Markets collapse: a matter of three risks with the potential for a rebound

Fed, China, oil: these are the three risks that precipitaded the makets since the beginning of 2016. They could stay for long but Benjamin Melman, head of asset allocation and sovereign debt Edmond de Rothschild AM thinks there is the potential for a market rebound

A drop that does not look like near a stop. It could be a description of the markets since the beginning of the year. A drop that “may surprise given the total lack of catalysts and news that might explain it”. Fed, China, oil are not new issues and yet “they are three risks now coming together”. This is the main point according to Benjamin Melman, head of asset allocation and sovereign debt Edmond de Rothschild AM, which however sees the potential for a market rebound. 

The Chinese risk

 “Markets reacted strongly at the beginning of the year due to downward pressure on China’s currency – Melman explains -. And yet, China’s central bank had spelt out its new exchange rate policy in December. In our view, it is unthinkable that after defining a new strategy in December, Beijing could have changed direction so quickly. As a result, the market reaction looks overdone. But it can be explained: China’s economic transition is a complex process which makes the country vulnerable. Add in unreliable Chinese data and poor government communication and the field is wide open for conflicting assessments of the situation”. 

The oil collapse risk

Wti has plunged by 70% in only 18 months. But there are several examples of similar movements in recent decades, during the 2008 crisis, the 1986 oil counter-shock and the emerging country crisis in 1998. Lower oil prices will have less of a positive impact on developed countries today because of rising US production. Negative impacts will be greater as producer countries now play a bigger role in the global economy. The good news is that we have so far seen more negative than positive consequences and the situation should reverse. We will nevertheless have to watch out for possible country and producer defaults as well as financial accidents. There will probably be some bankruptcies but we are not facing systemic risk.

The Fed tightening risk

The Fed’s incipient monetary tightening cycle is still encouraging emerging country outflows. But the Fed will not change its political stance unless the deterioration in the global economy or in financial conditions starts to jeopardise the US recovery. This has not yet happened.

The potential for a rebound

Melman thinks that there is a wide gap between the actual economic situation and the very pessimistic view taken by investors and that “markets always end up returning to fundamentals”. For this reason he is still convinced that European, and especially Eurozone equities have upside potential. “The cycle is still gaining traction and companies continue to benefit from the low euro, cheap commodity prices, the economic recovery and lower unit labour costs. Moreover, consensus expectations for EPS growth are not, for once, excessive. We still prefer domestic cyclicals and yield stocks but are also keen on the M&A theme”.

Source: Asset allocation strategy – Benjamin Melman, head of asset allocation and sovereign debt Edmond de Rothschild AM