Global Market Volatility Update

Short-term volatility always makes investors nervous. Importantly, for advisers and your clients it’s about talking through with clients the reasons why they are invested and relating this back to their advice goals and objectives. It’s vital to remember that inevitably short-term volatility is experienced in markets, and the longer the timeframe to achieve clients’ goals and objectives the more likely market ‘ups and downs’ will be experienced.

The fact is…
Market Update: Dr Ron Bewley, Woodhall Investment Research

No one can deny that markets have sold off heavily in the last little while, but why?

Markets are driven by investors who do not know the true value of the constituent companies and use all of the signals they can find to adjust their views. September has been a big month on the calendar for the whole of 2015. That is when most analysts expected the US Federal Reserve to make their first interest rate hike since the GFC struck.

The US

Quantitative Easing – the programme of expanding the money supply – ended nearly a year ago in the US without any tears. The current official interest rate setting is a band from 0.00% – 0.25%. Traditionally the Fed moves like us in multiples of 0.25% changes in rates. However, the Fed recently flagged that it is prepared to move in smaller amounts in the first instance.

Rates in the US, here and most developed countries, are currently so low that even a 1% hike would still leave us all at lower than emergency settings – so why would anyone be worried about a hike of 0.25% or less? The answer is simple. It has nothing to do with the cost of borrowing. It is all to do with what we believe the Fed is thinking in terms of its confidence in its own economy. If it hikes, the Fed thinks the economy is strong enough to take it. If it doesn’t hike then the Fed will be perceived as being negative on the economy.

To complicate matters, The Fed moved too soon in the Great Depression and arguably prolonged it. So it has a bias towards not hiking too soon. Moreover, the costs to the economy of not hiking when it could against hiking too soon are so, so small. We have argued for some time that the Fed does not need to, and may not hike before 2016 but Fed watchers had pencilled in September.

Now that September is all but here, and the Fed is vacillating, analysts are getting spooked about the strength of the US economy. However, the all-important jobs data keep coming in comfortably above 200,000 new jobs per month and unemployment is at much lower than anyone expected a year or two go. True, wages growth has not been strong but that has been a worldwide problem.

When interest rates return to normal levels in say a few years, the stock market will not look quite as attractive relative to the yields on safer assets. Of course, markets often did well when rates used to be at normal levels but some investors always want to be the first out.

So in terms of long-run investing, we always maintained that rate hike would increase market volatility – and we have certainly seen high levels of volatility – but is it time to do something about it?

If the fundamentals remain strong as we expect, volatility will pass and markets will climb back up. Since there is no obvious sign that the fundamentals have weakened there is no point in selling. Indeed, such investors could be locking in losses. It is true that the US August reporting season was a little softer than expected but many companies beat expectations.

China

China is always a possible worry but its stock market – the Shanghai Composite Index – should not be. The recent sell-off is a little like the Reserve Bank of Australia (RBA) getting worried because there was a bad run on pokie machines in Australia. The Composite is dominated by mum and dad type investors and not institutions like ours and those in the USA. What is important is China’s ability to regulate and control the market. It did a good job in the middle of the year but in the round 2 sell-off they are being perceived as being less successful.

At the weekend, China announced that pension funds could now hold up to 30% in China equities – up from 0%. The fact that it had no impact on day one should not surprise. If you had never been able to buy shares and someone gives you the green light, how long does it take to work out what you want to buy and when? China also has an enormous amount of wiggle room in terms of cutting interest rates and reducing the Reserve Requirements Ratio for banks.

We would be very surprised if China cannot cope with smoothing out the ripples in its stock market. But what about its real economy?

When the ‘flash’ Purchasing Managers Index (PMI) came out last week, it shook some investors as, at 47.1 it was not just below the 50 level that separates improving growth from weakening, it was below expectations and at a six-year plus low. However, this flash read recently taken over from HSBC sponsorship is based on a much smaller sample than the official read and the flash read is only based on small companies. The flash read is often much less the official read which has been at 50 or above for quite some time. The next official read is due on September 1st.

Europe and the EU

Turning to Europe, except for migration issues from Africa and the Middle East, its economy looks stronger than in a long time. The India economy is starting to grow in a meaningful way and lower oil prices help economies that are net importers of oil.

In conclusion

To us, the recent behaviour looks like a ‘shaking-the-tree’ exercise where the weak run for cover and the seasoned investors buy up cheap. Of course this could change but for the foreseeable future this all looks like what has been an overdue correction in the US. We all caught the cold but after a few ‘sick days off we could so easily be back to growth quite quickly.

Yours faithfully,

Ron Bewley PhD, FASSA
Director
Woodhall Investment Research

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