So far this month we've had - in no particular order - a plummeting oil price, a stronger USD, a submergent Rouble and Russian stockmarket, re-emergent political risk in the Eurozone in the shape of Greece, poor economic data from Germany, China and Japan, and worries over a more aggressive Fed stance on interest rates.
It's instructive that, as noted in this week's edition of "The Economist", the last time a number of these things were in similar alignment was shortly before the 1998 Emerging Markets crash. A strong USD, a strong US economy contrasting with weakness elsewhere, commodity price weakness, deflation in Japan, etc. The recent rally in US stockmarkets also has parallels in the market run up before the dotcom slump of late 2000, even if valuations today are not as stretched.
The one big difference this time round is that in reaction to the LTCM collapse of 1998, the typical central banker's response was to cut interest rates: not an option that's readily available this time round with interest rates hovering barely above zero in most developed economies.
Whilst we feel that this month at least, the sell-off looks overdone and should be bought back into, there is room for concern next year, and that the potential for mis-steps correspondingly greater. The core points on which to focus will be:
(1) US interest rates - On this we are more sanguine than we are on much else. The Fed has been every bit as consistent in its message about 'focusing on the data' as market commentators have been every bit as inconsistent in choosing to misinterpret that message. Yesterday's comments from Janet Yellen merely underscore more of the former - interest rates will remain low for a while and these will only change when the data does. Since lower oil prices and a stronger dollar are dis-inflationary by definition, the signs are that inflation will be held in check for the next 12 months or longer. Interest rate policy will therefore take this into account, by focusing on more of the same.
(2) Growth - Central banks in the Eurozone and Japan will have their work cut out for them in the face of politicians who talk a good game but seem unable to balance the need for stimulative policies with structural reforms. In Japan, much will rest on Prime Minister Abe finally getting to grips with the latter in the face of entrenched structures and opposition from various interest groups. In Europe it rests on the German government finally acknowledging that the Eurozone will cease to function if it does not give some of the peripheral nations some breathing space as they struggle to cope with high structural unemployment. The odds in favour of a return of the Eurozone crisis in 2015 look high.
(3) China - Unlike 1998, China will be a big swing factor for Emerging Markets in 2015. A sniff of easing has resulted in the local market in Shanghai surging by a 1/3rd since the beginning of October, but the benefits of such easing need to be reflected in improving data, which - so far - we have not seen.
(4) USD - The rise in the USD, if continued, will cause significant issues for many markets from Russian through to Brazil and foreign borrowings become more expensive to service and repay. Whilst the size of offshore borrowing is not as extreme as was the case in 1998, it still has the potential to cause problems.
(5) Geo-politics - This seems to be an example of a Rumsfeldian "known unknown". At what point, for instance does Vladimir Putin choose to either reverse course or double down in his so far fruitless confrontation with the West. History is replete with examples of leaders who, when pushed into a corner, react in extremis. There are however very few examples of leaders who recognise that costly mistakes have been made and that the only course is once of moderate compromise (largely because admissions of failure tend to be career ending). With the Eurozone economy in disarray, the opportunity for macro mischief making is high.
(6) Valuations - Global stockmarkets and the US market in particular - have benefited from a liquidity driven re-rating. Corporate share buy-backs have contributed to this. In 2015, we will arrive at a point at which the beef needs to be produced - on a global basis - and earnings from higher revenues need to start showing through. Whilst this seems likely to come through in the US, the position elsewhere is more difficult to predict.
(7) Oil prices - Lower oil prices are a positive for the major economies which are net consumers of oil, even if oil dependent producers such as Russia, Iran and Venezuela pay the price. However, the sharpness of the recent move will throw up risks in debt markets at a sovereign and corporate level which could likely bleed into other asset markets as risk appetites fall overall.
The net result of all the above is that we enter 2015 with a sense of much greater caution. Although low interest rates will remain in place and therefore continue providing support for markets on an opportunity cost basis (in this scenario equities remain the least unattractive option), it is clear that volatility will be much higher as a result of enhanced tail risks. Strong stomachs will be needed, and this will argue in favour of gradually increasing cash holdings to take advantage...
contact: +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.