October is living up to its reputation

Equity markets ended the week sharply lower as sentiment towards the global economy turned decidedly to the negative.  A combination of weak data from the eurozone and Germany in particular, the IMF lowering forecasts for the global economy for next year, the increased spread of the Ebola virus, greater tensions in the Middle East, the World bank modestly cutting forecast for the Chinese economy and S&P cutting Frances credit rating, all providing a perfect storm for equity markets. Equity markets were briefly boosted in the middle of the week by the FOMC minutes giving the impression the Federal Reserve are in no mood to raise interest rates in the near future.

 

The oil price weakness seems also to be giving cause for concern, partly as it is seen as bell weather for the demand from China for commodities, but also a reflection of the strength of the global economy. We reiterate what we said on Friday that the weakness in the oil price, for whatever reason, should be viewed as a positive for the global economy. The recent fall in the oil price is now being reflected in forecourt petrol prices, which on top of sustained low interest rates must in some way help boost consumer spending.

 

When one looks how sentiment has changed from the start of the year when we wrote about all the fear being in the bond market and all the greed in the equity market, it feels very much as if sentiment is completely reversed. The past week saw a big move into cash and out of equities; bonds continue to attract investor’s capital. The fear is now in equities and the greed in bonds.

 

The VIX closed the week at 21, the highest level since February this year. The previous occasion before that was this time last year.  On each occasion in the past year the VIX rising above 20 accompanied by a correction of circa 5% was enough for equities to form a base from which to recover from. Time will tell if this is the case on this occasion.

 

The uncertainties that have knocked investor sentiment this week are unlikely to go away in the short term which leads one to believe that volatility in equities may continue for a while yet. On the plus side balance sheets remain strong, interest rate rise expectations have moved out and governments along with central banks will remain focused on maintaining in pro growth strategies. The earnings season starts in earnest this week, hopes are that may be the ray of sunshine in an otherwise cloudy sky.

 

 

Posted on October 12, 2014 .