Equity markets continued to show positive momentum throughout November, steadily increasing with the S&P 500 reaching year-to-date highs.
However, the momentum has since faltered and equity markets once again have taken a turn for the worse.
Any signs of the traditional “Santa rally” (December has statistically been the best month for returns on the FTSE 100 Index since its inception in 1984) remain well hidden – with the FTSE dropping back to levels seen in October.
The fluctuating oil price is likely to have contributed to the market volatility experienced in recent weeks.
The fall in the oil price was initially deemed to be a good thing, putting more disposable income into the pockets of consumers at a time when global demand was in need of a pick-me-up, an indirect form of economic stimulus.
Markets duly followed that script for a while. But the faster the oil price fell, the more investors focused on the potential disruption.
This dramatic basis shift in the oil price owes much to politics, which is a factor that has been worryingly influential on financial markets this year (think Russia/Crimea, Scottish Referendum, etc) and is likely to remain so.
Much of the pain in the oil market is down to the fact that there was a generally accepted belief that the Organisation of the Petroleum Exporting Countries (OPEC) would support an unofficial oil price floor around $90 (through controlling supply).
However, in their November meeting OPEC refused to cut its output ceiling from 30m barrels per day in the face of sluggish demand and plentiful alternative supply, causing the collapse in oil price to accelerate.
Since this meeting the price has continued to fall to below $60, almost a 50% drop from its June peak of $115.
Possible theories for the lack of support from OPEC for a higher oil price range from: the Saudis appearing to be unhappy about the burgeoning production of US shale drillers; looking to increase market share through making shale production less viable; or (one for the conspiracy theorists) that Russia is out to destabilise the West’s financial system via the high yield bond market.
An estimated 16% of the high yield bond universe is represented by the issues of oil drilling and services companies.
Most of this exposure is to shale developments in the US – the very supply that the Saudis are allegedly trying to suppress by refusing to cut production.
Disinflation is considered beneficial and the boost to real incomes is a positive development, encouraging greater spending and economic activity, but if this is then followed by deflation there is much more debate regarding the impact.
Many believe that the ensuing fall in headline inflation will be more negative. It is entirely unclear exactly how consumers would react if deflation does occur, but shoppers withholding purchases in anticipation of even lower prices would be most unwelcome.
At least in the case of deflation it might encourage yet more monetary easing which would be positive for financial assets, so maybe it’s a win-win situation after all.
The fact that central banks seem determined to underwrite growth and inflation should provide both liquidity and support for riskier asset classes going into 2015.
