May 3, 2016    5 minute read

The Current State Of Market Affairs

   May 3, 2016    5 minute read

The Current State Of Market Affairs

There is a myriad of factors affecting the current state of affairs within financial markets that investors could find it difficult to move deftly.

The earnings season is coming to an end, with both winners and losers. Within the financial sector, JPMorgan Chase & Co. surpassed expectations and raised the bar, providing investors with strong results and strengthening its position. While earnings per share were supposed to fall by 13% from $1.45 one year ago to $1.26, they declined by almost half, reaching $1.35. The Corporate and Investment divisions, whose profits have dropped by more than a fifth, have been the most impacted by the financial turmoil. However, reliable figures and encouraging results have relaxed investors’ fears regarding the entire financial sector.

“We are strengthening the firm to withstand any environment and to maintain scale and profitability through the cycle”

Mr Dimon, Chairman of the Board and Chief Executive Officer of JPMorgan Chase & Co.

Citigroup and Barclays have also beaten expectations, with the latter on the verge of unloading its significant stake in the Barclays Africa Group. On the other hand, Goldman Sachs is struggling to meet investors’ hopes with profits tumbling by 56%. By opening a new lending business, the U.S. bank has increased its presence and it is now reshaping part of its business model.

On the political side, the deadline for the Brexit referendum is getting closer and fears regarding a potential decision to leave the EU is posing a threat to the global economy. On 26 April, a poll tracker reported that 47% of those polled were in favour to remain within the EU while an overall 40% would prefer exiting the European Union. The percentage of citizens supporting a “remain” vote widely increased after Mr Obama’ visit to the U.K. and his speech addressing potential issues following a possible exit. In particular, the U.S. President pointed out the need for a united and democratic Europe, for the benefit of everyone and the whole economy itself. Besides, the OECD has recently filed a letter underlining how the British citizens could be hit in terms of taxation. Mr Cameron, the British Prime Minister, is maintaining his diplomacy and different parties are rightly exposing their views, in a way that any democratic country should embrace.

Another way to look at how the fears of the exit of the U.K. from the European Union have lessened is represented by data. The British Pound (GBP) against the U.S. Dollar (USD) has shown a sparkling rally and now trades at 1.46. The implied volatility of 3-months options contracts has lowered from about 16.5% to 12%, although it has rebounded to 14%. Overall, the market positively reacted and has relaxed a bit.

From a macro viewpoint, Federal Reserve Chair Ms Yellen, in her last speech, has left interest rates at previous levels (25-50bp), outlining good performances from the labour market while being more cautious with regard to the slow growth rate the U.S. economy is facing. A neutral, at most dovish, assessment has resulted, guaranteeing the necessary flexibility to act according to next market moves and leaving space for a raise in interest rates, which is expected to happen by earliest by June or within the upcoming months. With the next meeting to be held on 15 June, the FED will have to take into account the possible outcome of the U.K. referendum, whose results will be released one week after. On a diverging path, the Reserve Bank of Australia is likely to cut interest rates next week. The pool of central banks embracing an easing policy is increasing. On the other side, the BOJ has been much more surprising, deciding not to inject further stimulus into the economy.

After a big rally faced in previous weeks, the S&P 500 has seen a sharp decline during past days due to a general “sell off” attitude, followed in part by the disappointing results announced by Apple and increasing fears the company has reached its mature phase. It currently trades at $2,065. Overall, caution ahead of the FOMC meeting, coupled with the never-ending threat of China and general uncertainty about the future of the global economy, held back equities, which however remain on a positive trend.

Perhaps, the High Yield sector is the one deserving more attention.

The junk bond issuance was very active last week, reaching $10.1bn by the end of 22 April. In 2016 YTD, the total issuance has been of $62.7bn, which is not a significant amount if compared to a +46% of the previous year. By the way, high yield debt yields, tracked by the BoA Merrill Lynch High Yield Master II Effect Yield, dropped by 19% to 770bp on 22 April, while the return on the Index rose by 110bp.

When yields fall, prices (more precisely, returns) get bigger. That is the law of financial markets.

Last but not least, oil prices. With the highest monthly rebound in seven years, Brent crude has increased by 70% from its January levels. On 29 April, it traded at $47.14.

What are the triggers of such outstanding performances? Firstly, a weaker U.S. Dollar. Most of all commodities are priced in U.S. Dollars. If the currency weakens, buying commodities becomes cheaper and investors have an incentive in doing so. To put it simply, investors have more purchasing power. If last month you could buy 1kg of bread with $1, now you can buy the same amount of bread with 70 cents. That is the reasoning, regardless percentages. Second, the reduction in production. Despite the Doha meeting failing to reach an agreement to freeze the output, the latter is likely to decrease, thus boosting prices.

Is this the rebound we have got used in the past, which therefore should be followed by a spark decline (again)? We do not know. There are diverging views and all of them welcomed, but there is an aspect everyone should agree about: markets are facing an eventful period.

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