Three things that could impact markets in the long term
What a week for financial markets. Volatility spiked and the vix index jumped above 30, the Nasdaq 100 sunk to its lowest level since June 2021, the Fed was perceived as hawkish which sent the dollar surging to its highest level since 2020, the strong dollar did not dent the commodity space and the price of Brent crude oil price surged to above $90 a barrel. Added to this, Apple reported record revenue of $123.9bn for Q4 2021. These are big moves, and they are pointing us towards the themes that could be in play as we progress through the first quarter of the year. We have picked out three of these themes that we think will dominate markets and that could help traders in the coming weeks.
1, The rotation into value remains, with some Apple on the side
US stocks may have finished lower on Thursday after the hawkish Federal Reserve meeting, however, the tech-heavy Nasdaq continues to underperform other US indices. For example, the Nasdaq 100 fell 1.4% on Thursday, while the Dow Jones was virtually flat, down 0.02%. In contrast, the FTSE 100, which is heavily weighted to value stocks, rose more than 1.1% and remains one of our top picks for Q1. In the S&P 500, energy, utilities and consumer staples managed to rise on Thursday even though the broader index fell 0.54%. The question now is, will the value over growth trade continue? To put the global equity market rotation into context, the shift out of growth stocks and into value stocks in the last month, has seen value shares outperform growth by 12%, which is a six standard deviation move, in other words, an extremely rare event. This move out of growth and into value is even bigger than what we saw during the dotcom crash. This suggests that the market is very long value stocks, and very short tech. Partly this move has been fuelled by a mass evacuation out of crypto currencies, that money had piled into equities and is thus partly driving the rift between growth and value stocks. While we continue to think that the rally in value stocks has further to go, we expect to see some differentiation when it comes to tech stocks. For example, Robinhood was hammered on Thursday, after announcing that it had fallen short of its revenue targets, it reported revenue of $363mn, which was $7mn short of expectations. We have mentioned before, that in this environment, the market is unforgiving of earnings misses, hence Robinhood’s share price fell 10% on Thursday. In contrast, Apple reported record revenue for Q4, and an 11% gain from a year ago. Net profit jumped 20% and Apple also announced that its supply chain woes were being resolved. Forward guidance was, unsurprisingly, strong and Q1 is expected to be another record quarter for Apple. Results like these are what dreams are made of, and its share price has surged more than 5% in post-market trading late on Thursday. We could see big gains for Apple as we move to the end of the week, which could lift the overall Nasdaq.
2, Oil remains resilient to the strong dollar
Oil used to fall when the dollar rose, because a barrel of oil is priced in dollars, as the greenback strengthened you needed fewer dollars to buy a barrel oil. However, that chain has been broken, and the price of Brent crude jumped above $90 per barrel on Thursday at the same time as the dollar index rose to its highest level for 18 months. The market is expecting further gains for the oil price on Friday, but is it sustainable long term? The IMF may have downgraded its global growth forecasts for this year, however, the strong US economy in 2021, which grew 6.9%, way more than expected, is giving commodity traders something to be optimistic about. As economists fret over a spate of global growth forecasts, the oil market is saying that these forecasts are wrong, and the global economy is strong. It even suggests that China could perform better than expected, the IMF expects China’s economy to expand at a 4.8% rate this year, a sharp slowdown compared to the 8.1% GDP reported in 2021.
Of course, a high oil price is also reflective of Opec production cuts and the Ukraine/ Russia conflict is adding a geopolitical premium to the price of commodities. However, we think that Brent at $90 is suggestive of a strong economy, which is supportive of risk appetite in the short term. In the longer term, a prolonged period with an elevated oil price tends to weigh on growth and thus stocks, but for now it supports the growth to value rotation in global equity markets and the current positioning in the bond market.
3, The future of the euro
There has been so much written about the Fed right now, that we thought it was time to concentrate on the ECB, especially as we lead up to their first meeting of the year on 3rd February. Any changes to the interest rate differential between the Eurozone and the UK will be the most important driver of EUR/GBP in the coming months. The market is currently pricing a 69% chance of a first-rate hike from the ECB in December this year. This leaves the ECB as a dovish outlier compared to the BOE and the Fed. The ECB’s stance has been a key driver of EUR weakness in recent months.
The ECB will meet for the first time this year, next week. If they suggest that rates will rise earlier than this due to rising inflationary pressures, then there is scope for the euro to rally as the market prices in earlier rate hikes from the ECB. This could limit further EUR/GBP downside for the medium term. We prefer a EUR/GBP recovery play compared to EUR/USD during the ECB meeting. Its decline below 0.8350, sees this pair testing a key support level that dates back to 2020 and 2016. Short positions in the euro are getting crowded, which we see as a contrarian indicator, thus a hawkish surprise from the ECB next week, could trigger a rapid turnaround in EUR/GBP back to 0.8500.