(1) China - The wild policy mis-steps by the regulatory and economic powers that be in the first two weeks of 2016 thrust Chinese markets into a global prominence that is probably unwarranted, but nonetheless had a big effect on sentiment. China's opacity in economic and monetary factors hasn't helped and these has merely led to investors bailing first on the assumption that if you don't know something, it's because the reality is worse. This is obviously a simplistic argument but the policy confusion has hardly helped in clarifying matters since it seems to suggest disagreements, or worse, incompetence at a political level. Whether or not this is justified is academic, although even the IMF has started gently suggesting that China needs to improve its communication skills. How ironic that this should now be an issue so soon after the IMF added the Yuan to its SDR currency basket.
The slow-down in the Chinese economy is clear from even the published data (with 2015 GDP growth officially posted at 6.8%). The question remains as to what the government will do about it. Memories are fresh of the mid 2015 Yuan "devaluation" of 3% overnight which triggered the first wave of Chinese market panic selling. In 2016, the forecasts from some are suggesting that the Yuan could be allowed to depreciate by 5% or so from here to 6.90 to the USD. If so, such a move, if not already discounted by markets, could trigger a round of zero sum game competitive devaluations amongst all emerging markets, as well as further commodity price weakness.
So - for China to return to being a positive for markets rather than a negative - as at present - we'll need to see currency stability, policy stability and signs of greater progress on the success of the structural shift in the economy from and industrial investment led growth model to more of a consumer led one.
(2) Commodities - You might have noticed that the oil price has been a little weak lately. in 2015, the same applied to pretty much all other commodities too, as sluggish demand from developed nations and China combined with the usual peak in supply at exactly the wrong time. Stock markets have usually treated weaker commodity as a positive since it gives the consumer cost discount, and usually such price declines are subsequently followed by a pick up in demand. This time round, though, the rally in demand has been notable for its absence. On the supply side too, marginal producers have been hanging in there for longer than expected so production cuts have been less significant.
So - for Commodities to return to being a positive for markets, demand will need to start rising (cf. China, above), supply will need to start falling, prices will need to recover. The correlation between stockmarkets and oil prices could remain fairly high for a while yet.
(3) Credit - It's all about the central banks. We saw last week how a few words in support of further easing from the ECB triggered a sharp change in sentiment. The central bank "put" which has served markets so well since 2008 is still in place. However, with interest rates as low as they are, it's becoming difficult for central banks to hold the line single handedly since their policy drawer is emptier than it used to be. In the US, the Fed's rate increase in December demonstrated it's desire to start pushing the burden of supporting the economy back to more traditional measures: private sector growth and consumer demand. Whether or not they'll actually be able to do that in the face of a weaker global economy remains to be seen. Suffice to say all policy statements from any central banker will remain required reading for a while yet.
(4) Consumer - The consumer remains supportive of economic growth, helped by solid employment and low interest rates. Can it conti9nue?
(5) Cashflow - Ultimately markets reflect the earnings base of companies and expectation of growth for that earnings base. 2/3rds of the rise in the market since 2012 has been not as a result of stronger earnings growth, but simply as a result of investors being prepared to pay more for the same $1 earned: the P/E has risen. Without further expansion in that P/E, the growth in the market relies more heavily on earnings and dividends for support. Q4 earnings from the US fell by 6.4%, although in Japan and Europe they still rose. In 2016 US earnings are expected to grow by 5% (including oil stocks, but these are now only 4% of the total), excluding dividends. In Europe, Japan and some individual Asian markets the outlook seems better.
So of the 5 points above, China, Commodities, Credit and Cashflow all look uncertain to greater or lesser degrees. The Consumer is still hanging in there, supported by lower prices and low interest rates. The hope must be that the Consumer sees support coming in from elsewhere rather than ending up as the last man standing.
What does that mean for portfolios...? If you've got cash elsewhere and this provides you with a cushion against volatility then you can afford to sit tight and avoid looking at the TV. If you are more fully invested, then taking advantage of any occasional rallies to raise a bit of cash seems sensible. Such caution could be proved wrong (we've seen market bounce sharply off lows countless times since 2011, and then march on to set new highs), but if it is proved wrong, the consolation can only be that it was wrong for the right reasons!
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