‘Blue Monday’, theoretically the most depressing day of the year, is supposedly calculated using factors, such as the days since Christmas, debt levels, the weather and low motivational levels.
This year ‘Blue Monday’ fell on 18 January. Technically, in stock market terms at least, the most depressing day was either 21 January - when certain measures of investor bearishness peaked, or 11 February - when many of the world’s equity markets fell to a two year low after six months of heightened volatility.
Price performance of index since March 2014
Source: FE Analytics
Despite the gloomy start to the year - is this seeming despair truly justified? And is the world in as perilous a state as market movements would suggest? 
While there are undoubtedly areas of concern, there is a large disconnect between hard economic data and policy action on the one hand, and investor confidence on the other.
Financial markets have likely over-reacted to concerns about China, the oil price and the current economic soft patch, although we concede there is a real danger that investor angst creates a negative, self-fulfilling loop which begins to undermine real economic activity.
Examining each concern, it is possible to quickly construct a far less pessimistic scenario and one where financial markets may not have reacted in a wholly rational manner.
A barrel half empty
Let us begin with the oil price. The correlation between the price of oil and global equity markets is rapidly approaching that of a perfectly positive relationship; as oil prices fall, so do equity markets and vice versa.
Performance of indices over 2yrs
Source: FE Analytics
This is in stark contrast to a year ago when the correlation between the two was sharply negative; a falling oil price coincided with rising equity markets, while an increase in the cost of crude corresponded with equity weakness.
Depending on whom you believe, the reason the markets view a falling oil price negatively – a ‘barrel half empty’ mentality – could be due to:
a) Confirmation of a slowdown in the global economy
b) Its direct impact on profitability in the energy sector
c) The deflationary pressure being unleashed at a time when policymakers are still battling to kindle even moderate levels of inflation
d) Fears of significant write-offs in the financial sector relating to loans to distressed energy and resource companies
e) All of the above and a myriad of other factors.
Let us offer a few counterpoints to these negative interpretations.
Can low oil prices drive global growth?
Firstly, and arguably most importantly, net importers of oil account for the bulk of the global economy; the four largest net importers – China, the US, Japan and India account for over 50 per cent of global GDP.
For these countries, lower oil prices feed through to higher real incomes which, in turn, should support more general consumption.
Estimates for the actual positive economic impact will vary wildly and require so many assumptions that the validity of the results are extremely doubtful; but an IMF report has recently forecast that a 50 per cent reduction in oil prices would add 0.2 per cent to 0.4 per cent to global growth in the first year.
In large importing countries the impact was predicted to be closer to 1 per cent. Given the concerns surrounding China, it is important to remember oil imports account for 2 per cent of the economy’s GDP, for Taiwan the figure is as high as 7 per cent, with most of emerging Asia falling somewhere between these two extremes.
Rather than providing confirmation of a global economic slowdown, it is worth remembering the drop in prices is due to one thing – excess supply. The International Energy Agency expects supply to exceed demand by 1 million barrels a day for the third year in a row in 2016. This is not confirmation of a global economic malaise.
Is the knock on effect of oil really that bad?
Of course there is a correlation between oil prices and profitability in the energy sector - and oil & gas companies have endured a torrid time of late.
Performance of indices since June 2014
Source: FE Analytics
With Resource companies (energy, including oil & gas, and mining) accounting for c.14 per cent of the FTSE All Share, this has undoubtedly impacted market returns.
While there will also be some knock on effects to other industries, as energy companies shelve investment plans or mothball capital projects, arguably the majority of other sectors will either feel no direct impact or will benefit from lower fuel costs.
One area of focus is the financial sector and a potential sharp increase in non-performing loans emanating from the oil sector.
Many of the largest US banks have issued cautious statements in this regard but these need to be put into context – we are not facing sub-prime crisis levels of borrowing. While Bank of America has US$21.3bn in energy related loans, this accounts for just 3 per cent of their loan book.
Not all of these loans will turn bad and even in the event of default, some recovery of value can be expected.
Meanwhile, valuations in the financial sector already discount a more challenging future environment. Global financial companies are currently trading at levels which were last seen during the euro zone sovereign debt crisis in 2012 and are nearing their all-time lows of 2009.
Global bank stocks are cheaper today in relative terms than they were at the nadir of the financial crisis; a time when the viability of the entire US banking system was in doubt. Things are not that bad, surely?
Chinese whispers
As well as potentially over-reacting about the oil price, investors may have done the same about China.
Chinese economic growth has slowed from its heady pace of a few years ago. If the economy does avoid a hard economic landing, it would be hoped and expected that this would foster a broader increase in stability and confidence. In the short term, economic data for the first quarter in China is currently limited and forthcoming data releases will be distorted by the effect of the Chinese New Year.
However, a large part of the blame for the slump in investor sentiment can be placed at the feet of Chinese policymakers, whose misguided introduction of ‘circuit breakers’ to stem volatility within their stock market had exactly the opposite effect.
Performance of index over 1yr
Source: FE Analytics
Dismissing the head of China’s securities regulator is a clear sign that the authorities recognise the risks posed to the Chinese and global economy, with the replacement, Liu Shiyu, being renowned for his communication skills.
Slowing expectations
Finally, fears about the global economy have intensified, with concerns that the slowdown in emerging markets is spreading to the developed world.
GDP in the US fell to just a 1.0 per cent annualised pace in the fourth quarter and US households have been saving around half of the extra income they gained from lower energy prices.
While the odds of a US recession in 2016 have risen, the balance of probability suggests this is just a temporary soft patch. Recent surveys conducted within the eurozone paint a similar picture, with the recovery expected to continue at a solid pace in 2016.
Forget Greece and Portugal at your peril
The biggest concern for investment markets may be that investors are currently focusing on the wrong areas.
Greece or a break-up of the euro are macroeconomic issues that are not being discussed in any great detail at present, but remain a potential source of instability during 2016. Greece is currently at loggerheads with creditors over the steps necessary to complete its bailout review and to receive its next emergency aid payment as well as begin talks on debt relief.
The cost to insure against Portuguese debt defaults has recently spiked sharply higher.
Not such a Blue Monday
Our view remains that equity markets and risk assets can deliver positive returns for investors during 2016.
However, sentiment will remain fragile and we cannot rule out a further retesting and breach of February’s lows. It does seem as though investors have over-reacted to concerns about China, oil prices and the recent slowdown in certain parts of the global economy and it should not be forgotten that the US and euro area economies and banking systems are in fair shape while policymakers are determined to sustain activity.
Contrary to the headlines, the end is not nigh.
Justin Oliver is deputy chief investment officer at Canaccord Genuity Wealth Management. All the views expressed above are his own and shouldn’t be taken as investment advice.
