Skip to the content

Goldman Sachs’ three biggest risks to markets – How concerned should you be?

31 January 2016

Following a tumultuous start to the year, Goldman Sachs Asset Management’s Suneil Mahindru highlights the three major risks to markets and how important they are to investor confidence.

By Alex Paget,

News Editor, FE Trustnet

It seems 2016 so far has been characterised by falling oil prices, bear markets, negative outlooks and hyperbolic news headlines surrounding the state of the financial system.

According to FE Analytics, the MSCI AC World index has fallen some 5 per cent since 31 December and some parts of the industry seem to think it is going to get a whole lot worse – such certain brokers at RBS who recently painted an Armageddon-like picture of global markets.

In these times of market stress and rising headwinds, Suneil Mahindru – chief investment officer of international equity at Goldman Sachs Asset Management – says it is important to take step back and assess the major risks facing investors.

While Mahindru is cautious in his tone, he says there is no need to panic.

“The risks factors facing markets heading into 2016 continue to increase at the margin, so it leaves us with an outlook for very modest returns out of equities but again expect increased volatility,” Mahindru said.

Here, he highlights the three largest risk factors facing markets and questions just how dangerous they may be to an investor’s portfolio.

 

China’s woes

First and foremost, Mahindru highlights slowing growth in China as the principle risk.

The world’s second largest economy has been the major source of bad news for the past six months or so and, while it has little effect on the economy itself, the bursting of the domestic stock market bubble (which is now down 46 per cent since June last year, having risen more than 160 per cent in the previous 18 months) has certainly spooked investors.

Performance of indices over 2yrs

 

Source: FE Analytics

He says there are certainly risks involved with China, but questions why its well-documented problems have caused such an issue.

“In one sense, there is no surprise. It has been very well documented that industrial, manufacturing or investment side of China – which in its simplest context is about half the economy – has been slowing down aggressively over the past two to three years.”

“There is no real change to that. The economy is making a transition from ‘Old China’ to ‘New China’ – being consumption, services, and healthcare etc, which every economy goes through.”

That doesn’t mean Mahindru is necessarily sanguine over China, though.

“There are some parts which are concerning. One is fiscal policy is less effective now than it was five to 10 years ago. Monetary policy is also less effective, they have to stimulate more to get that growth out and the last thing is the amount of debt in the system (which is around 250 per cent of GDP).”

“We think a lot of it is somewhat related to the government, so it’s something to think about.”


 

Greg Bennett, co-manager of the FP Argonaut Absolute Return fund, says China is the biggest risk facing investors at the moment and will de-rail equity markets as too many investors believe all the bad news is factored into prices.

He says it is likely the Chinese authorities will need to devalue the currency further, which will seriously damage confidence.

“The biggest concerns is how people are underestimating China’s slowdown,” Bennett said.  

“They can devalue the currency further but if they do that, it’s an admission of the significant problems they have. Essentially, it’s not a profit motivated economy so there is a significant non-performing loan issue.”

“Chinese manufacturing is already in nominal recession so the realisation that things in China aren’t going to improve significantly and that they are actually getting worse – that is the big risk for this year.”

 

The energy complex

The next risk factor, according to Mahindru, is the impact the recent plunge in commodity prices may have on the wider economy.

“Commodity prices have been falling for a while but what we have seen recently is how extreme the declines have been. It has created financial stress in lots of different ways, whether that is with the energy/commodity companies feeling it, it’s coming through in the high yield market and in certain corporate bond funds.”

“It’s amazing how a lot of debt in one area and then some extreme moves creates dislocation. Now, we always say that a falling oil price is a positive.

“It’s a positive until these debt factors become self-reinforcing, by which I mean we understand some energy/commodity companies are not viable at current prices but if it then starts to dislocate other parts of the credit system then it starts to have a feedback loop onto the whole economy.”

“As yet, we don’t see that happening but it is something we monitor.”

Of course, often touted argument is that an oil price which has fallen by 66 per cent is a very positive sign for western economies as consumers and corporates have more money to spend elsewhere rather than on energy.

Performance of index over 3yrs

 

Source: FE Analytics

However, Tilney Bestinvest’ Gareth Lewis recently told FE Trustnet that lower oil prices for western consumers won’t have the significant impact that many expect it to.

“The problem is, in the western world which is the main beneficiary of a lower oil price, you’ve got a deteriorating demographic and we all suffer from an ageing population,” he said. It’s not just Japan, it’s China, it’s the US, it’s Germany, albeit less so the UK because of immigration policy.”

“As you get older you spend less of your net income and save more. The driving force that has been expected to come through in consumer markets from a lower oil price doesn’t have the same impact as your population ageing, because people are now more worried about their retirement.”

 


 

The age of this cycle

Last up is probably the most important risk factor: a rally in risk assets which started seven or so years ago (plus a somewhat meagre economic recovery) looks increasingly long in the tooth.

In some ways, the first two risk factors have been worsened by the fact that there are signs elsewhere that the market cycle is coming to an end.

Performance of index over 10yrs

 

Source: FE Analytics

“The final point regards rising rates, the fact we are long in the cycle, margins are at quite high levels particularly in the US,” Mahindru said.

“Those concerns have been with us for a while, hence our far more moderate view. We don’t think we have enough here to tip the economy over into recession but the risk factors are rising. Hence, the market is debating what to do.”

“The market is now going towards the fact the US industrial component is in recession, we’ve known that now for about six months and the market is starting to speculate or price in the broad US economy slowing down aggressively and going into recession.”

“We don’t see that. We see the consumer being pretty decent in terms of spend as the oil price has negative headline effect on retail sales as now people are spending less on petrol.”

There are many who disagree with this view, however, such as brokers at RBS.

Nevertheless, Invesco Perpetual chief investment officer Nick Mustoe echoes Mahindru’s more constructive view.

“I feel that this is a major correction. It is, obviously, as everyone says, technically a bear market in just about every market, but I do see it as a correction because my central premise is we’re not going into major recession, that economies are not going to fall off the edge of a cliff,” Mustoe said.

“I think it is a soft patch. I think it is driven so much by what has happened with the repositioning of Chinese spending and investment. And in fact, actually, when we have days of very big declines, it makes me feel more optimistic long term because I know that I can buy good assets in good companies, at cheaper valuations.”

“So, that’s why I feel relatively optimistic probably compared to a lot of the consensus views out there.”

ALT_TAG

Editor's Picks

Loading...

Videos from BNY Mellon Investment Management

Loading...

Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.