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Economic and Market Perspectives
January 22, 2016
Three Words, One Fear
China. Oil. Fed. These three simple words encapsulate
the primary sources of fear for investors as the New Year
begins. On the heels of the Federal Reserve’s (Fed)
tightening move last month, a resurgence of worry about
China’s weakening growth that gripped markets in August
and September is once again weighing heavily on investor
sentiment. So far this year, through January 20th, global
stocks have sold off to the tune of -10.5% as measured by
the MSCI All Country World Index and oil now trades at
levels not seen since mid-2003. Market dogma like the
“January effect” and the commonly expected election year
bounce would have suggested a better start for equities at
least. Looking past dogma and through the noise, as
intelligent investors should always do, where does this
leave us? Let’s break down the market’s worries word
by word.
China
China’s increasing importance in the global economy
over the past fifteen years cannot be understated. Its
rapid acceleration of demand significantly benefited
many commodity rich nations as it embarked on a massive
infrastructure spending spree on its way to becoming the
world’s second largest economy. However, China now
finds itself in a critical transition phase, where it must
become less reliant on infrastructure investment and more
on consumer spending. If lessons from past examples of
developing countries’ economic maturation are any guide,
this period should not be expected to evolve smoothly.
Unfortunately, the transparency and reliability of
economic data from Chinese government agencies has
historically been highly questionable. For market
participants seeking signals of such an influential
economy’s direction, this
has led to frustration and
The world economy lacks
speculation as to the ripple
enough economic growth
effects of a decelerating
ballast to absorb a ‘hard
Chinese economy. In
landing’ in China.
addition, a series of
unexpected policy measures may have tipped the Chinese
government’s hand, indicating that growth is even weaker
than outwardly communicated and that the market had
assumed. With developed markets in the midst of a
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stubbornly slow and shallow expansion, and commodity
producing nations along for the ride, the world economy
lacks enough economic growth ballast to absorb a ‘hard
landing’ in China.
Oil
One of the most obvious signs of slowing demand growth
in China and elsewhere has been weakening commodity
prices. Oil, the commodity that holds the most significance
in the world, has seen an even steeper price decline than
most. Since mid-2014, the price of oil has fallen by an
astounding 75% to the delight of motorists and the growing
anxiety of investors. Not only has oil been confronted
by the same softening demand dynamic that many other
commodities have experienced, it also faces (perhaps
far more meaningfully) a glut of supply brought upon
by advances in drilling technology.
While there is certainly an obvious benefit from lower
energy prices accruing to consumers, the destabilizing
impact on energy-related companies and countries has
outweighed the positive and rattled investor confidence.
The weakened fundamentals of energy and materials
related firms continue
to work their way
We expect commodity markets,
through the equity
including oil, to endure a very
and credit markets
bumpy road on the way to
as impairments are
resetting to a new supply/
likely to rise. From
demand equilibrium.
here we expect
commodity markets, including oil, to endure a very
bumpy road on the way to resetting to a new supply/
demand equilibrium.
“
Fed
In December, the Fed embarked on a path of raising
interest rates after seven years of “emergency” monetary
policy measures. While investors were prepared for this
move, it was by no means met with jubilation. Skepticism
lingers as the U.S. is currently attempting what several
central banks have attempted before and failed—to escape
the vortex of the zero-bound interest rate policy. With the
Fed’s stated intention to normalize rates, albeit slowly,
over the coming years, the U.S. stands alone in a world
economy that seems to be headed in the other direction.
We believe that U.S. economic fundamentals are strong
enough that the Fed can tighten monetary policy without
meaningfully impairing domestic growth. However,
heightened uncertainty surrounding global economic
growth will likely keep the pace of tightening well
below its projections. The end of global harmonization of
interest rate policies will produce increased volatility,
decreasing correlations and wider performance dispersion
among asset classes.
What does it all mean for investors’ portfolios?
Since the end of the global financial crisis, the easy money
policy of global central banks has lulled many investors
into a sense of complacency by creating a low risk, high
return investment environment. Going forward,
desynchronized central bank policy, more reasonable
valuations and slowing growth in emerging markets is
likely to reverse that trend. As such, our Asset Allocation
Committee has been
defensively positioning
Our Asset Allocation
portfolios by favoring
Committee has been
asset classes with a
defensively positioning
superior near-term
portfolios by favoring asset
risk/reward outlook. In classes with a superior nearparticular, we currently
term risk/reward outlook.
hold an underweight
allocation to Equities and an overweight to Alternative
assets and investment strategies that are less directly
exposed to market volatility.
“
While episodes of heightened risk aversion have not been
comfortable historically, they may present opportunities
for the disciplined investor. In the past, bypassing emotion
and playing the long term game have consistently
rewarded the patient investor. Even if market conditions
continue to worsen before they improve, we expect this
episode to be no exception to those in the past. Most
importantly, events like these serve as an important
reminder that a regular, ongoing dialogue about your
unique circumstances and risk tolerance never goes
unrewarded.
In summary, we believe that:
• The confluence of China, Oil and Fed impacts, have
cast an unsettling spell of increased volatility fueling
market declines.
• Market volatility is expected to continue and we have
positioned portfolios accordingly.
• While market volatility can feel uncomfortable, it
may also present opportunities for the disciplined
investor.
• The world economy lacks enough economic growth
ballast to absorb a ‘hard landing’ in China.
The focus must remain on long term goals as patient
investing is key. It is times like these when there can
never be too much communication and we welcome the
opportunity to speak with you.
S&P 500
The S&P 500 Index is a capitalization weighted index of 500 stocks, representing all major industries, designed to measure performance of the broad domestic
economy. It reflects the risk/return characteristics of equities in the large cap universe.
Economic and Market Perspectives is a publication of HighMark Capital Management, Inc. (HighMark). This publication is for general information only and is not
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