Last week in Strategy: Correction mode (12 December), we highlighted that risk markets were in correction mode after a strong rally from mid-October to early December. A decline in risk assets is not unusual following such a strong rally – especially when focus turns to event risk, as was the case early in the week, as focus turned to the significant stress to oil-exposed economies and sectors. Tuesday was a clear capitulation day, on which market participants ran for the door in RUB and NOK and other oil-related currencies, with contagion to emerging markets assets in general. The currency panic led to the general risk-off sentiment also sending stock markets lower.
However, it is not unusual that once capitulation has taken place, the market restores some calm, particularly if the underlying growth picture is improving in the US and Europe, as is the case currently. We see more and more signs of a synchronised recovery forming in H1. First, US consumption is running fast and we expect it to gain even more pace as gasoline prices have fallen substantially. Second, there is increasing evidence that the euro area business cycle has bottomed. This was evident this week, with the stronger-than-expected rise in the German ifo expectations index. Euro Flash PMI for December also supported the case for a bottom, as the order-inventory balance increased for the second month in a row. Medium-term indicators for the euro area such as real M1 growth also point to recovery in H1. Third, this week’s UK retail sales figures for November were very strong, rising 6.4% y/y (consensus 4.4% y/y). This is the biggest increase in 10 years and yet more evidence that lower oil prices are giving a boost to global consumers.
China is still delivering negative news as Flash PMI for December fell. Emerging market assets are challenged by three factors currently: (a) turmoil in oil-exporting countries, (b) Chinese slowdown and (c) Fed hikes moving closer. However, we believe it is only a matter of time before the Chinese central bank eases again and this normally gives some support to emerging markets following a flush-out such as the one we have seen recently.
Interestingly, the recovery in the RUB and risk sentiment was sustained, even with a further decline in the oil price below USD60 per barrel late on Thursday. The recovery in the RUB is maybe a sign that a lot of position squaring and hedging has already taken place. We still see the risk of a weaker RUB but if this happens in a less violent way, it may not have the same negative spill-over to risk markets. There is no doubt in our minds that the Russian economy is heading for a very steep decline in activity and GDP could fall around 5% next year. However, the trade links between Russia and the rest of the world are not significant and the positive effect on Europe and we believe the US from the decline in oil prices will counterweight this.
We continue to be positive on risk assets for the first half of 2015 as we expect synchronous recovery across regions and quantitative easing from the ECB to underpin a search for yield. We thus look for higher stock markets and more tightening of peripheral bond spreads. The key risk to watch is of course the situation in Russia and what ramifications it may have in the financial system.
To Read the Entire Report Please Click on the pdf File Below