UBS: What has changed in markets?

Perhaps the biggest concern driving investors' behaviour at present is the financial sector. In the past few weeks the spotlight has turned on the weak capital position of a number of European banks and the broader sector's exposure to both Asian and high yield default risk.

Clearly, banks remain the primary transmission mechanism for capital to the wider economy and any impairment to their ability to lend has obvious implications for broader demand.

To be clear, we do not ascribe a high probability of a repeat of 2007/8, but the risks of a more significant negative event have clearly risen.

Meanwhile, the sell-off in credit markets that started in December has accelerated. Initially the focus was just on high yield where energy-related borrowers constitute a large part of the investment universe. But concerns have now broadened to include higher quality Investment Grade borrowers. The sharpness and breadth of the credit sell-off is itself worrying equity investors.

Other investor fears impacting markets have been around a little longer, but have become heightened in recent weeks. These include
• The negative feedback loop from lower oil and its implications for global growth and for the further selling of risk assets by petro-Sovereign Wealth Funds.

• In Asia, high levels of indebtedness are also causing concern and clouding the outlook for growth as the necessary process of deleveraging takes place. Emerging market currency weakness v USD is also increasing the cost of servicing this debt.

• Continued uncertainty about China’s transition from a manufacturing- to a consumption-led economy.

• The slowdown in global manufacturing activity.

• A growing consensus that the effectiveness of central banks' quantitative easing programs in boosting consumer price inflation and economic growth may be waning.

• The influence of Target Risk and Risk Parity funds that are effectively forced sellers of risk assets as volatility and correlations rise with market falls.

• Illiquidity which means the price impact of these concerns is exacerbated. Illiquidity is more noticeable in credit markets than equity markets but is still prevalent in both.

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