Market Bulletin (04/01/2016)
One year, many tracks
It was every bit the rollercoaster year, not just because volatility has been exceptionally high, but because the major markets around the world tugged in very different directions.
The world’s most important stock index, the S&P 500, ended the year up just over 5% (once converted into sterling). It was the kind of middling return that might ordinarily have pointed to a quiet year; in fact, the story of markets in 2015 was far from smooth.
Yet if there were challenges and setbacks, the year had its fair share of melodrama, too. The VIX index measures volatility on the S&P 500; a score above 20.0 indicates elevated risk and volatility. In 2015, the index broke above that level on eight separate occasions, more than double the previous year’s figure – at the end of the summer, it reached above 40 for the first time since 2011.
In the initial months of the global financial crisis, such anxiety levels on markets fitted better with the facts. But in 2015 fears often got far ahead of the risks that sparked them. A Shanghai stock market crash in August was just one example; if a more mature index dropped more than 40% it would be deeply unsettling, but the Shanghai Composite index is very far from mature. Moreover, the index had already risen by almost as much in the preceding months of 2015.
Indeed, in China’s case the New Year had barely begun before the rollercoaster ride resumed; stocks in China fell so rapidly on the first trading day of 2016 that the authorities utilised a ‘circuit breaker’ mechanism to halt trading. The blue-chip CSI 300 Index fell more than 7%. The dip came partly in response to poor factory data. European equity markets followed suit and fell sharply in early trading.
The direction of the latest round of trouble in East Asia remains unclear, but the supposed ‘Great Fall of China’ of 2015 did not materialise. Of course, as growth rates slowed to around 7%, many investors fretted that China was in trouble. But the breakneck speed of its manufacturing growth had become so taken for granted that any sign of slowdown was taken as a pretext for panic. As it happened, China’s services growth showed consistent improvement over the course of the year, indicative of an important shift. Yet still some cried foul, arguing that China’s statistics were phoney. Perhaps so, but Chinese statistics have been widely doubted for decades, not months.
If China did begin to shift its emphasis away from manufacturing and towards services, then it was acting in concert with the rest of the world. Last year was not good for developing markets amid declining demand for manufacturing and its inputs; among the major players, only India managed to avoid a significant growth slowdown. While China continued to grow (7% is not to be sniffed at), Brazil and Russia both ended the year struggling under deep recessions.
Yet while global manufacturing found a ceiling, services took on the mantle of driving global growth, which the International Monetary Fund forecasts at 3.3% for 2015; last year was a time of recovery for major developed markets, albeit a stuttering one. This was driven by improved fundamentals in the US, as unemployment fell (aided by a few statistical sleights of hand) to 5% in November, while the economy continued to grow.
Nevertheless, it clearly did not grow as quickly as hoped for. The year had opened with high expectations of an imminent rate rise at the Federal Reserve. Yet come late summer, the world’s most important central banker cited concerns about China as one of the reasons still staying her hand. Raising rates for the first time since a recession is usually seen as a sign of confidence in the economy; by the end of the year, a December rise was viewed as just that – 12 months earlier, the prospect of waiting so long would have been viewed as bearish.
The issue of rates and inflation is likely to continue to dominate in the year to come. The Fed’s ‘dot plot’ indicates four further quarter-point rises over the course of 2016, but speculation remains over whether the Bank of England will follow suit. Recent announcements of easing measures in the eurozone and Japan point to the monetary divergence that is expected to characterise the year ahead.
Yet one element that has remained worryingly consistent across developed markets is the near absence of inflation, kept down by falling oil and commodities prices. The lack of inflation creates a dilemma for central bankers otherwise keen to respond to increased growth, employment and borrowing. In the case of the US, Janet Yellen indicated in December that she expects inflation to return to its target “over the medium term”.
Oiling fewer wheels
The price of a barrel of oil reached an 11-year low in 2015. Despite the hit to profits, the Organization of the Petroleum Exporting Countries, whose decisions largely determine the price of oil, declined to reduce production. Cheaper oil appears to have put the brakes on the US shale oil revolution, but analysts differ on whether the downturn is temporary or more fundamental. The oil-sensitive FTSE 100 dropped 4.9% over the course of the year. In the meantime, oil-exporting countries are severely affected, while most developed markets are enjoying an effective tax break.
Yet if cheap oil provided a boost to developed market consumers in 2015, it is yet to rescue corporate earnings, which remain under pressure in the US and other developed markets. In part, this is due to the headwinds faced by energy and mining companies, as subdued demand for both oil and metals keeps prices low; Glencore and Petrobras were just two companies that struggled through the year.
A notable feature of 2015 was heightened merger & acquisition activity, which had reached a record $5 trillion even before the year was out, according to Dealogic. There was also a handful of high-profile corporate crises, most important among them a ‘defeat device’ pollution-cheating scandal at Volkswagen, which continues to be played out. The scandal’s fallout has leached into the reputation of Germany plc more broadly and threatens to affect other automotive companies.
Bucking the trend of lacklustre finishes, the Nikkei 225 ended the year up over 13%. It was aided by good corporate earnings results, accommodative central bank policy, some level of ‘Abenomics’ economic policy success, and a cheap US dollar. Concerns at the impact of slowing growth in China appear to have been priced into Japanese stocks weeks, if not months, ago. Although growth has not been rapid, demographics make a subdued growth rate likely – but the fundamental direction of travel is winning increased investment.
Remaining fragilities have persuaded Japan’s central bank to continue accommodative policies in the short term – the eurozone has committed itself to a similar path. Recovery began to take a better turn in the eurozone in 2015, as the manufacturing and services outlooks both improved. Corporate profits were on an upward trajectory by the end of the year and the FTSEurofirst 300 only ended 2015 down 0.24% due to sterling conversion. Since the European Central Bank adopted a more easing-friendly stance, the prospect of the union’s debt woes finally being overcome has looked increasingly likely.
Although the currency union struggled through another Greek debt crisis early in 2015, it has remained intact, although expectations of ‘ever closer union’ ended the year far lower than at its outset. In the short term, this should tip even the more Eurosceptic EU countries towards participation rather than brinkmanship, and it will doubtless prove useful to David Cameron as he argues for Britain to vote to remain in the broader European Union.
Nevertheless, the Brexit referendum remains a major risk in the year ahead. Other uncertainties include the final details of Osborne’s pension reforms, which are due to be confirmed in the March Budget, and the size of public debt, which came in significantly higher than expected in December. The timing of any interest rate rise will also be important, and Mark Carney is yet to propose a clear timetable.
It is, of course, easier in hindsight to see that 2015, while hardly a bumper year, was not nearly as disastrous as markets were often pricing it to be. Oil may fall and China may slow, but the broad direction of the global economy remains positive and the best companies around the world will continue to offer both growth and income.
After the rollercoaster of 2015, it is worth acknowledging that 2016 is likely to offer some twists and turns of its own; as ever, level-headed investors will keep their eyes on the horizon – if they do, they will find plenty of bright spots. On this note, we offer all our readers a prosperous 2016.
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