Commentary on the stock markets – December 2016
Highlights:
- OPEC: agreement on oil production cuts
- Italy: voters say ‘no’ to constitutional reform in referendum
Commentary:
In late November and early December, OPEC oil cartel member states agreed to limit oil production. This is the first agreement since 2008, the last time members of the cartel were able to reach a successful deal. Current production levels stand at 33.6 million barrels per day and member states agreed to cut output by 1.2 million barrels per day, which should help oil prices rise. Russia has also joined the deal and will reduce output by 300k b/d. The tightening of the tap helped oil to appreciate by a significant 12.6% in December.
However, most investor attention in December was focused on the outcome of the Italian referendum. In it, voters rejected Prime Minister Renzi’s reform package, spelling the end of his government and a possible snap election. The Five Star Movement, which has strong anti-European tendencies and would likely seek to leave the eurozone and the EU, would likely have been significantly stronger in such an election. Despite Prime Minister Renzi’s failure, stock markets surprisingly reacted positively to the referendum result, with Italian stock indices rising strongly in December.
As expected, the European Central Bank extended its quantitative easing programme until the end of 2017 in December. It is therefore a 9-month extension of the programme. However, the volume of funds to be released will be reduced from the current EUR 80bn/month to EUR 60bn/month, which is lower than market expectations, which had anticipated maintaining the current level of monthly volume.
The main events of 2016 on the financial markets:
- The fall in Chinese equities at the beginning of the year
- Brexit – the UK is leaving the European Union
- Deutsche Bank in trouble
- Donald Trump becomes the 45th president of the U.S.
- Cheap money policy – Fed, ECB, BoJ, CNB and other central banks
- Oil: huge rise in price, gold: rise in the first half of the year, then fall
- global tensions – Syria, military coup in Turkey, terrorist attacks
Summary of developments in financial markets in 2016:
For stock investors, 2016 was a successful year if we consider the MSCI World aggregate stock index, which appreciated by 5.32% for the year. However, differences between regions and sectors were significant. Investments in Russia, Argentina and Brazil generated the greatest appreciation, while investors in China calculated high losses. Among the sectors, the oil industry was the most successful, followed by financial institutions. The industry also fared well, benefiting from the improving health of the global economy as well as low energy prices.
At the start of the year, the biggest theme was China, where the stock market lost a fearsome 22.6% in January. The cause of the declines was the slowing performance of Chinese industry. In the rest of the year, although the Chinese stock market mostly rose, it still ended the year with an overall loss of 12.3%. The Chinese economy continues to be plagued by a number of problems, such as high government debt, declining output growth and the risk of a bursting property bubble.
In June, the British people voted to leave the EU in a referendum by 51.9% to 48.1%. The British pound responded with an unprecedented fall. European stocks initially lost value, but were able to eliminate the losses relatively soon. However, the exit of one of the strong countries from the EU, which few had previously been able to acknowledge, could set off a chain reaction. Centrifugal forces outside the EU can also be seen in other European countries. There will be elections in the Netherlands and France next year, and possibly early elections in Italy. One can expect a rise in the preferences of parties that oppose European integration or make no secret of their intention to leave the EU. The European Union is coming under pressure, which seems to have only two possible scenarios for resolution: deep reforms or its gradual weakening and disintegration.
Germany’s Deutsche Bank found itself in big trouble in the autumn. It was fined a huge sum by the US Department of Justice. Other causes of the problems were the interest rate manipulation and money laundering scandals in Russia, which damaged the bank’s reputation. German Chancellor Angela Merkel has outright refused to bail out the bank, despite it being one of the most important financial institutions in the world. The bank’s shares even fell below EUR 10 at a critical moment, but after the US Justice Department issued a lower-than-expected fine, the situation stabilised and the shares gradually climbed to levels around the current EUR 18/share.
Probably the biggest surprise of the US election was the victory of Donald Trump. He first managed to win the Republican primaries and then, despite the polls, managed to defeat Hillary Clinton in a straight fight for the White House. Stock markets ultimately viewed Trump’s victory very positively and rose for the rest of the year as investors anticipated big infrastructure spending and possible tax cuts.
Equity markets have also benefited from cheap money policies this year, with virtually all major central banks pumping huge amounts of money into their economies. The US Fed only started to tighten monetary policy at the end of the year, but the ECB has extended its quantitative easing programme until the end of 2017. The CNB has kept the exchange rate peg at CZK 27/EUR all year and is expected to leave it only this year.
Among commodities, oil performed strongly, improving by 52.4% year-on-year after the knock-out hit in 2015. Gold experienced two very different halves. In the first half of the year, its price rose, while in the second half it lost ground. Nevertheless, it appreciated by 8.1% over the whole year.
One of the most significant exchange rate drivers and persistent risks over the past year has been global tensions. The war in Syria was ongoing throughout the year, with Russia and Turkey eventually intervening. In Turkey itself, there has been a consolidation of central power by Erdogan, who has been able to use the military coup to strengthen his own position. Terrorist attacks have recurred in Europe, as in previous years. Unfortunately, tensions between Europe and Russia seem to have increased. Perhaps a positive outlook for this year could be the so-far fragile, but nonetheless calming, Syrian civil war, the significant weakening of the Islamic State, and the declining flow of refugees into EU countries.
As the New Year approaches, the bag is always bursting with various analyst recommendations whose sole purpose is to lead retail investors/clients into tactical portfolio adjustments. We always try to avoid this in our regular report. The ideal strategy is to stick to the investment horizon originally chosen and have the investment as diversified as possible. This year, developments in the EU, which is facing a possible existential crisis, will be key for investors. It will also be important to what extent Donald Trump succeeds in meeting the high expectations of investors and the US population, who expect further growth in the US economy. Last but not least, the geopolitical situation will play a crucial role, especially further developments in the Middle East and relations between Europe and Russia. However, it is always the case that risk is not only a threat, it is also an opportunity. If the situation in these key areas develops positively, then, combined with the rising performance of the global economy, stock indices can rise further.