Commentary on December 2015
There was a lack of Christmas cheer for markets with falling commodity prices and concerns over the persistent weakness in both the Chinese economy and its currency dulling the outlook for 2016. This continued into the New Year, with the yuan hitting a 5-year low against the US dollar, leading to fears that other emerging countries would allow their currencies to fall so as to make their exports more competitive. This, plus the falling oil price, would increase the odds of global deflation, despite the best attempts of the world’s central banks..
Japanese and Asian stock markets rose by a couple of percent and UK shares fell fractionally but overall there was little change in stock markets over the month. Fixed interest bonds fell by around 1% and commercial property continued its run of consistent small monthly gains.
At long last the US Federal Reserve pulled the trigger, raising interest rates by 0.25% to a target range of 0.25-0.5%. This had been well sign-posted and was greeted with a relief rally by most stock markets which were also encouraged by a slightly lower projected path of future rate hikes.
Developed markets suffered their worst 5-day start to a New Year in history. Traders returning from the festive break were greeted with a 7% fall in Chinese shares triggering the circuit-breaker mechanism that closes trading for the day; other markets fell, albeit to a lesser extent and oil prices hit new lows. The mood remained bleak when a second 7% fall in Chinese shares triggered circuit-breakers which closed trading for the day after just 30 minutes!
Although the US Federal Reserve Committee toned down their interest rate projections it still suggests four rate increases during 2016. Current market expectations, as measured by the Fed Funds futures market, attribute only a 20% possibility to just three US interest rate increases. The past few years have shown that it’s pointless trying to predict the actions of central bankers but we can observe that there’s a divergence that will need to meet during the year.
Many market predictions are based on extrapolating previous perceived similarities with current conditions or by determining where we are in the business cycle. But the thing is, the world hasn’t been subject to a period of quantitative easing (QE) on this scale ever. Stock markets and economic cycles are showing different patterns to previous times so no-one really knows how things will pan out. Initially the fears were that QE would generate the highest inflation for decades; it might still do so many years down the road, but for now we have the possibility of commodity-based deflation to contend with.
The worries attributed to China aren’t just about the depreciating currency, or slowing growth, but about the actions of Chinese officials. Official interference in their stocks and currency markets are well-known, but in trying to open their markets there is still a reluctance to allow them to find their own level. The net result seems to be that there remains official meddling but that it no longer works, thus giving the worst of both worlds.
This year we will tire of ‘Brexit’, the terrible media slang used to describe the possibility of Britain leaving the EU. The likelihood is that we will see a referendum this summer and putting aside the pros and cons of the whole debacle what investors hate most is uncertainty. This has already been in evidence in the weakening of sterling and could also lead to higher yields on UK fixed interest bonds. There’s no certainty that these moves will last but it could lead to a summer of even more volatility.
How are we currently positioned?
We expect market volatility to persist and are therefore continuing to run robust portfolios that aim for performance over the longer term but with lower than average price movements during uncertain times.
Where we do hold bonds, on our cautious and income portfolios, we hold a blend of strategic, global, and investment grade corporate bonds. We also hold some bonds where the level of interest is linked to a rise in interest rates.
We remain over-weight in UK equity income funds across the portfolios. This is a sector rich in talent with a proven ability to add value over the longer term and with several top funds offering more income than fixed interest funds.
We remain ready to take advantage of opportunities if markets continue to fall but, with the current levels of uncertainty across the world, we feel that preservation of capital is paramount.