Global markets started the year with a bang but in the wrong direction. However, in time we have seen markets stabilise and there have been rallies from those sharp drops in January. The question many are asking: is the selling over or is this just a relief rally with more volatility ahead? Haren Shah, Chief Investment Strategist for Wealth Management at Citi Asia Pacific comments
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Global markets started the year with a bang but in the wrong direction. It was noted that this was the worst start in history for most global equity markets as the MSCI World Index was down 6.1% in January. It was not only equities and currency markets that were volatile. Most commodities with the exception of gold slumped, and again with the exception of DM sovereign debt, most corporate and high yield bonds fell. It felt like a perfect storm. Since then, we have seen markets stabilize and there have been rallies from those sharp drops in January. So the question many are asking: is the selling over or is this just a relief rally with more volatility ahead.
Firstly, we need to understand why markets were so volatile and nervous this year. Since late 2015, the main reasons for market uncertainty were related to China. In 2016, we are also experiencing other new concerns. Many are worried that the global economy is slowing and that growth drivers are looking fragile. The Japanese economy again fell into negative growth in Q4 and its low inflation which stayed barely positive, saw its central bank, the BOJ adopt negative interest rates. Furthermore, the ECB also recently rolled out more stimulus on 10 March and cut its deposit rate to -0.4%. This spooked the markets as it seems that central banks are running out of options to stimulate their economies.
The financial sector saw a significant selloff as low to negative rates plus slowing global growth, were seen as potential risks to balance sheets and earnings. Now markets are predicting that the Fed may delay raising rates as even the US economy is showing signs of weakening on the heels of the turbulence in the rest of the world.
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By GlobalDataThere is this growing feeling that central banks have done as much as possible and the onus of driving global growth may fall on fiscal support. Chinese data so far this year does indicate that the economy remains sluggish and that the traditional drivers such as exports, manufacturing and investments sectors are not improving. There is a view that the reforms may continue at a modest pace and that the government could use some levers of fiscal spending to stimulate growth.
The recent National People’s Congress did indicate that reforms will continue and that fiscal spending will be increased to ensure that economic growth remains within their 6.5-7% range. Markets however are taking a wait-and-see attitude as there are still significant headwinds that need to be addressed such as overcapacity and large overhang of debt. Compounding this is the poor outlook for commodities that is having a significant impact on commodity based EM countries as they try to manage their fiscal problems.
However, even though many markets fell into "Bear" market levels i.e. 20% fall from their peak last year; current fundamentals do not signal an onset of a bear market. Valuations are not stretched and after the recent pullback, are even looking attractive. Yes, earnings are under pressure but their drop are not at levels seen during past bear markets. Citi’s top down forecast for 2016 EPS growth is currently 3.5% and based on this, it does not support a "Bear" market thesis but also does not support significant upside to markets either.
What does this mean for investors? Even though earnings expectations are being reduced and look subdued for 2016 as the global economy slows, the dispersion of earnings within market sectors is wide. Value and defensive sectors are being favoured over growth and as such we feel Financials and Technology look interesting while Healthcare is a relatively good defensive play. For those who hold a contrarian view, the Energy sector appears to be showing some value.
We expect that the outlook for markets at least for the next couple of months to remain choppy as we get better visibility on some of the issues. The US and China economic data will need to be monitored for signs of stability plus the upcoming UK referendum on EU membership and US Presidential elections will weigh on sentiment. This means heighten volatility could remain and markets may be more range bound. Thus there could be opportunities when there is irrational selling and look to trade these markets. This is a year to remain nimble.
