December was punctuated by two key events that will have significant bearing on the markets heading into 2015. Crude oil fell by -18.3% during the month (it is down -45.6% for the year and down -33.2% in just the past two months) after the oversupply which has been building over the past two years finally resulted in a crash in prices, significantly benefiting consumers to the detriment of oil exporting countries. Meanwhile, the Greek government announced snap parliamentary elections after failing to appoint a new president; this jeopardises the country’s adherence to the terms of its bailout by the European Union (EU) and introduces a new potential crisis for the Eurozone.

The MSCI World index ended December down -1.7% and the year up +2.9%. In US dollar terms, the star performing markets for the year were China, the US and commodity importing emerging market countries such as India and Turkey. US and German 10-year rates diverged, with US Treasury yields holding steady at 2.17% (up from 2.16% in the prior month but still down from 3.03% at the start of the year) while German bund yields continued their steep decline to finish the year at 0.54% (down from 0.70% in November and 1.93% at the end of 2013).

As predicted in the previous month’s commentary, the oversupply in crude oil resulted in prices for the commodity falling into the $50-60/bbl range. The Organisation of the Petroleum Exporting Countries (OPEC) reduced its 2015 forecast of oil demand for its members to 28.9 million barrels per day, more the one million barrels per day less than what the organisation is producing. Saudi Arabia, the world’s largest crude exporter, started to discount oil prices heavily in order to defend its market share. These events caused the price of oil to continue its sharp collapse, having fallen by more than 40% since June and now at a five year low. Furthermore, the price fall has only encouraged oil exporting countries to increase production to make up for lost revenue, thus exacerbating the problem. As a result, there is the potential that the price of oil may fall further into the $40-$50 range, down from the current $57 level. At the current level of oversupply and pace of demand growth, it may take a couple of years for the oil market to get back to equilibrium. In the meantime, the current fall in prices equates to an approximate $1.5 trillion transfer of wealth from oil producers to consumers. This is a significant positive for global growth but is highly detrimental to oil producing nations, with countries running large fiscal deficits, such as Iran, Libya, Nigeria, Russia and Venezuela, being particularly vulnerable (all of them are experiencing negative fiscal and currency shocks).

The South African government had to enact a turnaround plan at state-controlled Eskom after the power utility ran into cash flow difficulties; this follows on a ZAR 20 billion bailout back in October. Eskom has been unable to deliver sufficient power to meet demand due to underinvestment in new power generation capacity over the past decade. This has led to an increasing number of blackouts in the country, crippling South Africa’s mining and manufacturing sectors and contributing to the country’s persistent current account deficit. Despite the energy issues, the JSE All Share index was only down -0.2% in December and is up +10.9% for the year. Stocks have benefited (particularly those with large non-rand revenues) from a fall in the value of the currency, down -4.4% on the month and -9.3% for the year versus the US dollar.

In Asia, Moody’s downgraded Japan’s government bond credit rating after Prime Minister Shinzo Abe decided to delay a sales tax increase to improve the fiscal deficit. However, Abe also called snap parliamentary elections, which it won by a landslide, in order to renew the government’s reform mandate. The government has since introduced its third major fiscal stimulus in the past three years but will need to make major reforms to the agricultural, services and labour markets in order to increase productivity to generate growth. Despite the government’s strong mandate, it is still doubtful whether Abe has the political will to enact such reforms. If not, then Japan may remain dependent on further monetary easing and debasement of the currency in order to sustain its economy. The Nikkei index was down -0.1% in December but is up +7.1% for the year, primarily due to monetary stimulus despite a weak economy.

China’s HSBC/Markit Purchasing Managers Index (PMI) fell to 49.5, below the 50 threshold which indicates growth. However, this prompted speculation that the central bank will ease monetary policy. In addition, the new Shanghai-Hong Kong Connect regime which loosens restrictions on foreign portfolio investment into China has led to a significant inflow of money and to a speculative bubble, sending the stock market soaring. The Shanghai Shenzhen 300 index was up +25.8% in December and was up +51.7% for the year, by far the best performance of any major stock market in the world. As it continues its transition from an investment and export-driven economy to a consumer-led one, China must grapple with the excesses of its previous boom, including a housing market bust and a higher amount of bad loans on bank balance sheets. It is likely that the central bank will continue to stimulate the economy to negate these issues, providing further fuel to a continued stock market boom.

Further west, Russia’s central bank increased interest rates for the fifth and sixth times this year (to 17.0% from 9.5%), but this failed to stem the slide in the rouble currency, which fell to almost 80 roubles to the dollar (the lowest level in history and a 50% drop within a month) before recovering to around 56. The rouble has lost 42.0% of its value versus the dollar this year as Russia has suffered from the slide in the oil price. The rouble’s depreciation has made it difficult to contain inflation, which was up +9.1% year over year in November. Compounding the bad economic news was a cancellation of the South Stream gas pipeline, which failed due to sanctions by the EU, as well as the World Bank’s revised estimate that the economy will likely shrink by -0.8% in 2015 (compared to the previous forecast of +1.2% growth). However, that forecast was based on oil at $78/bbl, whereas the economy may contract by around -4% if the oil price remains at its current level. The MICEX index was down -8.9% in December and down -7.1% for the year, but that fall is in addition to the substantial debasement in the currency. Russia faces one of the most challenging prospects of any country in 2015; the currency may depreciate further in order to balance the government’s budget if the oil price stays around current levels.

Greek stocks dropped -13%, the most in a single day since 1987, when Prime Minister Antonis Samaras announced that he would seek a parliamentary vote on a new head of state; this failed and will lead to fresh elections in January. However, the opposition party Syriza, which has stated that it would reject many of the conditions of Greece’s bailout by the International Monetary Fund (IMF) and the EU, is expected to win the snap polls. As a result, Greek 3-year and 10-year bond yields soared to over 13% and 9%, respectively; they had been below 4% and 6%, respectively, earlier in the year. The Athens Stock Exchange General index was down -14.2% in December and down -28.9% for the year.

European markets in general seesawed back and forth during the month, first in anticipation of one trillion euros of quantitative easing measures by the European Central Bank (ECB) and then selling off when the ECB’s governing was not able to reach consensus on such measures; this was compounded further by the news of fresh Greek elections. The Eurozone inflation rate also slowed to +0.3% annualised in November (and is forecasted to be just +0.5% this year), reigniting deflation fears. The German Bundesbank also cut its GDP growth forecast for 2015 to +1.0%, half its previous forecast. The core French, German and UK indices were down -2.7%, -1.8% and -2.3%, respectively, on the month, while peripheral countries like Italy and Spain were down even more, -5.0% and -4.6%, respectively.

In the Americas, Brazil’s central bank raised its benchmark Selic rate by half a point to 11.75%, following a 25 basis point increase in October. The central bank is trying to contain inflation which has exceeded its target for the past four years, including a +6.6% annualised rise in consumer prices in November. In addition, President Dilma Rousseff’s new finance minister, Joaquim Levy, vowed to narrow the budget deficit (expected to be -5.0% of GDP this year) in order to improve the country’s economic imbalances. Rousseff is reversing many of the poor economic decisions made during her first term. However, the combination of lower commodity prices (particularly for iron ore and agricultural products), a stronger US dollar and fiscal austerity mean that Brazil’s economy should continue to struggle in 2015, putting further pressure on the real currency. The Bovespa index was down -8.6% in December and down -2.9% for the year, on top of a -12.4% depreciation in the real currency versus the US dollar.

Further north, the US continues to go from strength to strength. The US Congress reached a deal to fund most of the federal government through September 2015 except for the Department of Homeland Security, which is funded through February 2015 in order to force a debate on immigration policy. Though an element of political brinkmanship remains, the fact that a government shutdown was averted points to a slightly more constructive political process in the US. In addition, the country added 321,000 jobs in November, the most since January 2012 and leading the unemployment rate to fall to 5.8%, while housing starts exceeded one million annualised for the third month in a row. Federal Reserve Chairwoman Janet Yellen has indicated that the central bank will continue to hold down interest rates through the first quarter, effectively confirming market expectations that interest rates will start to rise in the spring to summer time. As a result of the positive economic and political news, US markets were the best performing amongst major developed countries in 2014, with the S&P 500 and NASDAQ Composite indices up +11.4% and +13.4%, respectively, for the year. However, divergence in economic prospects between the US and much of the rest of the world increases dependency on the former, and it is uncertain whether the US is strong enough to carry the global economy the way it did in the late 1990s.

Looking forward to 2015, it will be much more difficult for markets to continue their rally since late 2012 without further monetary stimulus or improvements to economies. The strong US economy should lead to higher interest rates in that country (as well as the higher volatility which usually accompany interest rate rises). In addition, energy-consuming countries (particularly Europe and China) should benefit from the dividend provided by lower energy prices, which should relieve some of the pressure on consumers. In contrast, commodity (particularly oil) exporting countries should see sharp declines in their growth rates, if not outright recession. These countries have been overly reliant on the commodities boom of the past decade to sustain growth and their fiscal budgets, in many cases funding unsustainable consumer booms. As mentioned previously, Iran, Libya, Nigeria, Russia and Venezuela should be the most affected, with Venezuela likely to default on its debts in the near future, but the likes of Australia, Brazil and Canada will also be negatively impacted.

The main political risk in the near future is elections in Europe, notably in Greece and the UK. Despite a stabilising economy, the projected Greek election win for the anti-EU opposition reflects public anger at the lack of credible political responses to the long and deep recession in the Eurozone. A rejection of the terms of its fiscal bailout by the Greek government would constitute a default on its obligations. Meanwhile, an inconclusive election result in the UK, i.e. a strong showing by the UK Independent Party and the Scottish Nationalist Party, could just lead to a fragmentation of the country.

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