Monday 05, March 2018 by Jessica Combes

Improving market sentiments


Vijay Valecha, Chief Market Analyst at Century Financial Brokers, provides Banker Middle East a comprehensive review of financial markets since the start of 2018.

One month into 2018, and investors have already started fearing the roller-coaster ride in global markets. They say morning shows the day, and with January starting off at a spectacular note, hopes shot high and investors expected the bull to continue its run. But little did anyone anticipate that a sort of ‘Black Monday’ was around the corner. 5 February witnessed the greatest slide in the history of Dow. Dow Jones Industrial Average, a forerunner amongst all US indices, lost a whopping 1700 points in 24 hours. The frantic February saw the US stock lose $1 trillion in the first week itself. Even though this correction was long overdue, it caught investors unwary as they were busy basking profits in the shiny Bull Run.

The recent correction in equities has thrown markets off guard despite sound global economy and everyone is contemplating what’s next. Before we divulge into that, let’s sum up what has brought markets to where it stands today. After a strong start to 2018, major indexes pulled back this week as strong wage figures in the monthly US jobs report added to concerns about a pickup in inflation and subsequent tightening of monetary policy.

January 2018 has been terrific in terms of employment in the US, which saw 200,000 jobs being added in the economy and a growth of 2.9 per cent in wages. The unemployment rate now stands at the levels of 4.1 per cent against 10 per cent in 2009. Post 2008 recession, this has been the most meaningful progress in the economy. In a tight job market, there were more jobs available than there were workers to fill them. This forced employers to offer higher pay to attract and keep workers. The uptick in the wages has been a clear indicator of improving economic status which, in turn, has pumped up inflation expectations.

This was reflected in a massive surge in the US Treasury Bond yields. For the first time since 2014, the benchmark 10-year bond yields rose above the 2.7 per cent mark. Markets have now become very certain of not only the impending rate hikes but also expect the Fed to raise rates at a faster pace. The rising interest rates along higher yields lead to higher borrowing costs for the corporates, and thus, lower the relative attractiveness for stocks.

While the limelight was focused on the robust US economy, growth in the European Union reached 2.5 per cent in 2017, the best since 2007, which saw a growth of 3.4 per cent. The European economy is at the cusp of a broad cyclical expansion, after years of economic stagnation and rolling crises, boosted by regaining confidence and monetary stimulus from the Draghi-led European Central Bank. The German bund mirrored this optimism as the five-year bund yield breached 0.01 per cent breaking above the zero per cent levels, for the first time since 2015. The 10-year German bund yield climbed close to 0.7 per cent.

The Asian markets displayed the same sentiment. China has held on to the baton of leadership in many segments of the economy. Now, the word on the street is that China is passing along its inflation to the rest of the world. Its Producer Price Index (PPI), which is a measure of inflation, turned positive for the first time in five years.

The PPI rose to 6.3 per cent for the full year of 2017, the highest in nine years. The GDP also grew for the first time since 2010 to 6.9 per cent. The attractive economic data buoyed on Chinese government’s campaign to reduce excess capacity in industries such as coal, steel and aluminium and improve international trade. The Chinese bond yields have been growing since late last year and can be regarded as the leading indicator of growth globally. The Chinese 10-year RMB bonds trade at 3.9 per cent, which remain unperturbed amidst havocs elsewhere.

Another major factor that can be considered for the sudden US debts sell-off was the surge in oil prices, which rose to three-year highs in January. This oil price surge led markets to markets expecting higher headline inflation. Rising inflation and a crash in the bond market can be considered as the greatest tail risk for markets in general.

Tighter monetary policies can crimp economic growth in the long term. This has underpinned much of the climb in stock prices over the past year.

Despite the recent dip across Wall Street, the Dow Jones Industrial Average rose three per cent in 2018 already. Strong corporate earnings and improving investors’ sentiments lend a bright picture for the stock market. With both the US and Euro zone growing in tandem and with Asian economies on a roll, 2018 is expected to deliver continued growth and economic stability for the first time in a decade.

Forex market
With Trump tax plan and US Fed’s intention to raise interest rates at least three times, the dollar could be a favourite in the trading community. Also, one should not forget that Fed is reducing the balance sheet size by $30 billion a month. This is going to be the first time in multiple years that Fed policies are going to contribute to rising bond yields. Counter intuitively, this could be termed as ‘Quantitative Tightening’. Well, if purchasing bonds is ‘Quantitative Easing’, reducing purchases is certainly the opposite. To put things into perspective, it seems that US Dollar has some strong tailwinds behind its back in 2018.

Oil: bright outlook
Major forecasts indicate that the positive sentiments in global economy will spill over to energy markets also. Oil demand could grow faster as the global economic growth is broad based and surprises to the upside. This could push the oil markets to deficit as demand for OPEC crude is expected to rise to 33.42 million barrels per day while OPEC compliance of more than 100 per cent means OPEC production growth will be stagnant.

Rising US oil production might not be sufficient to tip the balance. OECD oil inventories fell 4.6 per cent between January 2017 and December 2017 due to rise in global oil demand and strict OPEC compliance with production cuts. OECD oil inventories which touched a record high of 3093 million barrels in July 2016 has since then fell by six per cent.

US Energy Information Administration (EIA) forecasts suggest that oil inventories could further decline 1.4 per cent and average 2952 million barrels in 2018. Overall it, looks like this could be a good year for crude oil.

Middle East
With oil likely to remain stable in 2018, outlook for Middle-East markets are biassed to the upside, especially with political uncertainty easing.

Saudi Arabia’s crackdown on corruption had resulted in some prominent business men and even royals being detained in Ritz-Carlton, Riyadh. However, majority of the cases have resulted in settlement and it is rumoured that the Kingdom’s government had netted a bonanza of almost $106 billion. This should ease the fiscal burden of the desert Kingdom immediately while the proposed IPO of Aramco in 2018, might help it garner enough funds for funding transformational initiatives.

Outlook for UAE also is bullish as a slew of infrastructure projects have been announced ahead of the 2020 EXPO. The recent introduction of VAT should increase the fiscal strength of UAE government. Other GCC markets remain supported in light of rise in oil prices this year.