Investment Environment February 2012
The start of 2012 has shown a strong equity rally. As stated in the November Investment Environment, Investors have had to be patient since 2008 and having waited for nearly 4 years, 2012 has at least started delivering some positive returns. This is shown in the graph (in the full downloadable article) which bases both the S&P500 and the JSE ALSI40 in 2008 and shows the recovery in USD for both indices.
Equity markets are showing a strong recovery notwithstanding uncertainty on 3 key issues:
1. The European debt problems are far from solved.
2. In Asia, and in particular China, growth has slowed but the Chinese Central Bank has also cut reserve requirements implying an easier credit environment. The credit easing is probably against the backdrop of the recent announcement by the Chinese Premier Wen Jiabao of a declining economic growth trajectory to 7.5% from 8%.
3. Political tensions in the Middle East remain very high and are centred around Iran which produces 5% of the world’s crude oil and 16% of all oil produced passes through the Strait of Hormuz.
Against these uncertainties it is difficult to justify why equities have risen so strongly, particularly during 2012. However the simple explanation is that Investors have suffered a long period of negative returns induced by a significant economic slowdown and that markets are leading the recovery. Maybe Investors are taking the view that all problems are exposed and policy makers are finally addressing the issues correctly?
In the beginning of 2012 the potential of a credit crunch stimulated but the European debt crisis was foremost on Investors’ minds, but this seems to have dissipated with the focus switching to the political tensions in the Middle East. The oil price has reacted to Middle East events and this raises the question of the possibility of returning to the recessionary environment.
Previously very strong oil price rallies have been followed by major bear markets. Examples would be the 180% Y/Y oil price increase in 2000, the 94% increase in early 2008 followed by a big decline and the 113% rise in 2009. These oil events were followed by market corrections such as the 2000 tech bubble bursting, the 2008 credit crisis and the 2009 beginning of the sovereign debt crisis in peripheral Europe. However, these are examples of oil price shocks combined with other events and while it is difficult to forecast, the current oil price increases would not qualify as a shock. Therefore the current equity market correction (in March) is as expected but depending on the outcome of the Middle East tensions this sell-off might even be a buying opportunity as markets could resume their role in leading the recovery.
The good news is a gradual rise in the oil price does not induce a recession on its own ; in fact there is a high correlation between rising oil and equity prices. This is shown in the graph (in the full downloadable article) which compares the oil price and the MSCI World Index. A fully fledged oil shock of the magnitude described above would cause this correlation to break!
Therefore all eyes remain on the Middle East and we hope that the positive start to 2012 remains intact.