November was a bizarre and frustrating month. The overall increase in European stock market indices was due to anticipations of further liquidity injections by the ECB. The S&P500 was absolutely flat and the 4% increase of the US dollar versus the Euro just shows how illusory was the 2.7% gain by European markets in local currencies. The top performing sectors was a bizarre mix of defensives (Pharma and Telco’s) and cyclicals (construction, autos and semiconductors). There was more logic in the worst performers (Metals and mining, luxury, oil and gas services), as fears regarding China continue to mount. The de-rating of the luxury goods sector has started but I think that investors fail to grasp fully the fact that the sector is experiencing the same hangover as the miners after the end of their own “Super Cycle”, albeit on a far more moderate scale.
The year is ending on a totally different tone than it started. From January 5th to mid-April, the European equity index jumped 24%, with hardly a few down days. As I am writing these lines, The Eurostoxx is up less than 4% year to date. Worse, in dollars it is down 4%, which is marginally worse than the S&P500 (down 2%), whereas it was definitely doing better than its American counterpart on a same currency basis at the beginning of the year. Twelve months ago, everyone was raising estimates. Now everyone, is doing the reverse. The one thing which has not changed is the aggressively loose monetary policy at the ECB. We were then talking about the first round of QE, and we are now talking about the second. Has Draghi lost his magic touch? The problem is that the ECB is starting to sound like politicians, i.e. it is making empty claims. When Draghi recently declared that “We are doing it [QE] because it works”, he should not be surprised that his message is falling on deaf ears. The ECB’s policy has no impact on inflation (CPI still glued at 0) and no impact on economic activity (the spurt of growth this year was entirely due to the increase in real purchasing power for households created by the collapse of the oil price). The only result it is achieving (beyond postponing a real test of the viability of the Euro zone) is the weakening of the Euro, which is definitely one of the objectives Draghi is pursuing but he cannot go public about it. Currency war between central banks, though real, is taboo.
2016 appears packed full of challenges. First there is the obvious general macroeconomic slowdown, which may run against the Pavlovian tendency of the market to bet systematically on a cyclical recovery at the start of a new year. Then, there is the collapse in commodities which is not abating (the oil spot price is 32% below the average price of the year, 32% below for iron, 15% below for copper, 13% below for aluminium), which means that earnings for the sector will continue to fall heavily but maybe some investors will want to call the trough in 2016. However, the highest stake game in town will be the diverging paths between the ECB and the Fed. Can they run in opposite direction for a long period in time (at least March 2017, which is the new end for the ECB’s QE)? The US dollar and the Euro exchange will be the variable of adjustment, and this will have significant impact on corporate earnings development.