Market Bulletin (11/01/2016)
Toil and trouble
“But dawning day new comfort hath inspired,” said Shakespeare’s Titus Andronicus.
The same could not be said at the dawn of the 400th year since the Bard’s death. Instead, markets offered a sobering reminder that the global recovery is beset by challenges.
In an echo of 2015, last week’s troubles bubbled up in China before spilling over to markets right around the world. When Chinese markets opened for the year last Monday, the Chinese currency immediately began to drop against the dollar; it ended the week more than 1.5% below its value at the end of 2015. Despite the intervention of the index-supportive ‘national team’ on Friday, the Shanghai Composite index had a dismal start to 2016, ending the week almost 10% below where it had finished 2015.
The extent of the fall raises questions over timing. There was no groundbreaking news in late December to merit such a rapid decline. If anything dictated the precise timing of the fall, it was politics, not economics.
Of course, the largest question mark of all still hovers over China’s economic outlook. But last week the People’s Bank of China chose to allow the currency to drop much further against the dollar than previously expected. In its defence, the central bank argued that it no longer pegs the renminbi to the dollar but to a much broader basket of currencies – against that basket, the currency fell far more marginally. Yet it is the dollar–yuan exchange rate that matters most on markets – and to the watching world.
In the event, the world did far more than just watch. The S&P 500 suffered its worst start to a year in its history, falling 4.89% over the course of the week, while the Nikkei 225, an index with considerable exposure to China, dipped 7.01%.
The extent of the Shanghai dip had the effect of triggering the official ‘circuit-breaker’ mechanism twice over the course of the week. Naturally, two halts to stock trading in a single week rattled nerves on the markets. But some investors were cheered when the central bank chose to postpone the withdrawal of its rule that major shareholders could not rapidly divest themselves of their holdings, and by the ‘national team’ of investors reportedly stepping in to keep stocks close to the surface – if not exactly buoyant.
There are two principal issues at stake in the wake of last week’s Shanghai stock slips. The first is whether the Chinese government and the country’s central bank can create a more liberal and rational system for its stock exchanges, one that enables stocks to do a better job of representing true value. The Shanghai and Shenzhen stock markets may well be due some corrections; continually propping them up and halting trading is unlikely to help China’s major mainland indices grow up – even if such moves quell investor disquiet in the short term.
The second concern is more fundamental: is Chinese growth in dangerous decline? Although some of the ructions on Chinese stock markets are driven by short-term distortions and fear – retail investors are unusually dominant on Chinese stock markets – there appears to be both sustained downward pressure on the renminbi and persistent doubt over the stock valuations of Chinese companies.
Much of the answer depends on whether it can make the economic transition from growth based on high investment, low-end manufacturing and strong exports, to growth that is more reliant on high-end manufacturing, services and domestic consumption. The general trend for services (despite a poor services growth reading for December) is positive, but a successful transition will take years – not months. In the meantime, stock market immaturity and economic uncertainty mean occasional bouts of high stock volatility in China are to be expected.
“The bad news is that the Chinese yuan will probably fall further now that it’s been decoupled from the dollar,” said Ajay Krishnan of Wasatch Advisors. “But we don’t believe the problems will rise to the levels of the 1997 Asian Financial Crisis because emerging market balance sheets are in better shape and emerging market debt has been increasingly denominated in local currencies.”
Over a barrel
Last week, fears that Chinese energy demand will fail to meet expectations immediately put pressure on the price of oil. The cost of a barrel of Brent crude fell to just above $32 on Thursday, an 11-year low. Metals also dipped: copper reached a seven-year low.
The FTSE 100 is strongly exposed to the mining and energy sectors. Little wonder, then, that it shed 5.28% during the week; Anglo American and Glencore were among the energy companies hit. A report published on Wednesday by Wood Mackenzie predicted a swath of cost-cutting oil and gas deals in 2016.
Automobile manufacturers also suffered on stock market expectations that the growth of Chinese demand will continue to slow. Among those manufacturers, Volkswagen had a particularly bad start to the year, as the United States Department of Justice filed civil charges against the company for its pollution-deception practices.
New Year resolutions
Among those pointing to troubles in China last week was the UK Chancellor. In a speech delivered last Thursday, George Osborne warned that fixing the UK economy was far from over and that decisive policies would be needed in 2016. Yet as he highlighted global headwinds, focus in the UK is inevitably turning to dilemmas facing savers.
Bank of England figures published last week showed that interest rates for UK savers have sunk to a new low. As individuals begin to review their finances ahead of the end of the tax year, news came that the average rate on Cash ISAs fell to 0.85% in December, from 0.99% in November. Many banks now offer a higher interest rate on current accounts than on savings accounts, raising more question marks over the appropriateness of cash as a home for valuable annual ISA allowances.
Meanwhile, the Financial Conduct Authority revealed worrying statistics showing how people are taking advantage of the new pension freedoms; two thirds of those who cashed in a pension between July and September withdrew the whole pot. The remaining third used the money to buy themselves an income, but nearly half of those took an income at an unsustainable level – above 10%. Yet take-up for more attractive guaranteed annuity rates has been disappointing; poor understanding of the new rules may indicate troubles ahead.
The news comes as speculation continues over whether the Budget in March will introduce radical cuts to the rate of tax relief on pension contributions – and what the timetable will be. Faced with such uncertainty, and the challenge of finding the best home for their money, those looking to help secure their financial future by making the most of the tax breaks available should act sooner rather than later.
In the eurozone, last week’s inflation figure for December 2015 came in below expectations – inflation is likely to be a particular concern for markets (as for central banks) in the year ahead. Late last week Philip Lane, the new governing council member of the European Central Bank, was quoted as saying that the bank has room to carry out further quantitative easing if needs be. Despite the comments, the FTSEurofirst 300 continued its fall on Friday, ending the five-day period down 6.74%, its steepest weekly drop since late August.
Minutes of the December Federal Reserve meeting were released last week. Although the vote for the first rate rise in nine years had no dissenters, concern was expressed that inflation would not reach the Federal Reserve target of 2%.
On markets, even good non-farm payrolls news in the world’s leading economy could not redeem the S&P 500 from a negative week. Nevertheless, it was significant that US payrolls were up by 292,000 in December, with unemployment flat at 5.0%. This particular winter’s tale is not without bright spots.
Wasatch Advisors is a fund manager for St. James’s Place.
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