Wednesday, February 07,
2018 05.35 PM / Vetiva Research
What triggered the rout?
The market rout was accompanied by high volatility. The most widely used measure of U.S. market volatility – the CBOE Volatility Index – spiked to its highest level since 2015, and the main gauge of market anxiety in Europe saw the sharpest change since the September 2001 terrorist attacks. A positive growth outlook and policy stability had created unprecedented calm in the U.S. market (as measured through volatility gauges) but this turned sharply in recent trading sessions. Heightened volatility is negative for Emerging market assets and other riskier assets such as commodities. Unsurprisingly, whilst gold prices rose at the start of the week, commodity prices dipped significantly – Brent crude down nearly 3% from previous week close on Tuesday.
Despite the spillover to commodity prices, we note that prevailing commodity fundamentals are different from global equities. Commodity prices should be supported by strong global demand in 2018 whilst supply dynamics would remain more important for commodities such as oil.
What happens next?
The U.S. market in particular is likely in the middle of a market correction. Cheap money fueled by loose monetary policy in the U.S. spurred a multi-year rally in equity prices, leaving the U.S. market arguably overvalued. In this sense, the market correction was anticipated, though the timing and sharpness are surprising. The S&P Relative Strength Indicator hit its highest point on record at the end of January, a fair sign that the market was due a significant correction. Likewise, the Shiller Price-Earnings ratio, a comparison of prices and cyclically adjusted earnings, rose two standard deviations above its mean for only the third time in the last hundred years – the previous two occasions precipitated the Dot Com bubble and Great depression.
On the monetary policy front, the Fed is conservative on the impact of the recent jobs data and it is unclear whether the prescribed path of monetary tightening would be materially altered anytime soon. With the recent Trump tax cuts expected to support corporate profits and against the backdrop of a stronger economy, market fundamentals remain firm. The slide is likely to be short-lived – S&P 500 and Dow Jones were both up 2% on Tuesday – but the broader equity outlook is muted compared to recent trend. More generally, we expect healthy fundamentals in the U.S., commodity space and global economy to buffer capital markets in the medium term.
How will Nigeria fare? Rising interest rates in the U.S. would likely trigger some capital to that region and Nigeria is unlikely to be fully spared, depending on the broader outlook for the country relative to other Emerging Markets. Movement in the MSCI Emerging and Frontier market indices indicate that Emerging Markets have already begun to suffer the effects of the global equity panic amid notable capital outflows. Similarly, Nigeria’s Eurobond yields have inched up recently as investors reprice Emerging Market dollar-denominated assets on the back of more hawkish U.S. rate expectations.
Nevertheless, global crude oil prices remain the crucial variable for the Nigerian markets and economy, underpinned by the 16% rally in the Nigerian Stock Exchange All-Share Index on the back of strong oil prices in January. As such, we would continue to monitor global crude prices as a tool for inferring the health of Nigeria’s capital markets. With global oil prices likely to be propped by the OPEC output cut, growing global demand, and persistent geopolitical concerns in the Middle East, we maintain our relatively bullish view of the oil market in the first half of 2018 despite the mild moderation recorded in the last few sessions. Moreover, we note that Nigeria’s risk environment has improved, primarily as a result of stronger macroeconomic conditions – moderating inflation, stable currency, etc. – adding to the appeal of investing in the country.