Very few financial analysts, if any, could have expected that by the end of the first quarter, international equity indices were to completely reverse or significantly recover the substantial, multi-year record losses suffered in the first six weeks of 2016.
At the peak of pessimism on February 11, all the major equity indices were showing double-digit losses for the year, with some even entering into bear market territory. In the US, the Dow Jones Industrial Average (DJIA) and the Standard & Poor’s 500 (S&P 500) indices were just over 10 per cent lower since the start of the year, while the tech-heavy Nasdaq closed nearly 14 per cent down.
The performance across Europe was significantly worse than the US. The benchmark Eurostoxx 600, which represents large, mid and small-capitalised companies across 18 European countries, was 17 per cent lower in the first six weeks of the year. Further afield, the Chinese Shanghai Composite was down nearly 22 per cent while the Japanese Nikkei 225 closed 17 per cent lower.
Despite these significant losses, there was a substantial recovery between mid-February and end March. In fact, the DJIA and the S&P 500 even managed to recover all losses and moved into positive territory on a year-to-date basis with gains of 1.5 per cent and 0.8 per cent respectively.
Also in the US, the Nasdaq still closed Q1 in negative territory with a decline of just over two per cent despite the recovery of 13 per cent since February 11.
The positive investor sentiment was also noticeable across European stock markets. However, despite an increase of 11 per cent in the Eurostoxx 600 during the latter part of the first quarter, it still ended Q1 with a loss of just below eight per cent. Similarly, the other main European indices (the FTSE MIB, the DAX 30, the IBEX 35, the CAC 40 and the FTSE 100) all gained between 11 and 15 per cent from their respective closing levels as at February 11.
In contrast, the Shanghai Composite and the Nikkei 225 had the worst relative performance as these two indices “only” recovered by nearly seven and nine per cent respectively and closed Q1 at -15 and -12 per cent respectively.
The roots of the rebound in stock markets go back to January 27 when, during the first meeting for 2016 of the Federal Open Market Committee (FOMC), US Federal Reserve chief Janet Yellen left interest rates unchanged at between 0.25 and 0.50 per cent .
She sent out a warning regarding the increased risks to the world’s largest economy stemming from declining global economic growth, particularly linked to increased vulnerabilities in emerging market economies including China, a relatively stronger dollar at the time which was at a level of $1.08 against the euro, and subdued commodity prices (particularly oil).
Seven weeks later, on March 16, at the subsequent FOMC meeting, the Fed not only left interest rates unchanged for the second consecutive time but, more suggestively, struck a more dovish note and admitted that “global economic and financial developments continue to pose risks… inflation is expected to remain low in the near term … [and] that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate”.
This stongly worded statement effectively curbed markets’ expectations for only two interest rate hikes for this year – rather than four as at end of December 2015.
As a consequence, the value of the US dollar declined considerably against all major currencies except for the sterling amid Brexit fears. In fact, on March 31, the US dollar touched an intra-day, Q1 high against the euro of $1.14, representing a weakening of fiveper cent against the euro in only three months.
Insofar as commodities are concerned, another key turning point mid-way through Q1 was the notable recovery in the price of oil. On March 22, WTI closed at the $41.45 level – up nearly 60 per cent and the highest since mid-November 2015, largely on speculation that a number of oil-producing countries, both members and non-members of the Organisation of the Petroleum Exporting Countries (Opec), were going to join forces in a coordinated effort at stabilising the price of oil.
The statements, actions and any divergence from markets’ expectations by the world’s central banks are likely to continue to be the prime forces impacting global equity indices
Amid the intense volatility across most asset classes, another very important commodity is gold, normally regarded as a safe haven asset in times of turbulence. The price of gold rallied by over 16 per cent in the first quarter of 2016 – the best quarterly performance since the third quarter of 1986. The major part of these gains were registered in the first six weeks of the year, when stock markets were in total turmoil. However, despite the improved investor sentiment since mid-February, the price of gold remained relatively steady until the end of March.
The possible reasons for such an astonishing performance are various, perhaps the result of a combination of factors which include diminished US rate-hike expectations, worries about the health of the global economy in general, intensified competitive currency devaluation strategies, renewed geopolitical and terrorism risks and expanded ultra-loose monetary policies, first by the Bank of Japan and, more significantly, by the European Central Bank.
In fact, hardly a week prior to the FOMC’s second meeting of the year, the ECB announced its most accommodative monetary policy stance when it cut its main refinancing rate by five basis points to zero; cut its marginal lending facility rate by five basis points to 0.25 per cent; cut its deposit facility rate by 10 basis points to -0.40 per cent; expanded the amount of monthly purchases under the asset purchase programme by a further €20 billion to €80 billion a month; extended its list of assets that are eligible for regular purchases to also incorporate investment grade euro-denominated bonds issued by non-bank corporations established in the euro area; and lastly, launched a new series of four targeted longer-term refinancing operations (TLTRO II), each with a maturity of four years.
The above is of particular significance to local investors given that prices of Malta Government Stocks broadly reflect movements in eurozone yields. In fact, the 10-year benchmark German yield sank to a low of 0.10 per cent at the end of February compared to 0.64 per cent at the end of 2015. In parallel, the 10-year US counterpart ended December 2015 at the 2.28 per cent level and touched a low of 1.64 per cent also on February 11. By the end of Q1, both the 10-year German Bund yield and the US Treasury were 48 and 51 basis points lower at 0.16 per cent and 1.77 per cent respectively. The decline in yields sent global bond markets higher.
Meanwhile, amid the rebound across international stock markets, not all indices performed at the same level. The worst performing indices were those of China and Japan as, despite the numerous interventions by the respective central banks to their economies, dark clouds still continue to shade the dynamics and fundamentals of these two particular economies.
Likewise, European indices underperformed sharply compared to the US, possibly because of the relative underlying strength of the US economy when compared to the continued sluggish recovery across the eurozone; the important influence of the banking sector on European indices (the latest manoeuvres of the ECB may put further downward pressures on banks’ earnings prospects), and the overarching deflationary concerns – particularly within the Single Currency area. Furthermore, despite the ECB’s heavy intervention at lowering interest rates and contrary to expectations by most analysts, the euro strengthened and acted as a significant burden to the eurozone’s exporting sector.
Going forward, the statements, actions and any divergence from markets’ expectations by the world’s central banks are likely to continue to be the prime forces impacting global equity indices. Accordingly, the performances of all financial asset classes – equities, commodities, sovereign yields as well as currencies – are set to remain extremely volatile and highly correlated.
Rizzo, Farrugia & Co. (Stockbrokers) Ltd (RFC) is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.
© 2016 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.
Josef Cutajar is a research analyst at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.