City Insider: Falling oil and fragile China marks the start of 2016

City Insider David Stevenson considers a fraught start to the year on global stock markets

Global markets have not been in overly joyous mood since the first week of 2016, when the benchmark FTSE 100 index plunged 3% while the S&P500 tumbled 4.5%.

For share investors, these were terrible numbers. If we look back at the first weeks of trading since 2011, there was only one week of losses with the S&P (barely noticeable at -0.09% in 2013).

The FTSE All Share index also showed three years of positive starts with only two years with small losses – 0.05% in 2012 and 0.28% in 2014.

What worries many investors is that these dreadful numbers might be a portent of worse to come.

Perhaps the most-prominent City exponents of a doomsday scenario for 2016 have been RBS analysts who reckon: “This all looks similar to 2008.” A repeat of 2008? God help us.

Of course, no one has privileged insight into what might happen, but both the hard numbers and the dismal economics are looking more than a bit grim.

Let’s take the hard numbers about markets first. Tim Edwards, senior director of S&P Dow Jones Indices has done the maths on historical data for the S&P Global 1200 index and reckons there is a strong relationship between the performance of the first week of the year and the overall return in the subsequent year – although I would say a closer reading of the results isn’t quite so conclusive.

Looking at single-week correlation to end-of-year performance suggests it’s the first week of September that is most influential for returns.

The second week of November comes next, followed by the second week of March. By contrast, the first week of January comes in at number five.

Nevertheless, if stock market numbers are anything to go by we should be worried.

Turning to economics, it’s easy to see how it could all get much worse. The markets are currently freaking out about two key drivers. The big factor is declining oil prices. As readers of this column will know I banged on about a rout in oil markets for most of 2015.

I’ve long stuck to the view that oil won’t bottom out until prices hit $20 a barrel. Now I seem hopelessly optimistic as Standard Chartered Bank reckons the low could be a staggering $10.

If either of us is right, we’ll see a massive wave of bankruptcies, defaults and general carnage in the oil sector in the next three to six months. Dozens of big businesses will go to the wall.

This massive market move will kick start a more ominous trend. Big sovereign wealth funds will start selling their Western assets as they try desperately to repatriate some cash.

Rising US interest rates will also result in American investors pulling money back from exotic climes, prompting an even sharper appreciation in the US dollar.

Market volatility will climb the wall and investors will get spooked. More materially, lots of bosses of big businesses might delay plans for expansion in 2016 because of this market turbulence.

As for China, I can’t see any let up for at least the next few months. President Xi is making his mark and needs to get all the nasty, painful stuff out of the way.

But I would be cautious about ascribing too much concern to oil and China. As oil prices head ever lower, their impact on wider markets starts to diminish. It’s a similar story for China where many Western investors have almost no meaningful exposure.

The real concern is with the US and the UK where evidence is starting to emerge that corporate earnings growth has stalled. This is partly a result of the stronger dollar hitting businesses diversified internationally. Put simply, the US economy will stall.

For the travel sector, I would also keep a beady eye on Spain. As RBS analysts note: “The market is too complacent about Spanish politics. We think the parliamentary deadlock in both Madrid and Barcelona will result in Catalan elections in March and national elections in Q2 2016.”

The desperate struggle to build a unity pact will consume a huge amount of energy and there is the distinct chance that Catalonia might go for independence.

All in all it has been a miserable start to the year for the markets. But there is a decent chance that Wall Street and the Square Mile might prove far too pessimistic. The UK economy is still strong, the US economy is stronger still and the euro zone is picking up speed fast.

David Stevenson was writing ahead of the move to negative interest rates in Japan on Friday.

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