Deflation is haunting global markets

Deflation is haunting global financial markets. The idea that prices, in general, are in a downward track worry everyone from policymakers to investors because it implies over supply or weak demand, neither of which is conducive to economic growth.

Without economic growth, companies and governments start to suffer financially and that impacts employment and debt levels, both of which can trigger further bouts of economic misery.

One month into 2016 and for anyone engaged in financial markets it feels as if a long session inside a turbo-charged tumble dryer.

There are extreme bouts of volatility afflicting major parts of the world’s capital markets and, within that, sustained downward pressure on certain asset prices.

Risk management seems to be the only product attracting a premium currently.

The speed at which asset values are crumbling is alarming, and needs to be observed by those caught up in the Irish economy bubble.

Among equities, I note the scale of share price declines in huge international banks.

The largest banks in Europe have seen their share prices decline sharply, with the behemoth Deutsche Bank declining 35% in just five weeks and the supposed Swiss blue chip bank UBS falling 21%.

Credit Suisse is now trading at a 25-year low. In the US, similar double digit percentage declines have been incurred.

This large piece of the equity market is having its performance reflected in broader indices.

Measured in US dollars, the Nasdaq, FTSE 100, and Hang Seng Index are down 11%, 7%, and 13% respectively in the year to date.

Many companies and sectors are being subject to repeated waves of selling that are reducing company valuations and reversing gains made over recent years.

Commodity markets have started 2016 in very poor shape, something that may explain stress within the financial system.

Oil is the headline commodity to have tanked by 20% since January 1, following a 40% fall during 2015.

Agricultural commodities too are struggling.

Grains and dairy prices are not showing any signs of recovery and dairy industry leaders in New Zealand are warning about an extended period before milk prices will begin to rise again.

Bond markets are producing mixed performances.

High quality corporate bonds and sovereign bonds from countries that are deemed ultra high quality have remained robust as investors chased safety.

That has kept yields on those type of bonds at very low rates.

At the same time, bond yields on less favoured instruments have ballooned.

Moreover, issuance of new debt instruments has slowed down sharply, suggesting investors are very nervous about committing fresh capital to new projects.

So, it is extremely difficult to generate a positive return in financial markets, presently, by buying equities or bonds.

The investment community is searching for signals that could arrest the malaise which has swept across asset markets.

Those signals would include:

(1) Evidence that developing market economies and currencies have stabilised and started to resume strengthening, even at low rates;

(2) Data showing economic demand in developed economies, is steady and expanding;

(3) Stability and growth in commodity prices, including oil, industrial metals and agricultural products.

Usually, when the price of anything is falling it requires increased demand and/or less supply to change fortunes for the better.

In equity markets, primary issuance is collapsing and long-term investors are being attracted by lower valuations.

In commodity markets, suppliers are butchering employment and capital expenditure plans.

Economies in developed markets are regaining competitiveness as FX rates are falling.

These features, eventually, will help financial markets to rise but for now global financial markets are in turmoil. How all this plays out in Ireland is an intriguing subject.

Joe Gill is director of corporate broking with Goodbody Stockbrokers. His views are personal.


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