New Year hangover

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Please note that this article may contain technical language. For this reason, it is not recommended to readers without professional investment experience.

Markets opened the New Year sharply down, occasioned by crashing Chinese equities, intervention by People’s Bank of China in the stock market and a change to the Yuan peg, and a circuit-breaker close after just 15 minutes of trading. This in turn caused global equity markets to lurch downwards, and as of Monday January 11th, most markets were down around 7% with the S&P recording its worst start to a year since 1929. The parallel does not inspire confidence. It is commodities that have attracted the most interest though, with the front crude oil contract now trading at a little over $31/barrel.

The temptation may be to believe that all this doesn’t really matter. Deutsche Bank’s Oleg Melentyev has taken issue with this, not least the idea that only US exports to China are worth less than 1% of US GDP. He points out that few exports from the US are booked as such, owing to the use of overseas corporations to book profits. Apple, for example, sells phones manufactured in China, through a Chinese subsidiary, to China. These are not counted as exports, yet clearly expectations of sales to China will have a very direct impact on Apple’s profitability if they suffer as a result of sharply slowing growth.

Exhibit 1: In the first week of 2016 prices of crude oil fell to $31/barrel (the graph shows prices for crude oil for the period from January 2011- January 2016)


Source: Bloomberg, as of January 8, 2016.

This is happening across the world of mostly emerging commodity-producing nations, of which Brazil may be the clearest example, which is experiencing the longest recession in 100 years as well as huge political scandal, and with commodity prices where they are, no end is in sight. Apple has a manufacturing plant in Brazil. Volkswagen, Ford and General Motors have several. The transmisssion mechanism of emerging market weakness to developed markets may not be so very obscure.

Yet the outlook is not so simple. In the US, Friday 8 January 2016 also brought the monthly jobs report. By any standards, it was strong: headline job creation was much stronger than expected, upwards revisions were strong, and even the labor force participation rate increased a little. The fear is that this is backwards-looking – although in point of fact, the reason why we look at unemployment is that it is amongst the pieces of economic data with most predictive power.

December’s US auto sales data was also strong – not as strong was expected, but full-year sales in 2015 of 17.4 million are the all-time high. As analysts have pointed out though, it is the mix of sales within this that is particularly noteworthy. Car sales were down around 3.5%, but crossover sales (that is, smaller SUVs by and large) were up 3%.These cost more than cars, and are less fuel-efficient. As an indicator of consumer confidence and as an indicator of reaction to cheaper energy, the message could hardly be clearer. At the Detroit Auto Show, BMW also reported that it had had its strongest-ever year in the US in 2015. Auto sales were not just strong in the US. Mercedes Benz reported sales growth of 33% in 2015 – in China.

Average hourly earnings growth remains disappointing. On a monthly basis, growth was flat, against expectations of a 0.2% increase. On an annual basis though, average hourly earnings increased by 2.5%. That may be unexciting, but it does outpace inflation: headline CPI is running at 0.8%. But there has been a steady, if faint, drumbeat of better news here too. The Federal minimum wage remains a modest $7.25/hr. But 14 states increased their minimum wage on January 1, with both California and Massachusetts increasing theirs by over 11%. The national average increase was almost 6%. These workers are not perhaps the “middle class” beloved of politicans vying for election, but they do suggest that there is more wage growth than received wisdom might have one believe.

So what do we conclude? Broadly, that growth may be weaker in 2016 than we – and central banks – had forecast. But lower growth does not equal no growth. The Federal Reserve likely will continue to raise rates – perhaps not four times, but not no times either. That push and pull means higher volatility – and as this week has shown, volatility can be much higher than we expect, much more quickly. 2016 will be a year of managing this volatility, and, we hope, profiting from it.



Alex Johnson

Head of Absolute Return Multi-Sector Fixed Income

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