US economy

Weak financials are prime fodder for bear markets


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After yet another rocky week for financial markets, at least we have the respite of the weekend, and the Opec meeting has settled on a 1.2m barrel a day cut in production well before deadline time.

Given the big swings seen over recent days, the arrival of the latest US monthly jobs report on Friday sparked a modest market reaction before Wall Street opened. 

European equities maintained the bulk of their bounce after hitting a two-year low on Thursday, bolstered by higher oil and commodity prices. Once Wall Street faded early gains and then resumed falling (ending the week on a brutal note), eurozone shares began trimming their sails, with Germany’s Dax settling a touch lower. 

While the headline US jobs figure was lower at 155,000 (versus an estimate of 198,000), one talking point was the drop in hourly earnings for November. The pace of wage growth for the year held steady at 3.1 per cent, but only just as the raw figure was 3.052 per cent.

The upshot is that the data fit a pattern of a still expanding US economy that keeps the Federal Reserve on track to tighten policy later this month. After that, a degree of flexibility is warranted by the Fed, which with a press conference after every meeting next year, is no longer locked into a quarterly cycle of shifting rates. 

Here’s Jim O’Sullivan, chief US economist at HFE:

“The data likely remain strong enough for the Fed to raise rates again at this month’s meeting, although the statement and the dot plot [The Fed’s estimate of interest rates in the future] will probably have a more dovish tone than last time.”

The jobs report crowns a week characterised by big shifts between asset classes with leading equity markets firmly in correction territory and long-dated bond yields dropping sharply.

A key question for global equity benchmarks is whether they are destined to follow China and enter a bear market. This is what markets are wrestling with at the moment and for now they are leaning towards a more negative outlook.

Some counsel a sense of perspective after this week’s big drop in yields and rout in shares.

Chris Iggo at AXA IM notes:

“Unless we are totally misjudging the impact of the current level of real interest rates, it seems to be the case that if the Fed pauses after a hike in December, optimism on the growth outlook and markets will come back very quickly.”

If we are looking for a sign of a sustainable bounce in equities, financials need to reverse course. This is an important leadership group for equities, particularly in Europe.

What should worry equity investors is the dire performance of global bank stocks this year and one that shows little sign of ending. In Japan and Europe banks are in bear market territory and this week their respective equity financials indices made new lows for the year. Indeed, on Friday the Stoxx bank index erased an early rise of 1.7 per cent to end flat on the session. The FTSE 350 bank index remains down more than 20 per cent from its peak for the year and this week approached its nadir of October.

In the US, the KBW bank index is not shy of a 20 per cent drop from its peak in February, while the S&P 500 financials sector hit a new intraday low for the year this week as a flattening US yield curve only hurts prospects for the sector. 

JPMorgan’s outlook for US equities in 2019 takes a neutral view on financials, “as the sector will increasingly come under pressure from flattening yield curve, slower loan growth, rising deposit costs, and higher provisions”.

Falling long-dated bond yields around the world have only compounded a miserable year for banks and also asset managers. One can argue that this year’s price action means a lot of bad news has been absorbed. But, unless we see financials turn round soon, broader equity markets will stay under pressure and remain in correction territory and challenge “buyers of the dip”.

This is why the performance of credit markets matters from here. Financials will hardly prosper if credit spreads continue widening, suggesting stress is rising and that the cycle is indeed turning.

On that less than cheery note, a good weekend to all readers. I suspect next week will keep us all pretty busy.

Quick Hits — What’s on the market radar

Oil finds a floor? — That’s the question for the market after Friday’s production cut. Prices have rallied on the news, but they remain well below the peak of early October. The drop we have seen in long-dated global bond yields in the past two months reflects how lower oil saps inflation expectations.

Here’s Ashley Kelty, oil & gas research analyst at Cantor Fitzgerald Europe:

“Our initial snap judgement is that prices will stabilise in the $60-65/bbl range, as the cuts are likely to be insufficient to stem the near term supply glut, given US output is continuing to rise (albeit at a slower pace due to capacity constraints).”

Farewell to bonds — The European Central Bank is expected to signal the formal end of asset purchases, and this comes when eurozone financials are loathed, official overnight interest rates remain below zero and the German economy is flagging. This is not what quantitative easing was supposed to deliver. Expect more easing via long-term financing for banks and a longer wait for a rate rise in 2019.

Mark Dowding at BlueBay AM says:

“We sense that the ECB will be pushed towards delivering an operation twist and a commitment to extend the long-term refinancing operation (LTRO) when it meets next week, and it seems increasingly as if rates may remain on hold well beyond the end of Mario Draghi’s tenure.”

A vote looms — Yes next Tuesday, the UK parliament is expected to vote on the Brexit deal and deliver a negative verdict. That sets us on the path towards an amended deal and keeps the pound locked in its current range, but the options market reflects worries of a breakout in either direction. Here’s the FT’s Eva Szalay explaining why investors are hedging risk and keeping short-term volatility elevated. 

Your feedback

I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.





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