As we prepare to head into the New Year, let us look at global economics and assess the fundamental underpinnings of the market. We still maintain that the global economy is on a positive foot and there are no signs of a broad global slowdown currently (Fig 1). Whilst growth is divergent between regions it is still on a better footing when compared to some years back (Fig 2). What is clear is that growth is likely to be led by the US, with the economy expected to accelerate in the coming year. For the Eurozone, there are signs that growth will remain slow for the time being, but there are positive factors in place such as lower oil prices and the weak currency which should help to support the economy. China continues to remain mixed amidst its restructuring and anti-corruption drive but the government remains committed to using stimulus where necessary to achieve the results they want.
Fig 1: Global PMI Has Moderated Recently But Still Expansionary
Fig 2: OECD 2015 GDP Heat Map Shows Divergent Trends Throughout The World
Data out of the US continues to indicate an accelerating economy. Recent ISM surveys were strong, with the manufacturing survey coming in at 58.7 and services at 59.3. November retail sales grew more than expected and consumer confidence remains at very high levels. The chart below shows the recovery of the big four indicators which the NBER Business Cycle Committee uses to identify whether the economy is growing or stalling (Fig 3). With growth at these levels, we can expect companies to continue reporting a high single digit earnings growth which will be supportive of the equity market.
Fig 3: Big Four Economic Indicators of the US
The Deal With Oil. Much ado has been made about what is happening to crude. The media has tried to put disaster and falling oil prices in the same sentence. Let’s not get confused. The fact of the matter is cheap oil is very good for the majority of countries except for oil producers (Fig 4). Inflationary pressures subside, consumers have higher spending power, governments are able to reduce fuel subsidies and the list of benefits goes on. For economies like the US, where consumer spending represents 68% of the GDP, and for Emerging Asia where countries like China and India import more than 60% of their oil, this represents a boon. Analysts have not revised earning expectations despite knowing that cheap oil is good for earnings because they are unsure how much higher to revise their numbers. What is certain is that oil producing countries will bear the brunt of this decline in oil prices and run budget deficits as their breakeven oil price is typically above USD80 a barrel (Fig 5).
Fig 4: Net Impact on GDP Levels From Every USD10 Decline in Oil Prices
Fig 5: Current Oil Prices Will Force Many Oil Producers To Run Deficits
Here Comes Santa Claus.
We have seasonal tailwinds to help markets track higher. Two interesting research papers documented the existence of the “Sell in May and Go Away” phenomenon where stock markets typically performed better during the Nov to Apr months. In addition, we also have this phenomenon called the Santa Claus rally where stocks surge during the last trading week of Dec and first trading week of Jan (Fig 6). The most logical explanation for this is investors sell loss making stocks to claim tax breaks to offset gains and then reallocating to winners in the market. Whatever the reason, there is no reason to be affected by volatility and not to be invested in the market.
Fig 6: The Santa Claus Rally Is Not Isolated To The US Only
Technical and Not Fundamental. The decline in the markets during these few days also appears to be technically driven as there is no fundamental reason for the sell-off. Short term indicators highlighted oversold conditions late last week and we expect market to continue to move higher (Fig 7). An explanation for the sell-off could be investors taking some money off the table after the decent gains markets chalked up following the Oct sell-off. Another reason could be a reallocation of investor accounts in view of the strengthening US dollar and impending rate hike next year. Whatever the case, this episode has not triggered our financial and technical risk indicators and we remain fully committed to the market.
Fig 7: Short Term Oversold Indicators Triggered
We note that the global economy continues to chug along although trends continue to diverge in the world. The US will continue to lead the way, whilst China and parts of Emerging Asia will benefit from cheaper commodity prices and allow their governments more room to manoeuvre fiscally. The recent sell-off has no fundamental underpinnings and is more technically driven and we want to remain fully invested during this seasonally strong period for markets.
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