Market Bulletin (25/01/2016)
Done decoupling?
Last week investors had to contend with news that major world bourses were in bear market territory – that is, a fall of at least 20% from peak to trough; such headlines generate understandable unease. Yet the stories of markets and economies in 2016 appear to have largely decoupled.
Markets can sometimes predict crises, of course, but they can also start believing their own narratives all too readily – or simply follow their own momentum. In the end, they tend to catch up with fundamentals. Those global economic fundamentals may not be stellar at the moment, but they are far better than markets had been indicating. As it happened, Thursday and Friday brought some respite.
James de Uphaugh of Majedie Asset Management summed up the long-term opportunity presented by such periods of volatility. “Both the challenge and the opportunity for investors is the fact that good news and good prices don’t go together.”
The FTSE 100 ended the week up 1.65%, its first weekly gain of the year, aided in part by a rebound in the oil price; Brent crude ended the week back above $30, having dipped close to $27 on Wednesday. There was a similar, if less pronounced, bounce on Wall Street, as the S&P 500 rose 0.95%.
The atmosphere at the World Economic Forum in Davos last week was, like the alpine winter weather, often discomfiting. However, the market dips of early 2016 do not appear to reflect the most important economic trends: growth in the US and China.
“The stock market movements of the last two weeks are puzzling,” wrote Olivier Blanchard, former chief economist at the IMF, last week. “Take the China explanation. A collapse of growth in China would indeed be a world changing event. But there is just no evidence of such a collapse – at most… of a mild slowdown, and even that is far from certain. The mechanical effects of such a mild decrease on the US economy should also be limited.” US exports to China represent less than 2% of US GDP.
“Herding is at play. If other investors sell, it must be because they know something you don’t. Why [are they selling] now? Perhaps because we have entered a period of higher uncertainty… political and geopolitical… the ability of the Chinese government to control its economy is in question. In this environment, it is easier for the bears to win the argument,” wrote Blanchard.
In this context, it is well worth remembering that US GDP growth remains solid at 2%, and an impressive 292,000 US jobs were added in December. Last week, 2015 GDP growth in China came in at 6.9%, within the target range – December’s sectoral growth figures were barely below expectations. These should provide a bedrock for long-term stock growth, too.
The IMF predicts global growth of 3.4% this year and 3.6% next year – quite a jump from last year’s 2.5%. Similarly, it forecasts GDP growth of 2.8% for the US, 1.6% for the eurozone, 2.2% for the UK and 4.5% for the emerging markets. Capital Economics forecasts an encouraging year for US services, employment and inflation and an increase in economic activity in China. Such numbers may be lacklustre, but they are not recessionary.
“So far this is a very clear financial markets meltdown,” said Ken Rogoff, Professor of Economics at Harvard, last week. “It’s hard to point to the fundamentals that justify the order of magnitude of the financial panic.”
Even though the stock bounce late last week was accompanied by a significant drop in volatility, markets are likely to remain uncertain. Against that backdrop, it is vital that long-term investors continue to look beyond the immediate market hubbub.
Short-term sell-offs are, of course, an acknowledged feature of markets. In the US, there have been 20 sell-offs of this magnitude or greater in the past 42 years. Yet on only three occasions was the US market lower 12 months later: in December 1973, July 2001 and January 2008. Significantly, all three took place at the start or end of a recession. Such corrections are naturally unsettling for investors but need to be set against the longer-term context.
“These difficult periods are when managers are paid to make ‘sweaty palm’ decisions, and the same goes for all long-term investors,” said Chris Field of Majedie Asset Management.
“We’re finding lots of opportunities because of the fear. Cash in our global portfolio peaked last year around 15%,” said Tye Bousada of EdgePoint. “In November it was 9% and today it’s around 5%.”
A similar picture is emerging on credit markets. While bonds have been hit by recent volatility, high correlation has led to quality bonds going down with the rest.
Scott Service of Loomis Sayles took a similar line: “I just see it as an opportunity to further invest in credits where we see value that are currently being negatively impacted by this environment.”
Risk-rated
Another surprise at the end of last week was the late rise in the price of oil; although following Friday’s 10% surge, prices tumbled again today as OPEC said producers needed to tackle oversupply. A price floor will be found eventually, but oil may still have to drop a few dollars first. “Oil prices are not going to normalise at $27,” said Adrian Gosden of Artemis.
The other major concern on markets is China. As it happened, the Shanghai Composite ended last week broadly flat, a breather at last after a troubled start to the year – but not a recovery. The Nikkei 225, which is heavily exposed to China, finished last week down 1.1%.
In some ways it is policy, not growth, which is the real cause of investor fears on China’s stock markets, especially currency and financial market policies. Last week, Beijing even seemed willing to acknowledge the fact.
“Our system is not structured in a way to communicate seamlessly with the markets. You bet we can learn,” said Fang Xinghai, vice-chair of China’s securities regulator and a member of a key financial policy committee, in Davos last week. “A depreciation in the Chinese currency is not in the interest of China. It’s not good for domestic consumption.”
It is to be hoped that Fang’s more communicative approach will gain currency in Beijing in the coming months. Volatility is likely to persist on Chinese stock markets, but alarmism is clearly misplaced. It will not only be Chinese stocks which are affected by these ructions but, as ever, diversification will be key to managing the inflows and outflows caused by anxieties over China.
Rate caution
Central banks are showing decided caution in the New Year. Last week, figures showed average UK weekly earnings growth slowing to 2%, having been at 3% in mid-2015. Government debt is higher than formerly targeted. Yet growth is being maintained, unemployment is low and car sales have hit a multi-year high, indicating a healthy consumer climate. Inflation, of course, remains low. It is a mix that looks set to stay the Bank of England’s hand for the time being.
“The year has turned and, in my view, the decision proved straightforward: now is not yet the time to raise interest rates,” said Mark Carney last week. “The world is weaker and UK growth has slowed.”
Perhaps he was taking his lead from Frankfurt; on Friday, the European Central Bank not only declined to raise rates as expected, but also suggested that further stimulus was on the cards. The FTSEurofirst enjoyed a surge on the news: it ended the week up 2.72%.
Artemis, EdgePoint, Loomis Sayles and Majedie are fund managers for St. James’s Place.
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