Market Bulletin - Running low
As hopes for an interest rate rise strengthen the dollar, the commodity slide hits miners hard.
Last week saw commodity prices decline to historic lows, obliging certain natural resource companies to take drastic defensive measures. Some investors saw this as a buying opportunity. As the oil price continued its descent below $40 a barrel, one analyst predicted it would touch $26 in 2016.
In the US there was growing conviction that this will finally be the week when, for the first time in nine years, the US Federal Reserve raises interest rates. Policymakers start their two-day meeting on Tuesday 15 December and will announce their decision the following day. Last week's US employment figures were positive, further supporting the case for a rise.
Any increase is likely to be a quarter of a percentage point which, technically speaking, is negligible. But it would be a very important psychological moment for financial markets which have been concerned, among other things, about its possible effects on emerging market currencies and economies. If the Fed does hike, this is not expected to set off a market meltdown, since the move has been so widely anticipated – it is already, as they say, "in the price". That said, there may be some volatility in the bond markets, particularly in the high yield segment. It has been pointed out that every central bank which has raised rates since the financial crisis has eventually had to reverse the hike. Pessimists say that a weakening US and global economy could force the Fed to lower rates again next year.
Encouraging jobs data helped US equities begin the week in good heart, but commodity price falls took their toll on energy and raw materials companies. News of merger talks between chemicals giants DuPont and Dow Chemical, whose marriage would create the world's largest chemicals business, prompted a short-lived rally, but global growth fears meant that the S&P 500 index ended the week down 3.55%.
As has been the case for much of this year, those global growth fears are linked to the slowdown in China which, in turn, has depressed commodity prices. And the November export figures for China published last week were, again, disappointing. Commodity prices have not been helped by the fact that they are typically quoted in US dollars, which are getting more expensive. The assumption that US rates will rise has strengthened the dollar, which is now trading near 12-year highs. Last week, the Bloomberg Commodity index fell below 80 for the first time in more than 16 years. The index, which tracks everything from lean hog futures to natural gas, has lost 23% of its value in the year to date and is down by two-thirds from its peak in June 2008.
Notable fallers last week included iron ore, which fell below $40/tonne for the first time since 2008. Oil prices, already 70% off their 2008 peak of $145/barrel, have been under further pressure since OPEC's recent decision not to impose production cuts on its members. As Brent oil fell below $40/barrel, RBS credit analyst Alberto Gallo predicted a further fall to $26 by next year and said that lower prices were here to stay.
Anglo American reacted to the continuing commodities slump by announcing it would withhold dividend payments for the next 18 months, cut its workforce by two-thirds and close or sell up to 30 mines. Majedie Asset Management, which has been selectively adding mining stocks to its UK portfolio, says that, with the Anglo American share price down 90% from its highs, the risk/reward for holding a small position is now attractive. “With miners losing money on 30% to 80% of supply, cuts are inevitable as it’s the only way to get prices up again.” Headlines such as those last week are, Majedie adds, "a pretty good contrary indicator".
Trading and mining group Glencore raised its debt reduction target from around $10bn to $13bn and said it would cut capital expenditure on its mines by even more than previously announced. Glencore was the worst performer in the FTSE 100 index for most of this year, until it was overtaken last week by Anglo American. All this had a negative effect on the FTSE 100, which closed lower for four consecutive sessions and fell by 4.58% over the course of the week.
UK rates stand
UK economic indicators were mixed. Manufacturing fell slightly in October, not helped by a strong pound and subdued foreign demand. In its fourth quarter outlook, the manufacturers’ organisation EEF reported that manufacturers planned to scale back investment spending and hiring for the first time since 2010. However, survey indicators suggest that the services sector is still performing robustly and this, according to Capital Economics, gives confidence that the economic recovery will have quickened again in the final quarter of the year.
Whatever the Fed may choose to do this week, the Bank of England's Monetary Policy Committee left interest rates untouched yet again after its December meeting. Only one of the nine members voted to hike. Even lower oil prices and an easing off of wage growth should keep inflation lower for longer, suggesting rates can stay where they are for the time being.
Meanwhile, in Greece....
The Greek parliament narrowly approved (by eight votes) a 2016 budget. This includes another round of spending cuts and tax increases but assumes that the economy will shrink by only 0.7% next year, in contrast to the 2.3% forecast earlier. Among the difficult reforms yet to be implemented as part of the latest €86bn bailout package are an overhaul of the pensions system and, for Greek farmers, a doubling of income tax, which must be paid in advance. These measures will be all the harder to enact as the governing Syriza party has a parliamentary majority of only two seats.
In the eurozone's GDP performance figures for the third quarter, however, Greece shone as the only economy to beat expectations. The overall eurozone economy grew by 0.3%. Weak international trade held back Germany and Italy. Portugal stalled and, while France returned to growth, it was by less than expected. Greece had been forecast to contract by 1% but, in fact, shrank by only 0.5%. The Eurofirst 300 index, weighed down by poorly-performing oil shares, ended the week down 4.14%.
With the US poised to raise rates and the UK standing pat, the European Central Bank recently opted for a brief extension to its quantitative easing programme rather than the expansion that had been expected. When this was criticised as not sufficiently accommodative, ECB president Mario Draghi declared that "there cannot be any limit to how far we are willing to deploy our instruments, within our mandate, and to achieve our mandate".
Pledges in Paris
In Paris, delegates from nearly 200 nations finally agreed terms on how to limit greenhouse gas emissions. The agreement was, necessarily, a compromise and some environmental groups claimed it fell far short of the rhetoric with which heads of state opened the summit two weeks earlier. Some emerging nations, like Indonesia, felt disadvantaged by the deal.
Others hailed the advantages that will flow for the green economy. However, representatives of polluting industries such as coal and oil did not appear unduly troubled. Benjamin Sporton, CEO of the World Coal Association, said he couldn't see the accord driving wholesale change for producers of coal, because so many developing nations would stick to their plans to keep burning it. Oil industry executives say that, right now, they are more concerned about the falling price of oil.
Majedie Asset Management is a fund manager for St. James’s Place.
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