Losses in January Erased Two-Year Stock Market Gains

In just three weeks in 2016, all gains made on the stock markets over the past two years were wiped out. This is the view of Steen Jakobsen, chief economist at Saxo Bank, and although many point to China as the main excuse, he believes the root of the problem lies in the constant increase in the cost of money, primarily due to the Fed’s planned policy to raise interest rates during this year.

The slowdown in China is by no means news, and while he considers it an important factor, for Jakobsen, oil and the cost of money are additional important indicators that investors and analysts must not forget. All three are linked to the exchange rate of the US dollar, with a strong dollar most harming the results of the global economy, as we are all dependent on a ‘primitive economy’ based on that currency.

– Italy is on the brink of a new banking crisis, the new government of Portugal will almost nullify the gains made over the past five years, and the United Kingdom is under pressure from its exit from the EU. There are also refugees as a major political problem and the fact that anyone with any wisdom can clearly see that the elections in the US are going from bad to worse, as well as the threat of implosion in the Middle East due to low oil prices – lists Jakobsen, emphasizing that there are three main market drivers: the increase in rates in the US affecting the cost of money, then the price of oil, or energy, and the economy of China and the stimulus it creates for demand, with the value of the dollar defining the interrelationship of these factors.  

The Fed is the main central bank in the world and dictates the overall direction of global interest rates. The rate increase that the Fed made at the end of last year occurred after a significant rise in financing costs for the corporate and private sectors, but now the rates of central banks and markets are aligned, with a growth projection. The cost of money is always the most important starting factor for any economy, and currently, the market estimates the Fed’s increase of 1.7 in 2016 (42.5 basis points) while the Fed promises three to four increases (75 – 100 basis points).

Oil, as an additional factor for Jakobsen, is the main driver of fuel prices for motor vehicles and electricity, so the input cost of energy is a key determinant for real wages and consumption.
 
– The increase in the cost of money is also influenced by the reduction of so-called slush money, as the Middle East and all commodity producers no longer have surpluses in their current accounts and therefore invest less in the fixed income market in the US and Europe. Studies have already confirmed that we have a net reduction in yields of about 100 basis points when there is a free flow of ‘slush money’ in the market – says Jakobsen, adding that oil and energy prices also stimulate growth. Europe, for example, will feel the full impact of low prices in 2016, and as a net importer, the private and business sectors will have more income available, which will make it more difficult for the European Central Bank (ECB) to print money during this year.

The ECB is always lagging behind the real world, believes the chief economist of a Danish investment bank, explaining that, besides pausing until summer, the delay also means that the ECB will start aggressively but will ignore the fundamental net positive effect of energy and the overall recovery of the private and business sectors.

Similarly, the decline in China’s GDP should not surprise anyone, which does not mean that China has no problems and that the slowdown is inevitable. However, it will be a ‘slow descent’, predicts Jakobsen, as he believes there is enough private savings in China for the game to last long enough, and there are also the advantages of the so-called New Silk Road, the internationalization of the Chinese currency, and the AIIB bank. The Chinese economy is structurally slowing down, but Chinese tourists will spend 275 billion dollars abroad, and that is the new Chinese export, followed by money.  

– The devaluation in China is more of a trial of free capital flow and support for the economy through increased liquidity to finance borrowing. The fact that China is finally moving forward again with more free capital flow and allowing loans to financially hungry emerging markets can only be interpreted as a point to be focused on – says Jakobsen, although he still does not understand surveys among investors showing that China is their main focus for 2016, and only then the Fed’s decisions and other important market factors.

The market seems to be able to focus on only one risk at a certain moment, and since the beginning of 2016, everyone has been focused on China. The only real concern should be the mismatch between the Fed’s view of the interest rate hike cycle in 2016 and how the market predicts it, and the resolution of that situation is the main direction in macroeconomics. Weak indicators will not stop the Fed this month, but as data comes in, I expect the Fed to retreat to the initial two to three rate hikes, then to one to two, and finally one or none, although we are currently in a deadlock where it is hard to see who will win, concludes Jakobsen.