Markets hit by fresh wave of fears

SINGAPORE - New fears have emerged in financial markets - be they over European bank balance sheets, central bank limitations, or the weaknesses of the US economy. The "R" word (recession) is also being bandied about, with some commentators even talking about negative interest rates in the US.

The widespread pessimism has dragged down financial markets this week, and is also linked to older worries over the impact of China's slowdown and indebted companies going bankrupt due to the oil price collapse.

Singapore's benchmark Straits Times Index (STI) fell almost 3 per cent early on Wednesday following the Chinese New Year break, giving up last Friday's gains. But it recovered slightly with European stocks later in the afternoon. The STI eventually finished at 2,582.10, down 1.57 per cent.

Analysts are trying to untangle which of the litany of fears are justified. Some, like CIMB Singapore equity research head Kenneth Ng, told The Business Times in an e-mail on Wednesday that debt problems should be taken seriously, especially in a slowdown. Leveraged sectors like oil-and-gas, commodities, and China infrastructure are shaky, he said.

"The straw that broke the camel's back this year is not the effect of rising rates but the dearth of revenues as many sectors like oil-and-gas, banks and consumers shrink capital expenditures and spending.

"As the cycle of reduced spending and reduced hiring takes place, a recession unfolds," he said.

For now, bottom-up valuations point to cheap stocks, but top-down macro news can get worse, he said.

"Entry points are great when valuations start to hit or breach previous crisis lows. We are getting there, but we are not quite there yet," Mr Ng added.

Others, like Bank of Singapore chief economist Richard Jerram, said in a Wednesday note that financial markets are poor indicators of a recession.

Demand for oil grew at the fastest pace in a decade in 2015, he noted. Globally, services and manufacturing readings still show expansion, while economic growth is set to be in the 3 per cent range in 2016 - the fifth year in a row, he said.

"We think markets have overshot with excessive risk aversion despite little change in economic fundamentals. As a result, we have upgraded our asset allocation position towards equities to 'overweight'. It promises to be an uncomfortably bumpy ride, but offers decent returns in coming months," Mr Jerram said.

Across the world, bank stocks - typically the most sensitive to the health of the economy - traded sharply lower even as Chinese, Taiwanese and Korean stock markets remain closed for Chinese New Year.

One of the hardest hit was Deutsche Bank, which recently posted a large 2015 loss due to impairments and litigation charges. The bank, trading at below a third of its book value, reassured investors on Monday that it can repay its debts. Credit Suisse and UBS shares have also plunged.

In Europe, one key near-term uncertainty is the possibility of Britain leaving the European Union. Citi analysts put a roughly 30 per cent chance on this occurrence, saying last Friday that "Brexit" will trigger major economic weakness in the UK as trade and business arrangements get reworked.

In the US, the implied probability of a rate hike in the coming March meeting, based on Fed Fund futures, has declined from 50 per cent at the start of the year to zero. Markets are assigning a low probability to any hike this year - a total divergence from the Fed's average forecast last December of four 25-basis-point hikes.

Analysts are watching Fed chair Janet Yellen's semi-annual congressional testimony these two days for clues on whether things will change.

DBS analysts do not think the Fed will budge from its stance. "Why backpedal when the labour market is stronger, and inflation and wage growth are higher?" they asked in a Feb 10 daily report.

"Stock markets are important. But they are notoriously jumpy and they are notoriously fickle. We are about to find out if the US Federal Reserve is, too," they said.

Societe Generale analysts put a 20 per cent probability on a US recession. They said the US economy has to experience a far bigger financial shock before the momentum in its labour market will stall, and before the Fed can justify keeping rates on hold for the rest of the year.

Yet any hints of a change in the Fed's stance can weaken the dollar, with commodities and emerging markets the biggest winners, they said.

Bank of America Merrill Lynch analysts said in a Wednesday report that negative interest rates in the US are not their base case, though a possible way for the Fed to ease policy.

"However, before it adopts negative rates, we expect the Fed to first move rates back to zero, reintroduce forward guidance, and make stronger pleas to Congress for fiscal policy action," they said.

This article was first published on Feb 11, 2016.
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