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7IM Market Commentary - The Bad News and, Dare We Say It, the Good News

Posted Wednesday, 27 January 2016, 10.39am

"The bad news is that the markets are the news!

Volatility is rampant again and very few hiding places have been spared this time around. Last summer it was possible to avoid the worst of the fallout by being invested in less-liquid asset classes such as smaller companies, listed private equity companies and even ‘Frontier Markets’ (the racier end of Emerging Markets).

This time the shock has impacted a wider range of assets more equally. What’s also different this time is that most large stockmarkets have tracked the oil price with uncanny precision.

Overlaid one on top of the other, in fact, each can substitute quite well for the other (see chart below).

US Stockmarket & Oil Price

Source: Bloomberg

This is strange, not to say absurd, for two reasons.
Firstly, changes in the oil price are good for some companies (airlines, for example) but bad for others (the energy sector).

Secondly, there are many, many other factors that affect a company’s profits far more than the oil price. Plus there are many factors that affect the oil price but don’t have any impact on corporate profits.
Now a lot of people depend, for their living, on being able to explain why markets do what they do, and a lot of ink is being spilled connecting these dots. I don’t know exactly what is causing this but I can say what I think is not a feasible cause.

…And demand for oil is not the cause: there is no evidence that demand for oil is falling off, either in China (the conventional wisdom) or across the globe as a whole.

Chinese demand for oil increased by 10% last year.

Global oil demand reached an all-time high at the beginning of the year (this is normal when the global economy grows).

The problem for the oil market is that production is running ahead of consumption (see the chart).

Oil Supply & Demand

Source: Thompson Reuters Datastream

That is the good news. The counterargument is that the oil price is predicting a decline in future demand, implying a slowdown in global economic growth, and stockmarkets are simply reflecting that.

But I can assure you that neither the oil market nor the stockmarkets can predict the future. Neither can any of the participants in those markets. On the other hand, I can say with a high degree of certainty that 50% of their positions are going to lose money.

It’s the hardest thing to do, but investors should avoid taking their cue from short-term market movements.

Even more importantly at the current time, try to ignore market histrionics and melodramatic explanations being proposed (after the event) by market commentators. Stick to the longer-term game plan, check the risks, try to buy low and sell high.

When are stockmarkets more risky: before or after they have fallen?"

Chris Darbyshire, 7IM Chief Investment Officer

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