George Lucas
What a start to 2016, says George Lucas, managing director Instreet Investment. “With a change in calendar year, came a change in investor sentiment sparking a large sell off in the markets.
I think this was unexpected because:
- There is no sign of a recession on the horizon for the US, Australia or China and there are no signs of negative global growth
- Growth in Europe isn’t shooting the lights out but it is accelerating
- Japan is doing what Japan does with growth trending at about 0.5% per annum thanks to population issues. So I don’t think we should be expecting any change in GDP growth there
- There is no collapse in the banking/payment system or credit squeeze like there was in 2008.
“Which leaves us with a fall driven by a changing sentiment. Market participants appear to think that stocks were overvalued and needed to come down. The oil price along with news out of China were the catalysts the market was looking for to sell.
To panic or not to panic? That is the question.
Three reasons you might choose to panic about oil:
- The US is a large producer of oil so the fall in oil will affect direct investment into the sector – similar to what is happening in Australia with mining. The oil sector investment is, however, small in comparison to mining here in Australia.
- Oil producing countries like Nigeria, Saudi Arabia, Norway, Canada, Indonesia and Russia will do it rough. Social unrest is possible as governments cut back spending. In fact, some of the recent volatility could be due to sovereign wealth funds in these countries selling liquid assets to bring the funds home.
- The fall in the oil price affects the S&P500, ASX200 and FTSE100 due to their heavy weightings to oil companies. It will affect headline market earnings growth and some US oil companies may go broke or default on loans.
Reasons not to panic about oil
Or you may choose to remain calm in the knowledge that:
- Lower oil prices will boost growth in Europe, Japan, China and other countries that are net importers of energy. We even saw this in Europe in the first half of 2015.
- The current oversupply of oil should be worked through as demand for oil continues and maybe increases due to lower prices.
- Lower oil prices should boost consumer growth in the US, Australia and other consumer oriented countries.
- Europe doesn’t have a heavy weighting to oil producers in its indices so this should lead to better performance in equity indices across the region.
To panic about China
Panic
Why some people are panicking about China:
- China’s markets continue to fall and some recent bad data could indicate a slowing in the Chinese rate of growth.
- China is a growth engine of the world and a slow down here will cause a recession elsewhere.
- There is fear that Chinese regulators have lost control of the market and that the People’s Bank of China is losing control of the currency. This could cause more market unrest if proven true.
Not to panic about China
Or you can take a more relaxed view:
- China is big but it isn’t that big yet. And it is smaller than what Japan was (as a percentage of world GDP) when Japan stopped growing for 25 years. China is not forecast to stop growing like Japan.
- The market is focused on the data that paints a picture of slowing growth, and it is ignoring the data that shows an environment of stabilisation.
- The fall in the Chinese stock market in August did not have an impact at all on consumer spending in China and the service sector remains healthy.
- Unlike other countries, China has kept enough “powder dry” to put its economy back on track.
More data is due out of China on Tuesday, which could help or hinder markets.
Likely fallout?
We think volatility in markets will continue for a while, probably taking several months to dissipate.
Although it’s not a great way to start the year, we think it unlikely that recent falls will hit the real economy. Of course, it may not be over yet and another 10% fall could filter through.
Unlike shares, commodities eventually need to be bought to satisfy demand, so the crash we see in commodities will stabilise. We just have to wait for sentiment to swing.