In February, we continue to see more swings in the financial markets. Thus far last month, taking the US market as a proxy, broad market action has resulted in eleven down days offset by eight days when the market moved higher. As of last Friday, the month’s weekly performances were split between the first two weeks, when stocks moved respectively lower by 3.1% and 0.81%, and the last two weeks, when the market moved up 2.84%.On balance, the markets are down but actually by far less than you would assume in listening to the tabloids.
What is captivating the financial markets?
Divergent central bank policies:
The US is further advanced in the economic recovery than Europe and Japan: we expect the US economy to expand between 2.0% and 2.5%, in line with its stable post-crisis recovery while growth is also steady in Europe and picks up slightly in Japan. The Fed is the only major central bank having increased rates in 2015 and looking at raising them more. On the other hand, the Bank of Japan has reduced its rates further and is now in negative territory while the ECB may also decide a further push into negative rates at its next meeting. These policy moves into uncharted waters challenge long-held beliefs and behavior of market participants and thereby causes great uncertainty.
Swings in foreign currency:
We may see more abrupt and more pronounced swings in the foreign exchange markets as interest rates take diverging paths on each side of the Atlantic. The recent drop in the GBP was due to the increased uncertainty of the UK’s Brexit or exit from the EU which will be decided in a referendum on June 23rd. Higher US interest rates are likely to attract more yield-hungry cash from Europe and Japan which in turn will generally be beneficial to the USD and more likely detrimental to the EUR and Yen, but do expect strong corrections and temporary counter-moves.
Uncertainty about inflation:
There is greater uncertainty regarding inflation. Low oil and commodity prices are leading to increased concerns about deflation. However, there are a number of factors that could cause global inflation to pick up somewhat in 2016. Primary amongst these, energy-related commodities could end 2016 significantly above both spot and forward. As the US economy operates closer to full employment, we should see a closing of the output gap and faster wage growth, leading to an uptick in inflation. If our base case view on oil prices ending 2016 around USD 50 per barrel is realized, we expect global inflation in 2016 to be in the 1.75%–2.25% range, up slightly from the 1.6% experienced last year.
Uncertainty about Emerging Markets:
In the emerging world, Brazil, Russia, India and Mexico (BRIM) should experience growth higher than 2015 as Brazil and Russia, while still contracting, improve from the deep slowdown of 2015. Meanwhile, China is likely to continue its bumpy journey toward a slower but more balanced economy. While Emerging markets will remain a topic of concern for the financial markets – the level of foreign debt of corporates, dependency on natural resources among the major concerns – the overall picture starts to look more positive this year.
What is an investor to do?
As the markets will remain volatile for most part of the year, volatility offer opportunities. Opportunities to trade stocks that you know and feel comfortable with – buy on the dips and sell on the upswing. Opportunities to buy good quality stocks – either value or growth - on the dip and keep for the long term. Opportunities in oil related stocks if our forecast proves correct. Opportunities in value stocks, some Emerging Market and oil related. Opportunities in dividend stocks for the long-term.
For more details on our view, please drop us a line.