Market Update

 September 1, 2015

Over the past few weeks global equity markets have experienced significant volatility, as it appears that investors everywhere are dramatically revising expectations. The principal trigger for this market correction has been the combination of weak economic data from China, along with the precipitous fall in Chinese equity prices, which has confounded the authorities’ increasingly clumsy and apparently desperate attempts to stabilise the market.

Analysis of the main Chinese market (Shanghai A Share Index) over the past year highlights the main issues that investors face when investing in China. Approximately 80% of Chinese investors are retail investors, meaning that they tend to be inexperienced.

Despite the economic slowdown in China over the past year, it did not stop the Shanghai rising from 2,290 points in August 2014 to a peak of 5,411 points, an increase of approximately 134% by mid-June 2015. An increase of this magnitude over such a short timeframe, when Chinese GDP was in fact slowing confirms, that this rise was primarily “hot money” from fairly inexperienced investors.

Since mid-June, there has been a significant pull back, despite the Chinese Governments desperate attempts to prop up stock prices. These interventions only magnified the fall and by Monday of this week the Shanghai A had fallen back to 3,000 points. Although still a healthy gain in one year, this represents a significant fall from the mid–June highs. The Chinese economy is still expecting to grow year on year by at least 4%, which is very healthy compared with most global economies, but way below the reported 8.5% we have seen in the recent past.

Global equity markets had not taken much notice of the huge gains in Chinese equities over the last year, although as the Shanghai A plummeted from mid-June the rest of world began to worry. We witnessed a fall of approximately 17% on the FTSE 100, from the high of 7,104 points in May after the General Election to 5,898 on 24th August. During the day the FTSE 100 actually fell to 5768.20 points.

Since Monday, we have seen most major equity indices rally and erase some of those losses. At the close of business on Thursday, the FTSE 100 closed at 6192 points, a rise of 5% in three days. This rally was fuelled by significant upward revision to US GDP growth figures for the second quarter to 3.7%, significantly higher than Bloomberg estimates of 3.2%. As the US markets opened, the S&P 500 opened up 1.6% at 1,971 points, while the Dow Jones was up 1.4% to 16,518 points. After a volatile day’s trading, the S&P 500 recovered about half of its 11% drop over six days, up 2.4% to 1,987 points. The Dow Jones soared 2.27% to 16,655, moving out of correction territory (a correction is defined as a 10% fall from its high).

Turning to the UK, the FTSE 100 is primarily constituted of large multi-national companies and overall approximately 75% of earning from these companies is generated overseas. This means that events overseas can have positive or negative effects on the fortunes of these companies.

Mid-cap and small-cap UK companies are far more reliant on the health of UK Plc and as such experienced far lower falls as the UK is performing very solidly. For example, two of the funds in our investment portfolios, Unicorn UK Income and Marlborough Multi Cap Income, focus more on small and mid-cap UK companies and have increased by 10.05% and 9.05% respectively during 2015, whereas the FTSE All Share has fallen  by -1.05%, as at the 27th August 2015.

The British Chamber of Commerce (BCC) upgraded its UK GDP growth forecast for the next two years, from 2.6% to 2.7% in 2015, and from 2.4% to 2.6% in 2016, due to stronger than expected growth in household consumption and services. The latest forecast also makes the BCC’s first prediction for UK growth in 2017 as0 2.6%. Although these are only forecasts, it does highlight that the prospects for UK companies look relatively positive over the coming few years.

As can be seen from the recent US revised GDP figures and the UK upgrades to GDP by the British Chamber of Commerce, it is not all doom and gloom. Although the markets are indicating that the Bank of England and the US Federal Reserve will tighten monetary policy later than previously expected amid the recent selloff, both are still expected to be the first major central banks to increase interest rates. Forward contracts show that traders are now expecting an increase of 0.25% to the Bank of England’s Base Rate beyond October 2016, rather than in August.

This recent emotional sell-off implies that the consensus view reflects a significant slowdown, if not a potential contraction, in the global economic recovery. However, similar to past recovery declines in commodity prices, it is possible that once commodity process bottom, the global economic recovery is more likely to accelerate.

Massive economic stimulus has been introduced around the globe in the last year and most recently this year in the Eurozone, meaning for the first time in the 6 year recovery, global economic stimulus has been synchronized. This is most likely to improve the pace of growth, as highlighted by the recent revised GDP figures in the US, rather than cause a contraction.

All of the Penney Ruddy & Winter investment strategies are well diversified, investing in a broad range of asset classes. In addition to a broad spread equity funds, the portfolios include commercial property and a variety of fixed interest investments, which have experienced hardly any downward pressure on values in the past two weeks. This has helped protect portfolio valuations during the recent global equity sell-off and we see this recent global market fall as an attractive entry point for investors.

Our advice to any long term investor is to remain invested throughout this volatility. We feel that the Chinese sell off was due to the market overheating, but that the fundamentals for the UK and US economies are positive, and that the continued monetary stimulus will inflate asset prices further. However, there may be a continuation of this volatility for some time to come.