Del

Concern is warranted – but not panic

Chief analyst Bo Bejstrup Christensen explains why market panic will subside.

Steep falls on global equity markets in January have been followed by further declines in early February.  Corporate bonds have also taken a hit. In short, risk assets have had a poor start to the year, while yields have fallen on the back of concerns about growth outlooks and low inflation, which has pushed prices higher on secure government bonds.

The financial markets are worried about a new global recession prompted by a new bank crisis. Given the low price of commodities in general and oil specifically, a wave of losses is looming.

Major energy companies are already heavily writing down their assets, which has significantly cut into earnings. A wave of bankruptcies is also approaching among minor energy companies, who have been responsible for the fastest growth in corporate bond issuance since the crisis in 2008/2009 – and many banks have of course also been involved in financing the US oil adventure. Finally, several emerging market nations are heavily dependent on commodity prices, which is why the market is also worried about potential losses here.

An extended period of uncertainty
Recent developments have resulted in eurozone banks again trading at a P/BV (price/book value) of 0.6 – a level last seen during the debt crisis in 2013, and a fall from almost 1.0 early in 2015. This is a clear indication of deep anxiety about bank earning capacity and potential future losses.

Generally speaking, current investor concerns are warranted. We continue to hold the view that commodity prices will remain very low for a long time, and given our scepticism on China, we also expect to see heavy losses on commodity-related lending. Unfortunately, it will take some time before we have a proper overview of the scale of the losses, and also what it will mean for the world to have to live with generally lower commodity prices.

Banks can absorb the losses
Nevertheless, we view the current panic as overdone – primarily because the years since the 2008 crisis have been used to build a stronger global bank system. The ability of banks to absorb losses is higher due to much stricter core capital requirements, greater liquidity and improved transparency. Banks will be able to survive the coming losses without particularly tightening credit to other sectors – which is why we believe the recoveries in the US and Europe will continue.

Ironically, the root of the fears – especially the lower oil price – is good news for most consumers and companies in Europe and the US. And while China is fighting a hangover after its construction boom, its bank system has been secured via ample central bank liquidity and a closed capital account. The latter makes it difficult for companies and individuals to move money out of the country and thus destabilise the bank system.

We have therefore capitalised on market jitters to buy more equities, just as we used the high prices in summer 2015 to reduce our holdings. We do not expect the anxiety to disappear overnight. But the current overdone panic will subside as the economic data confirm further growth is continuing in the US, Europe and China. Further policy easing by the ECB in March will also help. If our expectations are correct, markets will calm – and equity prices will rise again.
 

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