talk of the implications of a deflationary, if not a recessionary, environment.

Although the beneficial effects of lower fuel costs (noting unleaded petrol was sold at UK pumps at 99.7p this weekend) will take some time to come through, the oil industry may have to take more obvious painful action (including the loss of jobs) in terms of curtailing production, sooner. Looking at such developments, and in particular wondering if slowing growth in a number of emerging economies (notably major energy producers, Russia and Brazil) will pull down the larger developed countries, has cast a pall over the equity markets. As ever, no-one has a definitive answer to such a question - economies, like asset market valuations, are 'moving feasts' (or 'famines', at times). Bottom line: heightened uncertainty, exacerbated by the magnitude of the accelerating fall in energy and other mineral prices, has prompted investors to become more risk averse.

So what other macro-economic news broke last week, or is due this, to test investors' nerve? In the US retail sales in November were the strongest in 4 months, initial jobless claims were higher than forecast, and an interest rate hike is expected from the central bank at the FOMC (Federal Open Markets Committee) meeting this Wednesday. The latter, reflecting stronger economic conditions in recent months, has an 80%+ prospect of being delivered - which would represent the closure on a key uncertainty (i.e. bottom of the rate cycle in the world's largest economy). Mario Draghi, the president of the ECB (European Central Bank) has promised further monetary stimulus if the continent's major economies falter. Closer to home, the IMF have commented on the relative health of the UK economy and indicated that GDP could remain around 2.25% to 2.5% over the next 5 years, driven by a vibrant London (3.0%). Essentially, in nautical language, a 'steady as she goes' economic backdrop with the probable exception of China whose data is, as ever and at best, unpredictable.

Looking on a 'bottom up' basis, the companies most obviously impacted by the decline in raw materials have made further efforts to address their immediate trading outlook, adjust their business strategies and re-engineer their balance sheets - which could lead to asset disposals, cash raising exercises and cuts in dividend payouts. This is perhaps most obvious amongst mining companies, with Anglo American, Lonmin and Glencore continuing to make headlines this week. As previously intimated in an earlier blog entitled 'Identify, and run with Winners', the author would not be inclined to own these natural resource stocks at present and to ensure this message is clear, will delete reference to Rio Tinto and Royal Dutch Shell in the monthly monitoring exercise.

By contrast, most other businesses are major consumers of fuel with the transport and leisure companies such as airlines easyJet, Flybe and International Consolidated Airlines (owner of British Airways) and cruise line Carnival particularly obvious beneficiaries. The prospect of a lower fuel bill, for longer, is a major encouragement for these companies enabling them to lower ticket prices and/or improve profit margins. As an example, easyJet boasted a 9.6% increase in passengers carried in November, despite the Egypt and Paris inhibitors which contributed to cancellations rising from 16 to 378 (176 related to Sharm-el-Sheikh).

Other corporates updates which took the writer's eye included a better than expected trading update from volume, national house builder Bellway whose encouraging remarks on the outlook for the year to July 2016 (10% increases in completions and selling prices forecast) took its share price up to a new high of 2673p on Friday last. Capitalised at £3.275 billion, the builder is knocking on the door of the FTSE100 and could soon overtake the likes of Sports Direct International (£3.5bn) which, by contrast, had announced disappointing interim results on the previous day. Revenue from the UK's industry leader in sport retailing was flat in the 6 months to 25 October, and pre-tax profit just 3.6% higher - which fell short of City expectations - and resulted in the stock falling by 100p to 586p over the week. While fund managers are not unduly influenced by non-financial considerations, recent media reports of poor working conditions and sharp business practice seem to have combined with this slippage in the figures to depress sentiment towards the group run by major owner (and the chairman of Newcastle United), Mike Ashley.

The other item to dominate the general domestic news was the stormy weather and flooding in Cumbria and Scotland, but the financial impact is unlikely to surprise management; insurers like Aviva and RSA typically possess very diversified risk profiles (by activity and geography) and last week their share prices fell by less than the wider market, 3% and 4% respectively. Perhaps as we reach the shortest days of the year when sunshine is hard to find, the so-called SAD (Seasonal Affective Disorder) syndrome appears to be affecting the UK equity market as well - after 7 consecutive days of negative return. However, like the weather, investor sentiment can change very quickly and the removal of, or reduction in, uncertainty (on issues such as US interest rates and Chinese growth) could be the catalyst to provide some seasonal cheer.

Written by David Harbage for lse.co.uk on the 12th December 2015

 
The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.