Will recent volatility impact the rest of 2016?

Adam Ryan, Manager, BlackRock Income Strategies Trust

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2016: reasons to be cheerful?

Most of us start the New Year with the best of intentions: a new exercise regime, a ‘dry’ January, a promise to sort out the pile of paperwork that has built up over Christmas. We are just three weeks into 2016, but I wonder how many of these have gone by the wayside already. And, given events in markets, who could blame investors for being a little distracted?

China jitters

We are not even in February and already fears around China have triggered a series of big swings in the price of shares, and many investors are still wondering what the impact will be of interest rates going up in the States but not anywhere else.

Many are asking how much all of this, along with the recent ups and downs in stock markets, will impact the rest of 2016.  The short answer is ‘somewhat’, and the slightly longer version is ‘potentially quite a bit’.  Before explaining this in more detail, I should start with the outlook we held coming into this year. At that stage, we felt 2016 would resemble 2015 in many respects: low but positive economic growth; little change to inflation – the price of goods and services – and from a markets perspective, we felt shares and corporate bonds (bonds issued by companies) could do well.

Admittedly, we felt prices were ‘fair’, though investors had little room for disappointment.  Differences in central bank policies also looked set to have an impact and, with different economies around the globe each with their own bright spots and challenges, it’s hardly surprising the outlook is uncertain.

China, for example, is trying to rely less on its exports to keep its economy in good health and much more on domestic demand – money generated from spending within the country.  I’ve felt for some time this change could come with a bumpier ride than many had hoped.  The swings in stock markets we are seeing now are symptomatic of this, and exaggerated by the fact this change is taking place in the world’s second-largest economy.

Brazil is in bother

But China is not the only large emerging economy facing challenges: Brazil is in a downturn but inflation remains stubbornly high and has a president facing impeachment for corruption; Russia has the impossible task of balancing its budget amid a slump in oil prices. In fact of Brazil, Russia, India and China – the so called the ‘BRICs’, a band of countries tipped in 2001 to become future economic powerhouses – only India seems it has what it takes to make strides ahead over the near term.  But even there, Prime Minister Narendra Modi is finding it increasingly difficult to push through some much-needed reforms.

What about the US and UK?

So what of developed economies, like the US and UK? Here the story is more positive – growth is improving in Europe and remains robust in the UK, while Americans are happily spending their cash, although activity has dropped off in the country’s manufacturing sector.

Given all this, it is perhaps surprising stock markets have fallen so sharply so far this year, particularly Western ones. I have to confess to being somewhat surprised and think investors may have become overly fixated by oil prices (which have now fallen more than 70%¹ from their 2014 peak) and China.

That said, it may be wrong to ignore what has happened recently (hence my ‘some’ response earlier), as at the very least it signals investors feel these events are important.

And this brings us on to my ‘quite a bit’ comment: at this stage, most of the data we see across Western economies is good, suggesting they continue to grow at a reasonable pace. Should this change for any reason, and if the malaise hurting emerging economies spreads to Europe and North America, then investors may wish to consider adopting a more conservative approach (as in this event, we could see further swings in the price of already fairly-valued shares).

However, given we are more upbeat on the outlook for developed markets like the US, UK and Europe, I feel this view may be too extreme.  However, the volatility we’ve seen may well signal a move into more difficult times, and while we would always support investing for the longer term, this could support a more cautious approach shorter term.

Sources:
¹BlackRock, as at 18 January 2016.