Many of the same worries from 2015 have triggered a poor start to the year for shares, including a sharp fall in Chinese shares and the value of the Renminbi (RMB). This in turn has caused renewed concern about the Chinese economy and has led to more commodity price weakness and fears of an emerging market crisis.
Soft US manufacturing data and geopolitical risks – this time regarding Saudi Arabia/Iran tensions and North Korea – have also contributed to sharemarket declines (US shares -4.9%, Eurozone shares -5.6%, Japanese shares -6.6%, Chinese shares -11.7% and Australian shares -5.4%). Commodity prices have also fallen with the oil price now at its lowest since 2009 and bonds rallying with safe haven buying.
What’s behind the sharemarket volatility?
The poor start to the year clearly warns that the global growth concerns remain, that commodity prices are still under downwards pressure and that volatility in investment markets will likely remain high. However, it is worth putting these developments in perspective:
- The latest fall in Chinese shares may have a bit further to go, but looks to have been exaggerated, driven mostly by fears and regulatory issues around the sharemarket and currency. The main drivers were:
- concerns about new share supply after a scheduled ban on selling by major shareholders commenced – Chinese regulators have since announced a restrictive limit on the size of stakes that major investors can sell.
- a new sharemarket circuit breaker that commenced on Monday encouraged investors to bring forward selling in an effort to beat the shutdown – the circuit breaker has now been suspended and after 6% plus depreciation in the value of the RMB since July, The People’s Bank Of China is now likely to step up efforts to try and stabilise it again.
- While the US ISM manufacturing index has been softer lately and is a concern, most US data points to stable underlying growth of around 2% or so.
- Signs that global growth remains fragile and constrained will have the effect of ensuring that global monetary policy remains easy this year, with the US Federal Reserve tightening likely to be gradual with perhaps just two 0.25% rate hikes, Japan and Europe continuing with quantitative easing and China continuing to cut interest rates. The continuing global weakness also adds to the case for the RBA to cut interest rates again.
- Tensions between Sunni Saudi Arabia and Shia Iran have been building for some time and partly flow from the shift that occurred in the US away from military focus in the Middle East. However, while they will continue to show up in wars in the region, e.g. in Syria and Iraq, they are unlikely to result in outright direct conflict in a way that dramatically pushes up oil prices. In fact, in the short term the tension ensures that OPEC will remain paralysed with Saudi Arabia focused on maintaining high production to inflict pain on Iran and Iraq, which will serve to keep oil prices low (or lower) for now.
- North Korea’s H bomb test is a big concern, but there is some question as to whether it was really an H bomb and North Korea has already had three nuclear tests since 2006.
Outlook for better returns ahead
While it’s been a poor start to the year for equity markets, and risks do remain high in the short term, our expectation remains for better returns this year than we saw in 2015. Sharemarket valuations are reasonable – being cheap relative to bonds and bank deposits – and global monetary conditions are likely to remain very easy which should help ensure a rising trend in sharemarkets.