Financial
Markets
– what is going on: observations, reflections, conclusions
Geopolitical turbulences and possible interest rate hikes in focus
The reporting period has
on the one hand side been characterized by the escalation of the
political turbulences in the Arabic region. On the other, an increasing
number of signs suggest that market participants’ focus is shifting to
the risks of inflation in those countries that have been less affected
by the financial crisis or are on the point of recovering from the
economic slump.
Despite this, financial markets have over all shown resistance. With
the exception of Singapore (-5,75 per cent) and Hong Kong (-3,43 per
cent), the main bourses of the industrialized countries have extended
their gains. The leader has been Japan (+5,43 per cent), followed by
the US markets (+3,13 per cent). The European markets slightly
underperformed the Morgan Stanley Capital International World Equity
Index (+2,75 percent). Most of the other Asian markets have for the
second time this year posted losses.
Growing inflation fears point to possible interest rate hikes
Mainly because of drastically higher prices for food and energy,
interest rates hikes have again caught investors’ attention. In the
financial markets of emerging countries, inflation fears have already
left clear traces. But also within the Euro zone, the topic has
attracted more alertness. Several members of the council of the
European Central Bank (ECB) have suggested, a change in the loose
monetary market policy could be on the way. And in Great Britain, in
their latest meeting, three of nine members of the interest rate
committee have voted in favour a rise of the key rate. That the Euro
has lately been keeping up quite well despite many imponderabilities,
is not least because of interest rate speculations.
Political conflagration in Northern Africa and the Middle East
The topic dominating media coverage in February has been the political
conflagration emanating from Tunisia. With its spreading to Libya, the
situation threatens to escalate dangerously and to draw further
autocratically governed countries into the maelstrom. The reactions at
the commodity markets have been quite diverse. For metals, the conflict
is viewed as a temporary strain. Adverse effects on the dynamics of the
economic recovery are no longer ruled out. Gold and in particular
silver prices are being pushed higher. In the energy sector, fears of
production losses in Libya are escalating. The price of WTI is soaring
and the difference to the significantly higher Brent is coming down.
Agricultural markets are reacting on a possible easing of the grain
export quotas of the Ukraine. And while investors have largely ignored
the crisis in the Southern Mediterranean Sea for a long time, edginess
is spreading suddenly. The escalating developments in Northern Africa
and the Middle East have alerted them.
Price of oil – chock for the economy
An oil price of above USD 120,- per barrel is likely to weigh on global
economic growth for a long time. For consumers in particular, it has
the effect of a tax. According to calculations of Bloomberg economists,
an increase in the price of oil by USD 10,- results in a reduction in
the US GDP of 0,5 per cent. The second estimate of the US GDP of the
fourth quarter 2010 reveal a growth that has been revised down to 2,8
per cent (from 3,3 per cent). In that quarter, the price of the black
gold was on average USD 85.-. At a middle price of USD 110,- (present
quotation: USD 115,39), this would mean a fall of the GDP to 1,8 per
cent.p.a. – with the relevant consequences for the labor market.
Because in order to be able to absorb new workers seeking employment
and to offer a new job to those who have lost theirs, the US GDP would
have to outgrow its so called trend growth of 3,3 per cent.
Swiss economists will have to revise down their growth forecasts to the
downside too. The State Secretariat for Economic Affairs (Seco) has
based its calculations on a price of USD 86,- for this year and USD 90,
for the next.
The estimate for the Swiss GDP of 2010 that was published by the Seco
yesterday came in at a real 2,6 per cent, 0,1 per centage points below
the last approximation.
Signs of fatigue in several countries
Germany: Germany
continues to count on growing domestic consumption. The euphoria has
somewhat been dampened by the details to the fourth quarter GDP
published a week ago. Compared to the previous quarter, private
consumption merely rose by 0,2 per cent. For the entire year, it went
up only by 0,4 per cent. Nothing has thus changed with regard to the
traditional German growth generator which rests upon exports.
UK: At the end of 2010,
he British economy was in even worse shape than so far believed. In the
fourth quarter, he GDP fell by 0,6 per cent. Statisticians’ estimates
pointed to a fall of 0,5 per cent.
USA: The US government
also revised their approximation (second reading) down. Instead of 3,3
per cent, the economy grew in the fourth quarter only by 2,8 per cent.
Personal consumption rose by 4,1 per cent (first estimate: 4,4 per
cent). A further negative impact came from lower government spending.
Expenses on the national level fell by 0,2 per cent and slumped locally
as well as in the states by 2,4 per cent.
US consumers’ restraint seems to last. In January, the savings rate
increased to 5,8 per cent after 5,4 per cent in December. Higher income
resulting from lower social contributions has thus failed to trigger a
spending euphoria.
Signs of weakness from the commodity front?
It is interesting to note that the price development of copper seems to
have lost its dynamics over the past few days. Contrary to the general
trend, copper prices have calmed down. Geopolitical tensions putting
strains on the economic recovery could be responsible for that.
Disturbances that could change the world
In retrospect, it seems that governments in Europe, the US and China
have been able to avert a collapse of financial markets and economy. In
the autocratic states of Northern Africa and the Middle East however, a
political melt down is in full progress. And in my opinion it is in no
way certain that the vacuums of power will be filled with „good“, i.e.
truly democratic, systems. Prospects of instability in Libya is nasty.
Moreover, I am expecting still more turmoil. If societies that have
been oppressed for such a long time and all of a sudden – and
unprepared – are confronted with (allegedly boundless) freedom, it may
lead directly to chaos. The mostly young opposition leaders are
impatient, as new demonstrations in Tunisia and Egypt show. In Algeria,
the end of the state of emergency after almost two decades has brought
about a turn of the tide – possibly for the better. The payoffs boost
people’s courage. More than 100.000 demonstrators demand the
resignation of the king of Bahrain and in Yemen, thousands show their
anger given poverty, unemployment, corruption and dissatisfaction with
the president. And in my opinion, the world largest oil exporting
country, Saudi Arabia, is in no way immune from these developments. The
fact that the Saudi government is trying to appease the people with a
present of USD 36 billions speaks volumes. The young, educated
population demands reforms, participation and jobs. And the women their
basic rights. All this is not included in the king’s program. Unrest in
Saudi Arabia would be fatal for global oil supply. So far, experts
consider a spill over of the protest to the kingdom unlikely. But on
Facebook, manifestations against the regime have been announced for
March 11th. It remains to be seen whether the latter can interpret the
signs.
Another result of the events is a diminishing influence of the US in
the region. And this in favour of the authoritarian hardliners in Iran.
I consider the fact that two Iranian war vessels have been sent through
the Suez Canal of high symbolic relevance that could herald a new area.
For me, the biggest danger is that the occurrences must not necessarily
lead to a quick economic liberalization of the states in the region,
but in a period of international political uncertainty. This would no
doubt result in higher volatilities at financial markets.
There is furthermore the question how much American and European Banks
are engaged in Libya. Because besides several governments, banks too
could have succumbed to the attraction of the enormous financial power
of the Gadhafi-Clan.
Currencies
The Euro zone’s debt crisis drags on and a quick solution is nowhere to
be seen. The Swiss franc has slightly receded from its unusually high
level which resulted in long positions to be wound up.
Financial markets are usually directing their attention to the topic
prevailing at the time. With the focus presently on the Middle East,
they seem to ignore that Ireland has just elected a new parlament. And
one that most probably will aim at restructuring the financial deal
with the EU and the IMF. Before the elections, the victorious
opposition voiced the call for holders of Irelands banks’ debt to
participate at their financial reorganization. We shall soon see
whether this has been pure campaign strategy. If not, it could turn out
to be fatal for the Euro. At the present rate of Euro/Dollar of 1,3842,
the common currency is testing the important resistance of 1,38.
Fuelling the move of the past few days have been speculations of a
widening of the widening of the interest rate difference after members
of the ECB – as mentioned before – are again considering to stiffen
monetary policy. Any loud thoughts about including private debtors in a
rescheduling of bank and state debts will no doubt remind market
participants that the financial system in the Euro zone remains highly
fragile. No doubt, a unilateral push of Dublin would provoke similar
moves from Athens, again rising concerns about cohesion in the Euro
bloc.
Conclusion
The outset for the current month and thus for the performance of the
first quarter of 2011 promises tension and volatility.
Short-term, markets are overbought and up for a consolidation, if only
for technical reasons. So far, the mentioned political changes as well
as inconclusive economic data have only marginally impressed investors.
Euphoric markets offer upward potential. But they are also vulnerable.
The present level makes them susceptible to sharp corrections should
the political situation in the Middle East not loosen up soon. Such a
consolidation can prove extremely healthy for the further course of
equity markets, as long as certain marks are not broken to the
downside. Short- and perhaps mid-term too, we should prepare for some
headwind. I recommend hedging part of the portfolios through the
purchase of a put option on the German DAX. (To some extent, capital
losses can thus be compensated by a gain in the option.)
Thalwil, March 2011
