Chief Economist and Head of the Investment Strategy team
It’s been a rough start to 2016. On the first trading day of the year, sharemarkets have fallen – in some cases sharply – with Chinese shares down around 7%, European shares losing around 3% and the US sharemarket dropping 1.5% after an initial decline of 2.7%.
What’s driving the market volatility?
The recent falls have been driven by a combination of factors including increasing tension between Saudi Arabia and Iran, worries about the Chinese growth outlook and softer-than-expected manufacturing data in the US with the much followed Institute for Supply Management (ISM) Manufacturing Conditions Index falling further in December.
The volatile start to the year indicates that the global growth concerns seen through the second half of 2015 clearly still remain. However, it is worth putting these developments in context.
Some things for investors to keep in mind:
- The tensions between Sunni Saudi Arabia and Shia Iran have been building for a while, partly flowing from the US’ shift in military focus away from the Middle East. However, while Saudi Arabia and Iran will continue to show up in ‘proxy wars’ in the region, e.g. in Syria, they are unlikely to result in outright direct conflict in a way that dramatically pushes up oil prices.
- The latest fall in Chinese shares may have a bit further to go but looks to have been exaggerated. A softer than expected manufacturing survey, worries about new share sales following the scheduled end of a six month ban on insider selling later this week coupled with a continuing decline in the value of the Renminbi all helped trigger the sell-off. This was likely exaggerated since yesterday was the first day of a new circuit breaker that shuts the market down after a 7% decline (the anticipation surrounding this appears to have boosted selling as investors thought they better sell early to beat the circuit breaker). Meanwhile, although the Caixin manufacturing Purchasing Managers’ Index (PMI) that came out yesterday was softer than expected, other economic data over the last few weeks, including data on manufacturing and services that was released on the weekend, has been more mixed suggesting stable growth.
- Most US data points to stable underlying growth of around 2% or slightly more, despite a soft US ISM Manufacturing Index.
- Fragile and constrained global growth should ensure that global monetary policy remains easy this year. Further US Federal Reserve tightening is likely to be very gradual with maybe just two 0.25% rate hikes on the horizon. Japan and Europe will progress with quantitative easing as China continues to cut interest rates.
Overall, while it’s been an inauspicious start to the year for equity markets our expectation remains for better returns than we saw in 2015. Sharemarket valuations are reasonable (relatively cheap compared to bonds and bank deposits), global monetary conditions are likely to remain very easy and this should in turn help ensure a rising trend in sharemarkets, albeit with bouts of volatility like those seen in these past few days of the New Year.
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