Extreme volatility across international equity markets during 2015

Financial Article 417 by Edward Rizzo - Jan 14, 2016

In last week’s article I reviewed the main developments across the local equity market during 2015. The MSE Share Index registered its best performance since 2005 with an extraordinary uplift of 33% as most equities registered double-digit gains. The strong share price performance across most equities materialized from improved financial performances and higher dividends to shareholders; various company-specific developments as well as the low interest rate scenario which led to a surge in demand for equities giving an attractive yield.

On the other hand, the main global equity markets had a difficult year. The indices in the US – the S&P500 and the Dow Jones Industrial Average – both registered marginal declines while the NASDAQ gained 5.7% following the strong performances of a number of technology companies including Facebook, Netflix, Amazon and Google which was rebranded to Alphabet.

The FTSE100 in the UK suffered a 5% drop given its large dependence on mining companies which were impacted by the sharp decline in commodity prices.

Across the EU, stock market performances were mixed. Among the larger markets, the FTSE MIB in Italy was the strongest performer with a gain of 13.9% followed by the DAX (+11.2%) and France’s CAC40 (+8.5%). On the other hand, Spain’s IBEX suffered a loss of 7% which can be mainly attributed to the uncertainity leading up to the general election in December which resulted in a deeply fragmented parliament.

As indicated last week, the smaller equity markets in the eurozone had some very positive performances. The strongest gainer was Latvia (+45.7%), followed by Malta (+33%), Slovakia (+31.5%) and Ireland (+30%). On the other hand the Greek equity market shed 18% and Cyprus was the worst performer with a 20% decline.

2015 was a very eventful year characterized by extreme volatility. In fact, during the first quarter of the year, European markerts in particular raced ahead with strong double-digit gains. The DAX in Germany rallied by 22% in Q1 followed by Italy’s FTSE MIB at 21.8%, France’s CAC40 at 17.8% and Spain’s IBEX (+12%). The main reason for this was the announcement of the quantitative easing programme by the European Central Bank in early January which then commenced on 9 March. The markets reacted positively to the larger-than-expected bond buying programme of €60 billion per month which will last until September 2016. The monetary stimulus programme is aimed at lifting the inflation rate across the Eurozone to just under 2% as well as weakening the currency to boost exports and support the economic recovery. The share prices of the large European exporters were among the most positive performers during the start of 2015.

Renewed uncertainty in Greece and fears of an exit from the single currency characterized the early part of summer 2015, leading to a partial reversal across European equity markets as negotiations between the troika of creditors (EU, ECB and IMF) and the Syriza government proved to be difficult. As a deal was finally reached after many weeks of uncertainty and a real fear among investors that grexit could really materialise, equity markets subsequently rallied in July.

As the year progressed, monetary policy divergence became a central theme, as analysts were starting to anticipate that the US Federal Reserve would commence a series of interest rate increases in line with the consistent signs of improvements in the US economy including a reduction in the unemployment rate towards 5%. On the other hand, speculation was rife that the ECB would implement further monetary stimulus as inflation remained stubbornly low. Given the negative impact on equities from a rate hike, the US market was volatile and very much dependent on the timing of announcements related to the US economic performance which signaled either the possibility of the start of the rate tightening cycle or a delay in this respect.

However, the summer months were best remembered for the sell-off during the third week of August which commenced in China. Monday 24 August was labelled “The Great Fall of China” or “China’s Black Monday” – a reference to the crash of October 1987 – as the Chinese Shanghai composite index dropped by 8.5% (the steepest daily decline since 2007). This led to a sell-off in other global equity markets as European indices dropped by around 5% on the day and the Dow Jones Industrial Average in the US declined by 1,000 points in the first few minutes after the market opened. The US equity market partly recovered by the close of the trading session of 24 August but still ended the day around 3.6% lower.

The Shanghai composite index tumbled by 24% between 15 June 2015 and 11 August 2015 as a series of interest rate cuts by the People’s Bank of China and other intervening measures failed to stem the sudden reversal of the debt-fuelled equity market bubble (China’s stockmarket had climbed by 150% during a 12-month period between June 2014 and mid-June 2015).

Many equity markets entered into correction territory in August after the worst monthly declines for several years. In Europe, the DAX fell by 9.3%, the CAC40 shed 8.5% and the UK’s FTSE 100 fell by 6.7%, whereas the S&P 500 in the US dropped 6.3%.

The slowdown in Chinese economic growth and the resultant impact across global stockmarkets during the summer led the Federal Reserve in the US to delay the rate hike programme and this supported equity markets during the final quarter of the year.

Moreover, at the European Central Bank meeting held in Malta on 22 October, President Mario Draghi had signaled the possibility of introducing additional monetary stimulus at its subsequent meeting in December in order to tackle deflationary pressures. This led many investment banks to predict a further weakening of the euro supporting European equity markets in November. However, at the ECB meeting on 3 December, although the ECB announced a reduction in its deposit rate to -0.3% and extended the QE programme of €60 billion per month for a further six months until March 2017 (or beyond, if necessary), the actions by the ECB were less than widely expected and the disappointment across global financial markets was immediately evident.

In fact, the 10-year german bund yield jumped from 0.47% to 0.68% on the day (one of the biggest one day moves in a long time), the euro strengthened by more than 4% against the US Dollar surpassing the USD1.09 level (the biggest daily rise in the euro since 2009) and equity markets also reacted negatively with the German DAX 30 Index and France’s CAC40 both sliding by 3.6%.

A few days later, the US Federal Reserve announced the first interest rate increase since 2006. Although this news was followed by some volatility, the overall movement in US equity markets during the final two weeks of the year was marginal as the move by the Federal Reserve was largely expected and underlined the confidence the Federal Reserve has in the US economy.

Following the steep sell-off seen last week (with many global indices suffering the worst start to the year in decades), it is fair to say that the volatile conditions experienced in 2015 will also characterise 2016. The main equity indices will remain sensitive to key developments affecting global demand, in particular the performance of the Chinese economy, the extent to which the US economy is able to handle a series of interest rate hikes and the speed of the economic recovery across the Eurozone. Other developments affecting investor sentiment will be political elections across various EU nations, Britain’s referendum on its future participation within the EU as well as the US presidential election. Additionally, geo-political tensions, particularly in the Middle-East, have the potential to not only affect consumer and business sentiment, but also to affect commodity prices, especially oil which recently dropped to its lowest level since 2004.

Monetary policy divergence will be a central theme this year. Although the Federal Reserve is widely expected to continue with a gradual increase in rate hikes, the economic slowdown in China and the subsequent impact on global economic sentiment can delay such decisions. This could widely affect equity, bond and currency market movements from one period to the next during the course of 2016.

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Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.