January was a terrifyingly volatile month, but how should trustees react? Louise Farrand explores
It all started in China. Barely giving investors time to recover from Christmas, stocks fell in a sharp downward trajectory from the 31st December. The Shanghai Composite Market Index fell by ten points between early January and early February.
The volatility may have begun in China – perhaps heralding the start of the year of the mischievous monkey – but the ensuing markets chaos reached all corners of the globe. In the early weeks of 2016, the UK stock market fell by 5.8%, the US was down 6.6% and Europe 7.4%.
The Vix chart, which measures market volatility and is commonly watched by investors as an indicator of confidence, also took an icy New Year’s plunge, spiking up again in mid-January and then plummeting again at the end of the month.
“The start of the new year is of course a traditional time to take stock of the situation and make resolutions for the coming year. Unfortunately, what many investors resolved to do when they got back to their desks in January was “sell, sell, sell”, says John Chatfeild-Roberts, head of strategy for asset manager Jupiter’s independent funds team.
What triggered the volatility – and how should trustees react? It’s a complex picture. Both China and the US reported some disappointing economic data in the last part of 2015, sparking fears that either country could tip the world back into recession.
We are going to have a violent slowdown”
Policy decisions in both countries triggered alarm, with the unreliability of China’s official data fuelling the panic.
Some asset managers are more concerned about what the sharp market dips in early 2016 will mean in the longer term than others. At the gloomiest end of the sentiment spectrum is the French fund manager Carmignac Gestion.
“We are going to have a violent slowdown”, predicted Frédéric Leroux, Carmignac’s global manager, at a January press conference in Paris.
In a note to investors, Carmignac said: “With central banks becoming increasingly restricted in their stimulus policies, 2016 is likely to be the year when the markets awaken to economic reality.”
The US Federal Reserve raised interest rates in a much-anticipated move at the end of last year. The decision was seen as an indicator of confidence that an economic recovery is on the cards, partially spurred by a recovering jobs market.
However, Carmignac’s fund managers are unconvinced that improving US employment figures are as significant as most economists believe.
Struggles to grow the US economy are likely to be felt in Europe”
Leroux says: “There is an assumption that employment has been doing well so consumption should do well – but there is a plateau effect. Jobs mark consumption, not the other way around. Since we have a negative consumption figure, we will have a negative employment figure.”
Struggles to grow the US economy are likely to be felt in Europe, Carmignac’s fund managers believe. “The European cycle is dependent on the American cycle. The present situation where European growth is outstripping US growth is all very well but it didn’t stop European stock markets dropping in 2008 along with the US market,” said Leroux.
Meanwhile, in China – where it all began – slowing growth, increasing debt levels and unreliable economic data are conspiring to spook markets. David Parks, who manages three of Carmignac’s emerging market funds, says: “The challenge for me is that earnings estimates created by consensus have been consistently wrong. I can’t trust the earnings and the sell side.”
No more drama
Other asset managers are convinced that markets are behaving irrationally. They believe that market fundamentals – i.e. the underlying economic conditions – have not changed enough to justify the level of panic that was evident in January.
“While further volatility cannot be ruled out, our assessment is that the weakness in the market has been driven primarily by sentiment rather than fundamentals,” says William Fong, lead manager of Baring China Select Fund and Baring China Growth Fund.
The Chinese figures for economic growth should not have come as any surprise to markets”
“The Chinese figures for economic growth should not have come as any surprise to markets. The government had long heralded a slowdown in growth, and the final figures for last year were similar to their indications over recent months. The Chinese economy, according to the official figures, is still one of the fastest growing economies in the world. As planned, its growth is now coming more from consumer demand and services and less from industry and exports,” says John Redwood, chairman of fund manager Charles Stanley’s investment committee.
Some investment managers believe that the underlying fear which is so spooking investors is the US economy. Policymakers have stated that they intend to raise interest rates again this year, sparking fears that the US economy is not in a strong enough position to withstand further hikes.
“The current crisis will persist and may become a full-blown bear market if the Fed decides to implement consecutive [interest rate] hikes as it indicated in December 2015,” says Yu-Ming Wang, global head of investment and chief investment officer, international, at Nikko Asset Management.
The current crisis will persist and may become a full-blown bear market”
However, Wang is unconvinced that the Fed will go through with its plan. “In our view, the Fed will blink, just as President Mario Draghi has hinted the European Central Bank will do and as the Bank of Japan did at the end of January by cutting interest rates to negative. This should be positive for global equity markets and may help us avoid the grim year that January has suggested,” he says.
Storm in a teacup?
As long-term investors, trustees should avoid the temptation to rush to sell their growth assets. Markets may have been volatile over the last month, but actually, scheme deficits only slightly increased in January, according to data from consultancy Mercer. The accounting deficits for the UK’s largest 350 companies’ pension schemes increased from £64bn at the end of December 2015 to £66bn at the end of January 2016.
“In part this is a recovery from a particularly difficult first half of the month for equity values, but it also reflects that on average around 50% of schemes’ assets are now invested in corporate bonds and gilts, which increased in value over the month,” said Ali Tayyebi, senior partner in Mercer’s retirement business.
In part this is a recovery from a particularly difficult first half of the month for equity values”
The last month’s volatility provides no clues as to what the future may hold. Asset managers have very different world views and forecasts differ. In uncertain times, what’s important is to have a long-term outlook and to avoid knee-jerk reactions to short-term noise.
Le Roy van Zyl, principal in Mercer’s financial strategy group, does not expect markets to calm down any time soon. He says: “Under such conditions it is very important that trustees and sponsors have a robust risk and cost management plan, mitigating threats and taking advantage of opportunities. This also fits with the Pensions Regulator’s recent integrated risk management guidance which emphasises the need for looking all key areas of potential risk. In our experience, volatile market conditions can present good opportunities for those that are well prepared and ready to act.”
Baring Asset Management’s Fong agrees. “In our view, the turmoil in the market has created an opportunity for nimble investors prepared to take a longer term view.”
The turmoil in the market has created an opportunity for nimble investors”
At Carmignac Gestion, the investment team are favouring areas which may avoid the worst of the turbulence. Current portfolio picks include Korean interest rates and Brazilian and Mexican inflation-linked bonds.
As a result of the slowdown, equities look very cheap at the moment. Trustees with a long-term horizon could consider buying at today’s lows. “There are tremendous equity market opportunities … the opportunity set is wider than it has been for quite a long time”, says Leroux.
However, the fact remains that today’s market conditions are very challenging for asset managers and investors alike. “Investors will need to be smart, wily and very cautious,” says Didier St George, a member of Carmignac’s investment committee.