Morningstar's "Perspectives" series features investment insights from selected third-party contributors.
Two weeks of uncharacteristic calm over Christmas, as weary investors called a timely truce, has given way to another bout of extreme volatility. Just in the last week alone we have seen the copper price collapse 8% in a few hours, the Swiss Franc gain by 15% in a session having been up 40% versus the Euro at one point, and the Chinese index plummet by 8% today. The week before last saw the Italian banking sector trading up or down 5% a day. Of course, these are all economically-rational moves.
Aside from the manipulation of the story by some companies, there were some excellent accounts of the famous Christmas Truce of 1914 over the festive period, triggered by the 100th anniversary of the event. One thesis behind the story suggested that rather than being a sign of camaraderie between similar enemies, embracing a break from the mutual misery of the trenches, it was instead an act of over-confidence; both sides fully expected to trounce the other in short order in 1915.
While we are luckily far from the grimness of those days 100 years ago, evidence of over-confidence was clear as we entered this year. In particular, investors still seem supremely confident in the central bankers’ ability to move us ahead in the recovery of these post-crisis years. This was reflected in the many outlook pieces penned by the investment banks, who all predicted at least minor gains for stocks, stability in commodities and an orderly pull higher in core sovereign bond yields. The early days of this year has called these forecasts into question.
Indeed we have seen panic aplenty already this year in some markets, with bond yields in relative safe-havens such as Japan, Holland, Germany and Switzerland falling to levels not previously thought possible. In many markets you now have to pay the respective governments for looking after your money. Even in the UK, where we have the potential for election-induced chaos in our currency and bond markets, we have seen new lows for government borrowing costs, way below those we experienced in the Great Financial Crisis of 2008. 5% daily moves in the oil price are now the expected norm, as investors try and guess where the supply/demand equilibrium will be met and at what price the Saudi’s bluff will be called.
So why has the start of the year been so bumpy. First and foremost our chums across the Channel have issues. This week we fully expect the ECB to finally grasp reality and try to blast Europe from its economic slumber. If Mario Draghi has learnt anything from the excellent Kuroda-san at the Bank of Japan he will go large and try to get Europe belatedly ahead of the curve. Immediately after the ECB meeting we will have the joy of the Greek election, where the horrible term “Grexit” is back en vogue, as markets fret over what direction the likely winners Syriza will take the country.
Our view, which we will add to later in the week, is that the politicians will do their usual trick of watering down their rhetoric once they have assumed power. However, one must not be overly-complacent about a potential prime minister on the tip of the Balkan peninsular with less economic nous than Gordon Brown.
As well as European woes, we have seen the usual ratcheting down of overly-optimistic economic and corporate profit growth predictions. The markets are grappling with cuts to expectations, although they have now come down to levels that we have assumed in our own forecasts. Investors might be forced to wake up to the fact that US earnings could be way below what analysts have prophesied. This could certainly be a challenge to overcome.
If this opening salvo of 2015 sounds overly cautious then it is not supposed to be. For those who suffered our own outlook pieces they will remember that we are actually quite balanced about the years ahead and can find plenty of investments to populate portfolios. However, we would like to point to the fact that we are running record levels of cash as clear evidence that we believe we might be in the trenches for a while yet.
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