There is little doubt that it has been a highly turbulent start to 2016 for investors.
Though geo-political tensions haven’t helped investor confidence, the fact that the newly launched ‘circuit breaker’ mechanism in the domestic Chinese equity market was triggered twice in 2016 thanks to poor PMIs, the devaluation of the yuan and fears of a ‘hard landing’ in the economy have largely caused the significant falls in global stocks.
FE data shows that, apart from the Nikkei 225, all major global stock market indices have lost more than 4.5 per cent over the past week or so.
Performance of indices in 2016
Source: FE Analytics
The FTSE 100 for example is still trading below 6,000, which represents a price fall of 5.28 per cent year-to-date.
In truth, very few market commentators were expecting a bumper year for equities in 2016 as the majority of headwinds that plagued markets last year are yet to be resolved. On top of that, it has been seven years since the global financial crisis and valuations aren’t exactly cheap.
However, given the increasingly negative situation in China causing contagion elsewhere in the world, should investors look to change their outlook and become decidedly more bearish on markets for the year ahead?
Though the likes of Tilney Bestinvest’s Jason Hollands have warned that investors should be turning to absolute return funds to protect their portfolios from further volatility and losses, David Absolon – investment director at Heartwood Investment Management – says now is the time to keep calm and carry on.
“We have made no significant changes to portfolios. We maintain an overweight equity exposure with a strong bias to developed markets as we believe this provides the best potential source of risk-adjusted returns,” Absolon said.
“Our broader view of moderate global economic improvement in 2016 remains intact. Notwithstanding the headwinds of slowing emerging market growth including China, domestic demand across developed economies remains healthy and is supported by low interest rates, low inflation and a strong jobs market.”
He says that growth in the UK and US will continue to be led by consumers and as inflation and interest rates should stay low, while Europe and Japan are likely to be the best performing equity markets over the year ahead thanks to grinding improvements supported by monetary policy, fiscal stimulus and improving corporate profitability.
Despite the genuine concerns about the world’s second largest economy, de Vere Group’s Nigel Green says investors shouldn’t be too caught up by the impact it will have on global markets.
The domestic Chinese equity market is down some 40 per cent since June last year (though that masks its 180 per cent rise over the prior year) and now Green believes the negative sentiment has been overdone.
Performance of indices since June 2014
Source: FE Analytics
“The devaluation of the yuan on Thursday got financial markets worldwide in a tail spin. However, China’s seesawing market needs to be put into perspective. The global sell-off this week was excessive and knee-jerk,” Green said.
He says the currency adjustment is a necessary part of China’s transition to a new economic model and will boost exports, which in turn, will help the global economy.
He added: “The markets will eventually get used to China’s transitioning phase, but meanwhile we can expect waves of volatility in the markets. Volatility presents important buying opportunities for medium to longer-term investors.”
Jim Wood-Smith, head of research at Hawksmoor, says that while “there is a risk of something horrible happening to markets”, the recent negativity around China has covered an important bullish trend.
In particular, Wood-Smith refers to the latest US non-farm payroll data which showed that 292,000 more jobs were created in December. 
“In the trade, we call that an absolute stonker,” Wood-Smith (pictured) said.
“Amidst the doom and despair surrounding markets, this shines out as clearly as Venus on a frosty morning. The United States is creating jobs hand over fist. Now there are two ways that markets can take this.”
“First, they could choose to argue that this makes another rise in American interest rates more likely and is therefore bad news. Or they could choose to treat this as evidence that the whole shooting match is not nearly as bad as feared and that this week has been a huge over-reaction. Both are equally valid.”
“And both fit with our belief that the current bear market is mostly a triumph of grumpiness over current reality.”
There are those who think now is a time to be more cautious on equities, however.
For example, Columbia Threadneedle’s Mark Burgess says the recent volatility and falling appetite for risk is part and parcel of the fact that the bull market in in equities is looking long in the tooth.
Therefore, no matter what happens in China, the chief investment officer says investors need to realise that equity gains are going to continue to be harder and harder to come by over the year ahead.
“My own view is that the easy yards have been made, and success in the future will depend as much on avoiding the landmines as it does on finding the winners,” Burgess said.
“When stock market historians look back at the period post the financial crisis, they may look at 2009-14 as the ‘easy’ phase when asset prices in general were fuelled by historically low interest rates and abundant liquidity. 2015 was the first year when betting on further asset price inflation and ‘buying on the dips’ didn’t work very well.”
Performance of index since the global financial crisis
Source: FE Analytics
“As such, this represents a return to normality where asset prices move in a random – and sometimes volatile – fashion. For long-term investors this is nothing new and nothing to worry about, but investors with shorter memories may have forgotten some of the outsized moves in stock markets that were relatively commonplace before QE took hold.”
His thoughts are echoed by David Jane, head of multi-asset at Miton.
Jane says that investors should not be taking big directional bets within their portfolios in the current market and, instead, says they should look towards more defensive equities to protect their capital.
“Whether the volatility is caused by worries in the Middle East, China or North Korea or simply the ongoing pattern of disappointing data on the economies, it reinforces our view that this is not a market in which to take positions that are hugely dependent on a fixed set of economic outcomes,” Jane said.
“Equity exposure remains the core growth asset for us but our mix has changed to a greater degree than is apparent from a simple regional perspective.”
“We have been moving up the size scale away from mid-sized growth and cyclical businesses into larger more defensive businesses to cover the risk that profits decline as the economy matures while wages start to accelerate.”
“Similarly, we have been moving away from export and consumer cyclical companies into more defensive equity names, particularly those with sustainable dividends.”
He says this strategy means he can continue to have material overweight to equities over bonds meaning he can take advantage of possible upside but, more importantly, it protects his portfolios from potential and sharp falls.
