Equity markets in 2015: Greece, China, oil, central banks and volatility…Enough is enough!
It is even harder than usual to draw useful lessons from the year of 2015 in the equity markets. If we consider performance in terms of change in price rather than total return we see that the MSCI AC World (in US dollar terms) fell by 4.3% while the MSCI Emerging (in US dollar terms) was down 17% in 2015. In this light, 2015 was a bad year. Meanwhile, the S&P 500 disappointingly lost 0.7%, while the Eurostoxx 50 gained 3.9% and the Nikkei 225 9.1% (returns for all these indices are in local currency terms).
Exhibit 1: Changes in the MSCI All Country World equity Index (in price not total return terms) for the period from 01/01/2015 to 31/12/2015Source: Bloomberg
Exhibit 2: Changes in the MSCI Emerging Market equity index (in price, not total return terms) for the period from 01/01/2014 to 31/12/2015Source: Bloomberg
Exhibit 3: Changes in the MSCI US equity index (in price, not total return terms) for the period from 01/01/2015 to 31/12/2015Source: Bloomberg
Exhibit 4: Changes in the MSCI Europe equity index (in price, not total return terms) for the period from 01/01/2015 to 31/12/2015Source: Bloomberg
Generally speaking, as the graphs above show, equity markets had a good first half in 2015, especially in Europe and Japan, but in the major markets the gains in the first six months of the year were given back during a negative second half.
It’s hard to say what these trends have in common apart from volatility, which spiked several times during the year, including once during the summer of 2015, when stress in financial markets almost matched the levels last seen during the European sovereign crisis.
There were several reasons for investors to be nervous in the first half of 2015. Beginning with the election of Alexis Tsipras in Greece on a platform of rejecting the implementation of reforms conditional upon European and international aid packages, Greece was in the spotlight. It would take too long to list all the twists and turns in this essentially political drama, both domestically and on a European scale. To cut a long story short, it led Greece to the brink of bankruptcy and the eurozone to the brink of implosion in July 2015. An eleventh hour compromise was enough to reassure investors, even though Greece continues to labour under the burden of a huge debt load.
No sooner was this issue resolved than a new source of volatility emerged, this time far from Europe and in a country on an entirely different scale to Greece – China. In response to a steep correction in continental Chinese equity markets that began in mid-June 2015, the Chinese authorities took various support and control measures, none of which produced tangible results. Doubts on the health of the Chinese economy were then fuelled by disappointing economic data. The surprise devaluation of the yuan versus the dollar on 11 August 2015 ratcheted up nervousness.
Finally, the renewed downturn in oil prices (see exhibit 1 below), beginning in late June 2015 (after WTI had rallied to 60 US dollars/barrel from 45 US dollars in March), was interpreted as a sign of a marked slowdown in the global economy. In fact, the drop in oil price drop was caused mainly by supply and demand conditions, which sped up the decline late in the year. OPEC’s decision to forego setting production quotas then sent WTI below 35 US dollars/barrel. In 2015, the oil price, which had dropped by 46% in 2014, fell another 30%.
Exhibit 5: Changes in the price of oil (West Texas Intermediate (WTI) for the period from 02/01/2014 to 20/01/2016.
Global equities, which had managed to eke out some gains in the first half of 2015, were driven off a cliff in August 2015 by indiscriminate selling, regardless of sector, stocks or indices. The Chinese factor remained on investors’ minds in September despite authorities’ efforts to stabilise the markets and convince observers that monetary and fiscal means existed to stabilise growth.
Central bankers again played a key role in 2015. Fluctuations of expectations on the path of monetary policy, particularly in the US and the eurozone, triggered sharp swings in equity markets, suggesting that equity investors are still somewhat “hooked” on liquidity. European equities got a boost from ECB quantitative easing in the first half of the year, outperforming US equities substantially. In October, a rally in global equities (which was not sustained) was prompted by hopes of a new round of ECB easing. Not until later were the Fed chair’s statements properly understood, but the key rate hike announced in December was ultimately rather well accepted.
Monetary policy: the Fed waits until December 2015 before cautiously beginning normalisation of its key interest rate; the ECB paves the way for more quantitative easing
While there was no particular reaction to the Federal Reserve's decision to curtail monthly securities purchases in November 2014 as a first step towards the normalisation of monetary policy, the Fed seems to have had a harder time steering key rate expectations. Guidance in the official communiqué published after each monetary policy meeting shifted from month to month. In late 2014, the Fed said that it would be “patient” before raising its key rates. A decisive step was taken in March when the word “patient” was removed from the communiqué. It was then that the economic scenario became the basis on which a decision would be made on whether to raise interest rates, with the Fed no longer committing itself to a definite timetable but claiming to be “data-dependent”. Janet Yellen insisted that once rates began to be raised, the increase would be gradual, while pointing out that monetary policy should be prospective in nature. Sadly, the linking of monetary policy decisions with economic data made analysis complicated, as data has been especially volatile since the start of 2015, so much so that rate hike expectations took time to take hold. After raising concerns on growth by foregoing a rate hike in September (due to a challenging international financial environment, namely the turmoil in Chinese equity markets), it was late in the year (on 16 December 2015) that Janet Yellen was able to announce the end of the zero interest-rate policy in force since late 2008. The ground had been laid for this policy shift at the previous meeting. The fed funds target rate will now range between 0.25% and 0.50% (up from 0.25% to 0.50% previously) and the Fed is planning more rate hikes in coming months (a total of 100bp in 2016, based on the forecasts provided by all FOMC participants). In our view the Fed's decision to raise rates was based on the clear upturn in employment, consumption and the real-estate market.
In 2015, the monetary policy of the European Central Bank (ECB) took a new, decisive turn. In an environment in which economic growth remained moderate and in which year-on-year inflation moved into negative territory in December 2014, the announcement of quantitative easing (QE), comparable to that undertaken in the US and UK, came on 22 January 2015. This was an expanded programme to purchase EUR 60 billion of assets each month. In addition to covered bonds and asset-backed securities bought since autumn 2014, the new programme included supranational agency and government bonds (including inflation-linked bonds). Purchases of public-sector bonds, which began on 9 March 2015, also include securities with negative interest rates, with the deposit rate serving as a cap. For several months after these operations were set up, ECB guidance consisted mainly of stating that they were unfolding “without difficulty” and that they would continue until at least September 2016. The financial turmoil of summer 2015 combined with stubbornly very low inflation in the eurozone led some observers to anticipate an announcement of additional measures, although the European economy appeared to be responding well to QE. In October, Mario Draghi hinted that ambitious measures would be announced in December 2015 and expectations were driven by other, highly dovish statements in November such as “we will do what we must to raise inflation as quickly as possible.” This talk may have been counterproductive, given that, on 3 December 2015, the ECB fell short of expectations in cutting its deposit facility rate by just 10bp, to -0.30% and leaving the two other key rates unchanged (the interest rate on main refinancing operations at 0.05%, and marginal lending facility at 0.30% - where it's been since September 2014) and to extend until “March 2017 or beyond if necessary” securities purchases under QE. It was also decided to “reinvest the principal payments on the securities purchased under the Asset Purchase Programme as they mature, for as long as necessary.” Monetary policy is thus more accommodative than it was in October in order “to secure a return of inflation rates towards levels that are below, but close to, 2%.”
Bond markets: long bond yields rose slightly over the course of the year in very different environments on either side of the Atlantic
In 12 months, the yield of the US 10-year Treasury note rose by 10bp (see exhibit 6 below): after trading between 1.65% in January 2015 (the lowest level since May 2013) and 2.50% during the summer, it ended the year at 2.27%. The full-year change looks modest considering that in 2015 the Fed had settled for reinvesting maturing securities, which stabilised the size of its balance sheet, and that key rates were raised by 25bp in December. Meanwhile, while volatile, economic data reflected the steady improvement in the job market, which is the key to solid growth.
Exhibit 6: Change in yield of the US 10-year Treasury bond for the period from 02/01/2015 to 31/12/2015.
Asset purchases by the ECB, which began in March 2015, have had the effect of reversing the normal relationship between US and European bonds. That's to say, the very steep drop in eurozone sovereign bond yields until April automatically enhanced the attractiveness of US bond yields. And, lastly, during the upward pressure on German yields in May and June, the speed and extent of the trend hit US markets. More generally, the period under review featured several spikes in bond volatility due to trends in other financial markets. While US long bond yields in June and July (about 2.50%) appeared to price in the improvement in domestic demand in the US, concerns over global growth and the new bout of weakness in commodity prices sent long yields down, exacerbated by poor equity performances. Beginning in August, 10-year yields traded in a narrower range (2%-2.35%), driven by Fed monetary policy expectations and actions. The surprising September status quo had led to a sharp decline in long bond yields, while the impact of the fully-expected December rate hike was felt especially in the short section of the curve, with the two-year yield ending the year at 1.05%, a high since spring 2010 (and vs. 0.66% one year previously), due to expectations of further normalisation of monetary policy in 2016.
In the eurozone, government bond trends essentially reflected ECB monetary policy (expectations and decisions). Paradoxically, the 10-year Bund yield rose by 9bp in 12 months (see exhibit 7 below) while the ECB in January announced a massive securities purchase programme that began in March. This was due to an excessive decline in yields during the first four months of the year. Against a backdrop of highly accommodating monetary policy and a clear slowdown in inflation, 10-year German yields slid almost constantly from 0.54% at end-2014 to under 0.08% on 20 April 2015. The safe haven status of German government bonds helped lower yields, given the fears raised mainly by chaotic developments in talks between Greece and its creditors. A sudden correction on the government bond market then occurred under the effect of technical factors, special market conditions and adjustments to positions by hedge funds. After settling in at an initial plateau around 0.60% in mid-May the 10-year Bund yield approached 1% on 10 June. It then returned to a downward trend, albeit one less strong and far rockier than in spring. Late year featured heightened volatility triggered mainly by Mario Draghi’s statements, which held out hopes for new, spectacular announcements before falling short of expectations, but while easing monetary policy further (but by less than expected). Throughout the second half, investors, without regard for economic fundamentals, were inclined to take profits each time the Bund yield slipped below 0.50%. The yield ended the year at 0.63%. The Italian market made up more ground in 2015, with a 29bp decline in 10-year yields to 1.60% while the Spanish yield (+16pb to 1.77%) was hit late in the period by the lack of visibility on the political situation (Catalonia, general elections).
Exhibit 7: Change in yield of the German 10-year Bund for the period from 02/01/2015 to 31/12/2015.
Currency markets: dollar and Swiss franc up; euro, yuan and commodity currencies down
Volatility remained high on the currency markets in 2015, returning early in the year to levels reached in 2012 and 2013 in the case of major developed economies, and exceeding those levels in the case of emerging currencies. This nervousness was visible from the start of the year, due to the outlook for a Fed rate hike, which would draw capital from emerging currencies. The difficulties of commodity-producing countries also played a role, affecting the currencies of developed economies (CAD, AUD, NZD, and NOK). Meanwhile, two adjustments in forex policy revived the spectre of a currency war and exacerbated nervousness. The completely unexpected decision on 15 January 2015 by the Swiss National Bank (SNB) to remove the peg on its currency installed in September 2011 (at CHF 1.20 for 1 EUR) triggered huge swings in the following days. In August 2015, the Chinese central bank’s rather awkward and, in any case surprising, devaluation of the Chinese yuan produced erratic shifts. While officially, of course, it is not a currency policy, the ECB’s highly accommodating policy, which further widened the monetary policy gap on either side of the Atlantic, drove trends in the EUR/USD exchange rate. After trading in a very broad range (1.05-1.21), the euro ended up giving up 10.3% to the dollar in 12 months (see exhibit 8 below). The year’s low was hit in March 2015 (in fact, a low since January 2003), with Greece concerns causing further harm to the euro. The exchange rate then traded directionless, driven above 1.14 on several occasions by economic data, political developments and shifts on other financial markets. In October, the European-US central bank divergence story returned to the fore. In hinting at a new marked easing, Mario Draghi sent the exchange rate close to its year’s low in early December before the actual announcements fell short of expectations, sending the euro back up to 1.10. It ended the year at 1.0861. Based on Fed calculations, the dollar’s effective exchange rate (calculated with regard to its main trading partners) gained 10% in 2015 to a high since spring 2003. Based on a JP Morgan index that expresses shifts vs. 10 emerging currencies, the dollar gained 19%.
Exhibit 8: Changes in the exchange rate for the euro versus the US dollar (US dollars per euro) for the period from 02/01/2015 to 31/12/2015.
Exhibit 9: Changes in the exchange rate for the Japanese yen versus the US dollar (yen per US dollar) for the period from 02/01/2015 to 31/12/2015.
The USD/JPY rate moved above 120 in late December 2014 (a high since mid-2007) before trading irregularly around this threshold until May 2015. It was unable to settle in for long at 125, its level of last summer, due to the Bank of Japan’s and the government’s reluctance to stick to the “weak yen” strategy. In August, the announcement of the Chinese yuan devaluation sent the rate briefly to 116 before it stabilised around 120 until October. The yen traded in a slightly broader interval (120-124) the rest of the year but without truly reflecting market operators’ convictions at a time when the Bank of Japan has maintained uncertainty on its next securities purchases while making a minor adjustment in December. The USD/JPY rate ended the year at 120.20, up 0.3%.
The Fed managed to avoid spooking investors with its first key rate hike in December and, while minds will be focused on the pace of normalisation of US monetary policy in the coming months, the Fed for the moment appears to have its guidance under control. Observers are reassured by its optimism on the US economy. To a lesser extent, the ECB’s halfway measures could be good news, as Mario Draghi was unable to impose further drastic measures, given the favourable outlook for the economy. The main question on the economic scenario comes from emerging markets with the renewed fall in oil prices in late 2015/early 2016 exacerbating concerns. The unsynchronised growth in the global economy is tending to scramble the message by hiding the encouraging news. This situation could continue and maintain some nervousness on the financial markets and hit one asset class after another. In December, neither the ECB nor the BoJ announced an increase in monthly securities purchases under their respective quantitative easing programmes. This had an impact on equities. To wean investors more easily off central bank liquidity, a clearer improvement in fundamentals will be needed. Microeconomic aspects remain favourable on the equity markets, judging by the sizeable mergers of recent months and the prospect that there will be more of them.