Recent Market Volatility
The New Year has not started well for markets. The current equity market weakness, which has seen the S&P/ASX 200 Index fall -5.8% since year-end with the US equity markets off 6% (at the time of writing), has been driven by a combination of both economic and political factors.
On the economic front, the sharp falls in the Chinese equity market (-9.7%) and currency have led to increased concerns about the Chinese economy and its growth. These concerns were also prevalent in our update to you last year. Given China’s importance as a user of commodities any concerns about Chinese growth flows through to commodity prices and to those emerging markets that are dependent on commodities.
2015 – In Review
- Collapse in commodity prices, especially oil. There was over capacity due to an over estimation of Chinese demand and a failure of OPEC to manage global oil supply as Middle Eastern suppliers have flooded the market in an attempt to bankrupt high cost shale oil producers.
- U.S. Federal Reserve bank monetary tightening policy – increasing interest rates. Expectation was there for a long time and finally it happened at year end
- Emerging markets (EMs)1 and oil exporting dependent countries – they fund their deficits in $US so a rising US dollar puts pressure on their currency. They are selling $US and assets to defend their currency.
1..countries outside of the traditional world growth centres, but increasing rapidly as they increase their standard of living and per capita income. Examples are all of Asia excl Japan and China, South American and Russia.
We expect more of the same because Chinese demand is slower, US will continue to raise rates and EMs will still be under currency and revenue pressures.
So what’s different?
China, as we have mentioned before, is undertaking structural change. It’s a bumpy ride. There are two issues going on at the moment.
Foreign exchange policy
In the past the Chinese currency was pegged to the $US and that was convenient for the authorities as they emerged into a global economy. But now they are there, that can’t continue and they need to let the currency rise and fall as other western currencies do. But you can’t do that overnight and it is the manner of this change that is worrying markets. The authorities have taken steps to devalue the Yuan.
The concern is do they take a gradual path or one big devaluation. The former is expected but events are transpiring against China to do that and the later may occur. The rise of the $US has clouded their approach. So this uncertainty over their currency direction and confidence in their ability to manage policy changes has led to markets react. See GDP comment below for why China’s economy is so important.
Chinese local stock market
Also as we advised in an earlier note, the Shanghai stock market introduced margin lending and the local stock market went into a bubble. The authorities took action to stem the growth of margin lending and this saw local investors sell out causing the market to fall. That was back in mid-2015.
The authorities are still endeavouring to control things by recently introducing ‘circuit breakers’, which sees the market cease for 15 minutes, if the it rises for falls by 5%. On resumption, if it falls another 2%, the market is closed for the day. What happens is a rush of sellers occurs at opening so the circuit breaker is self-fulfilling. This is the cause of the recent Chinese market volatility.
This policy has now been suspended. But instability created by authorities is never a good sign of good management so this has affected other markets as another sign of concerns over its management of the economy.
China and GDP – Why so important?
Emerging markets in 2015 represented 60% of world growth (GDP). Of that two thirds was China. It’s a big deal what happens in China as in the last ten years China has bought 50% of the world’s commodities. The world has tied itself fundamentally to China’s future economic direction. As a an analyst said recently, “It’s not Greece!”.
China is undertaking a significant structural change that will be ongoing for some time. They are endeavouring to achieve deliberate reform in a much quicker time frame than what present western countries achieved, in some cases piecemeal, over 100 years.
The demand for commodities has slowed and reduce production capacity available from resource centric exporting countries like Australia. This has an effect on shares prices for companies in that market. Supply and demand is a fundamental tenant of capital flow and the market will in time find a ‘new normal’, now that China is no longer in overdrive.
If you are concerned, we are happy to discuss how your super and investments are placed. What is important is understanding the level of risk you are prepared to undertake and your time frame to achieve your financial goals. In some cases, events such this current volatility create a reassessment of your risk level or opportunities for others to buy quality assets at lower prices.
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