Equity Markets have started the year on the back foot, with some market commentators publishing very bearish articles that have added to investor risk aversion. While we acknowledge that investment risk has increased, we do not feel compelled to move away from our more sanguine outlook for 2016. We expect this year to be difficult and volatile, but an active and selective approach will continue to provide opportunities to add value.
Since the turn of the year, two of China’s policies have stoked negative investor sentiment, one of these being a series of consecutive interventions in the foreign exchange market to weaken the renminbi and the other a short-lived experiment in the use of circuit breakers designed to limit volatility in its stock market. Both have been interpreted as signs that China’s authorities are worried that the country’s economy is experiencing a deeper slowdown than they expected. Alongside escalating tensions in the Middle East and further falls in commodity prices, most notably oil, these are the main factors that have driven the poor start for equities in 2016.
We believe the market impact of the Chinese policies has been overdone, albeit it is difficult to measure this directly in light of the other developments mentioned. We have postulated that further devaluation of the renminbi has been necessary for some time and, therefore, this action does not come as a surprise. Furthermore, we feel that headline statements have exaggerated the development itself; the renminbi has only fallen by 1.25% against the US dollar so far this year.
In regard to the experiment with circuit breakers, we judge this as characteristic of China’s desire to hold a similar degree of control over its stock market as it does over its economy. Although the longer-term effect of this clumsily-undertaken policy is likely to be minimal, it is likely that similar efforts will be enacted in the future. Any such attempts may have similar short-term repercussions, such as periods of elevated market volatility.
We still feel that there will be a gradual improvement in the global economic outlook over the course of 2016, with central banks remaining accommodative and very cognisant of the fragility of the economic recovery. Certain central banks, the European Central Bank and Bank of Japan in particular, have the scope to increase monetary stimulus through their existing quantitative easing programmes.
There is a clear divergence in terms of economic growth, and therefore monetary policy, across the globe and we believe this dynamic will persist for some time. As well as between economies, divergence has also been evident within economies; some of the manufacturing, industrial and commodity-based sectors have lagged stronger service and consumer-orientated sectors. We feel improving employment prospects, wage growth and the benefits of a falling oil price will continue to benefit these latter areas of the market.
Developed equity market valuations are not overly stretched and we continue to focus our allocations in these markets. We feel that structural issues are prevailing in many Asian and Emerging markets, particularly those exposed to the falling commodity dynamic, and these are likely to remain under pressure, at least in the short term. In any case, selectivity will be key to generating positive returns in 2016 and while we remain vigilant of the risks, we feel there is ample opportunity to add value through our active, fundamentally-driven approach.
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