FTSE suffers worst day in 2 months on Spanish and global growth headwinds

The FTSE 100 suffered its worst single day performance for over two months when the benchmark Index was dragged lower by heavy weakness in mining and banking stocks as investors fled risky assets on global growth concerns and a marked increase in benchmark Spanish bond yields.

We have seen investors move money out of risk weighted assets and that means pressure on the prices of banks, mining stocks as well as commodities where Brent crude oil and copper prices also lost 2%. At the same time we have seen a diversification of investment flows into defensive safe havens such as tobacco stocks and the US dollar.

VIX a concern
There has been a notable rise in the Volatility Index today too, which is a key gauge of market fear or pessimism and needs to be watched carefully as the VIX is bouncing from key support levels which last triggered a 10% slump in global equity markets.

The adrenaline from various Central Bank stimulus measures announced by the Fed, BoE and ECB has started to wane somewhat and now it’s time to pay attention back to fundamentals.

We have seen the S&P 500 and DAX Indices both hit fresh four year highs in the last week but is business fundamentally that strong? Perhaps not, as we have seen with various profit warnings from companies such as Caterpillar overnight. In that sense the markets may be due a correction.

Market correction?
Three factors will dictate how long lived the correction we have started to see in equity markets will last.

First and foremost, the motivation of investors to pick up stocks from their lows. With open ended stimulus measures being announced by the Fed and ECB, investors may use this dedication as added motivation to buy into price dips and bargain hunt stocks that are aggressively sold off.

Secondly, monetary policy from the People’s Bank of China, which many investors are still awaiting developments on. Should China move to cut interest rates or increase infrastructure spending, it may help to increase metal demand and support heavyweight mining stocks on the FTSE 100.

And finally, but of rising importance, developments in Spain. We have seen a German led move this week to call into question the ability of the ESM’s funds to directly fund Spanish banks as part of the original €100bn agreement to help Spain this summer. Add to that concerns over the strength of Rajoy’s government and Catalonia’s calls for a secession, Spain’s ‘willingness’ or ‘unwillingness’ to seek ECB assistance through Outright Monetary Transactions will likely play a large role in helping to suppress rising euro zone tensions in the market.

With Spanish benchmark 10yr bond yields rising 32 basis points today to breach back above the 6% level, this increases pressure on Rajoy to seek ECB assistance. Yet with the Bank of Spain confirming that Spain’s economy is slowing at a significant rate, this leaves Rajoy between a rock and a hard place to seek assistance which will ultimately come with stricter austerity conditions that may worsen growth in the near term.