Credit markets shake equity investors

Equity prices remain under pressure at the start of December, putting a question mark for the hope of a Yuletide rally. It’s been a rotten year for investors in most asset classes; equity markets are down on the year, as are bond prices. Commodities have taken a beating, and the expectation that yield in a low income environment would offer protection, has in many cases failed to cover against capital losses. None more so than in the oil and mining sector. Despite management convicted reassurances that the dividend remains sacrosanct, investors still appear to price in a strong possibility of dividend cuts.

 

The sharp move in commodity prices downwards during a period when the global economy is supposed to be growing, if only slowly, feels almost unheralded. The collapse in the oil price over the past 12 months was completely unpredicted, even by the industry, one feels. It’s amazing how one’s bias tends to ignore the obvious, only to call the ultimate event a black swan. In the case of oil, it was increased production, reduced demand from a combination of subdued economic growth and technological advancements, all of which was well known. Like all corrections it came swift and painfully. Despite the vast correction in the price, the International Oil Agency still predicts little increase in demand in the coming year.

 

High yield credit is down over 4%, since the start of the year. If equity markets are to stabilize then high yield debt has to recover. It is well documented that a bull market starts with credit recovery and ends with credit prices falling. Equity valuations are taken from the credit market.

 

To add further worries, the FT reported this week that over a trillion dollars of corporate debt has been downgraded this year, as defaults climb to post crisis high’s. S&P cut four of the US largest banks credit rating in the past week, on fears the US government will not bail them out again should another crisis occur.

 

Next week Janet Yellen and the rest of the Federal Reserve have all but committed to raising interest rates, in the backdrop to these developments. They appear to be basing their decision on the increasing strength of the labour market. Apparently prepared to ignore the recent weak manufacturing data and signs the service sector could also follow.

 

We discussed earlier this week a Tom Stevenson piece on consensus views. The consensus is currently that next week’s hike (should it come) will be followed by further gentle rises. Non consensus is that at the beginning of 2016 the Fed will be discussing undoing next week’s potential rate rise. 

Posted on December 10, 2015 .