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January 2016

Creating, Managing & Protecting Your Wealth

 

January 2016

In this edition we look at the irrational market turmoil in January and the Outlook for 2016.


China Unsettles the Global Markets

The first week of 2016 was a surprisingly weak and volatile start to the New Year, but the comments in some sectors that we are in for a cataclysmic year are overstated.

Last week the Shanghai Composite index fell 9.9% with the weakness spilling over to other Asian and World share markets; Europe was down 6.8%, US was down 6.0%, Australia was down 5.7% and New Zealand was down 2.5%.  The important factor here is this was on low trading volumes.

It is important to keep things in perspective. These declines just erased the gains from the last few weeks of 2015 and brought markets back to where we were in early December last year.

There is no reason to panic and sell. Simply ignore the short term moves in share markets and rely on a diversified investment portfolio. Some investors will see this as an opportunity to invest cautiously on the short term downs.

Last night and yesterday the share markets settled down a lot; New Zealand up 0.16%, S&P 500 Index (US) down 0.13%, Shanghai up 0.20%, Australia down 0.17%.

A number of factors contributed to the share market volatility last week:
  - Lower than expected Chinese manufacturing data: China had been targeting a 7% GDP growth and some analysts believe this may be closer to 5%. The reliability of Chinese GDP data has been questioned.  The weak manufacturing data coming out of China is not a dramatic or sudden deterioration

  - Renminbi weakness: The Renminbi is official currency of the People's Republic of China. You may be used to the Chinese currency being refrred to as Yuan. Its similar to referring to the British currency as ounds or sterling. The name Renminbi literally translates to "peoples money". The People's Bank of China pegged the rate against the USD in 2005 and sets the rate against the USD daily. 

The Renminbi was set last week to a four year low so that it would be included in the IMF currency basket.  This is positive news as there has been continuing criticism that the Chinese Government has kept the Renminbi stronger than it should. But the currency correction after last years correction was seen as China trying to prop up its weak manufacturing sector.  This is against the USD strengthening.

 China is being squeezed by the increase in US interest rates that occurred in December when the US Fed raised interest rates. It is difficult to control both a country's exchange rate and interest rates. The US Federal Reserve moved to raise US interest rates which strengthened the US dollar which in turn strengthened China's currency.  It created a tightening in the Chinese system that made it very, very hard to ease monetary policy without a devaluation in currency.

  - Change in Share Trading Rules: We think this was one of the key reasons for the large correction in the Shanghai index this year. The Shanghai and Shenzhen share exchanges are not open to foreign investors and have a high proportion of day traders. The Chinese authorities introduced a new circuit breaker mechanism into trading at the beginning of this year.  If the market dropped 5% this would trigger a temporary halt to trading and a further decline of 2% would cause a full day's suspension. This actually triggered a sell off as investors didn't want to be caught if the market closed.

In addition another factor was that after the July share market drop the Chinese regulators put in place a six month suspension of share sales for large investors (those holding more than 5% of a company).  The suspension was to be lifted on the 8th January and anticipation of this was one of the factors triggering the sell off in shares this year. Before the 8th January deadline the Chinese regulator announced that this would be delayed.

  - Oil Prices: Oil prices have continued to decline this year, currently they are around $32 USD a barrel, down from the high of $114 USD a barrel 18 months ago. Crude oil prices are currently at 12 year lows. We have seen speculation that oil prices will get down to $12 USD, but in our opinion this is absurd. OK, maybe it will get down to around $25 USD. 

A low oil price does affect the price of oil related shares and the economies of those countries that are dependent on oil exports such as Russia, Brazil, Saudi Arabia and Venezuela. 

Interestingly the drop in the oil price is not related to a strong drop off in demand but an oversupply as oil producers keep up volumes to generate revenue.

 Low oil prices should stimulate economies as it has a huge impact on manufacturing and transportation costs.

The US economy: One of the key drivers of World financial markets is the US economy. The US Federal Reserve raised interest rates in December 2015 which is a positive sign that the US economy is on the mend. In December 292,000 jobs were created well ahead of expectations.

The European economy: The latest manufacturing activity index for Europe was at a 20 month high with output growth and job creation up across every single nation covered.

The Volkswagen diesel scandal continues to unfold. Volkswagen shares fell 20% overnight. Car manufacturing and exports by VW, BMW and Daimler accounted for 18% of German exports last year. By comparison, dairy accounts for 27% of New Zealand’s merchandise exports at present.  As an aside Tourism is ahead of Dairy as NZ's biggest earning sector.


Share Markets and Currency Changes in 2015

Last year wasn't a great year for share markets. The key was there was a lot of divergence in share markets which also provided opportunity. Emerging markets were down 14%, small cap stocks in the US down 4%  with large cap stocks up 6%. The overall effect was the S&P500 Index was only down 0.7%.

In local currency terms the NZ share market was up 13.6% and the Australian share market All Ords index was down 1.3%. However at the end of December the NZD dollar over the previous 12 months had dropped 1.5% against the AUD, 7.3% against the GBP, 12.4% against the USD.  This meant from a NZ perspective the S&P 500 was up 11.7%, the All Ords was up 0.2%.

From a NZ investor's perspective when currency changes were taken into account the returns were OK.

 


Outlook for 2016

Chinese policy makers will continue with fiscal and monetary stimulus into the economy as well as some further currency devaluation which should stabilise things in China. This should also stabilise the global environment and World financial markets.

Emerging markets, commodities and high yield shares may continue to struggle in 2016.

Investors should expect some short term volatility but its very important to remember your long-term objectives.

If oil prices start to rise we will start seeing inflation increasing.  With oil prices low and China dropping cheap goods into the markets the concern is deflation.  Deflation can lead to a recession as consumers delay purchasing.  The world is in a low inflation and low interest rate environment and we need to get used to this. Its very hard when the writer can remember inflation in the 80's peaking at 18% in NZ and the high inflation 90's decade.

We expect the NZ Reserve Bank will continue to decrease interest rates over 2016.  This is making it harder for retirees who are dependent on income from fixed interest term deposits.

According to the theory of Burgernomics (the Big Max Index published by the Economist magazine) the NZD is now 20% undervalued so we may see a strengthening of the NZD especially if dairy prices start picking up.

We still expect equities will outperform fixed interest over the next 12 months.


Lyford Financial Services
174 Hutt Road, Petone, Lower Hutt 5012
T: 04 471 0662                W: www.Lyfords.co.nz     www.uk-pension-transfer.co.nz
Alison Renfrew FSP35961 and Richard Renfrew FSP35821 are authorised financial advisers (AFA) and registered to give financial services advice including investments. They are directors of Lyford Financial Services Ltd and Lyford Investment Management Ltd trading as LYFORDS. The information is given in good faith and has been prepared from published information and other sources believed to be reliable, accurate and complete at the time of preparation but its accuracy and completeness is not guaranteed. Information and any analysis, opinions or views contained herein reflect a judgment at the date of publication and are subject to change without notice. To the extent that any such information, analysis, opinions or views constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised advice under the Financial Advisers Act 2008, nor do they constitute advice of a legal, tax, accounting or other nature to any persons.
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