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Have the 2016’s major market risks really disappeared?

23 August 2016

Tom Becket, chief investment officer at Psigma, analyses whether the major market risks that caused the corrections in both August last year and in January/February are about to rear their ugly head again.

By Tom Becket,

Psigma

It has been a golden summer so far.

Medals galore at the Olympics, the weather hasn’t been too British and markets have provided frazzled investors with glorious returns. Even the tragicomic nonsense served up by our useless football team in France seems a long time ago.

Despite the recent moves higher in the overwhelming majority of global asset markets, there still appear to us to be a number of macro and market factors that have the potential to upset the welcome calm that has descended over the last month or so. 

Performance of index over 3 months

 

Source: FE Analytics

As regular readers will have got bored of hearing over recent months, we have ensured that our portfolios are currently being run with the highest levels of asset class diversification in our fourteen-year history and we have been extremely active taking profits across a number of investments into rising markets.

In today’s blog, I will dust off the list of macroeconomic risks that investors were freaking out about in the depths of despair in February and discuss whether any of these has the potential of turning the recent joy into misery once again.

Later this week I will switch focus to threats that corporate behaviour, equity valuations and earnings growth could pose as we head in to the home straight of 2016 and start our next lap. 

 

US interest rates and the dollar 

The market’s obsession over the next move in US interest rates still burns as strongly as ever, although the concern that the US Fed would raise rates four times this year, sending the dollar into orbit and impacting negatively upon bonds, commodities and the emerging world has obviously been wound down.

Indeed, Dr Yellen and her friends at the Fed have had one reason or another at every meeting this year not to put rates up. All attention has now switched to the pre-election Fed meeting in September and the post-election meeting in December, as debate rages over whether rates will go up again after the solitary nudge higher last December.

All things being equal, we would expect the next slow step in “interest rate normalisation” to take place in December, so the Fed does not appear to be “political” ahead of November’s presidential election.

Indeed, it would appear clear from recent Fed members’ comments that they recognise that there are distortions in bond markets that need addressing, and they believe that they are close to hitting the targets they set for raising rates.

However, we would caveat this view with the obvious fact that Yellen still appears to want to take any move slowly and that a lot of time and economic activity will pass before that meeting. Other excuses could well present themselves by the time of the meeting and the Fed certainly will be sensitive to any pre-emptive move higher in the dollar. We stick by our correct call from the start of the year that an ongoing surprise might be the dollar does not strengthen, as most are forecasting. 

 


The slumping dragon’s free fall 

According to the vast majority of investment commentators, hedge fund managers and the BBC’s Robert Peston, China was supposed to have collapsed by now.

In fairness, Beijing is a long way away, the leaders there are proficient at “book cooking” and they are busy trying to shake off the embarrassment of finishing beneath us in the Olympic table, but away from sport their fortunes seem to have fared better, and we have moved on a great deal from the chaotic currency depreciation of a year ago (now that was a summer to forget).

Performance of index in 2015

 

Source: FE Analytics

The Chinese political and monetary authorities have done well in stabilising the economy and financial markets in the short term and much of the hyperbole has proven incorrect so far.

However, the Chinese remain in full tightrope walking mode and the ongoing economic rebalancing will continue to create nerves for investors at regular intervals.

After a period of uncharacteristic tranquillity, it is entirely possible that another speed bump could be hit in the coming months over capital outflows, FX depreciation or patchy economic data, but our central case remains that one should be balanced on China and eschew the overly bullish and aggressively bearish views that many hold. 

 

Pressures in emerging markets

One of the key surprises for investors this year has been the sensational performance of EM assets, with the core EM equity index up 30 per cent and the general EM debt index gaining 15 per cent since the start of the year.

Performance of sectors in 2016

 

Source: FE Analytics

The aforementioned reasons of a static Fed, the stable dollar and less fear over China have all been key reasons. However, there are other improvements that can be attributed to the better sentiment towards all things EM, including political progress in places like India and Indonesia, a cooling of geopolitical tensions with Russia and a potential turn in the industrial cycle in countries like Brazil.

The sceptics would obviously say that we have been here before in recent times, before the hope evaporated, but we are hopeful that the current stability and gradual improvement in EMs can continue. 

 


The great commodity bust 

A major contributor to the better sentiment over the emerging world has been the stabilisation and improvement in commodity prices since the trough experienced back in February.

Commodity prices, particularly oil, have moved back to levels that we view as “fair value” and in doing so have alleviated the financial pressure being exerted upon many EM governments.

Clearly, any resumption of the falls in resources prices would be bad for certain EM economies, although as I wrote earlier it is clear that many EM governments have ensured they have taken their financial medicine and sorted out their current account issues while the going was tough.

Elsewhere, we still take the view that the tidal wave of debt defaults that many were suggesting earlier this year is unlikely. Certainly, there will be further bankruptcies in the oil sector and other commodities, although most of those bonds affected are now in the hands of specialist investors and distressed debt managers.

Our view is that damage can still be done from the commodity sector but we are in a different and better place now to where we were in early 2016 and 2015. 

 

Conclusion

Without wanting to sound complacent, it would appear that the key risks that investors fretted about at the start of the year have calmed down, which explains the extreme move higher we have seen across most asset markets this year.

As you know, being a “miserable sort” (thanks to cyclist Jason Kenny for this term) I spend the majority of my time thinking about what can go wrong in all parts of my life, but as I have explained today and will go on to discuss at a later date, the macro risks of yesterday might not be the factors that stop the recent rally in its tracks.

Indeed, as my next blog will discuss, I am much more worried about market factors than macro factors at this time. 

 

Tom Becket is chief investment officer at Psigma Investment Management. All the views expressed above are his own and should not be taken as investment advice. 

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