#Market Strategy — 07.01.2016


Roger Keller

A turbulent start of year on a rather fuzzy logic. Are stock markets reversing their trend?


Stock markets are tumbling. Bond yields are falling. The oil price is back to a 12-year low. Searches for safe havens are seen in foreign exchange markets and in gold. The common denominator behind all these moves is found in China, with cuts to daily USDCNY fixings.

Conditions remain in place for equity markets to deliver positive returns in 2016 but the ride promises to remain bumpy. 




A conjunction of factors results in the worst start of year memory can recall


  • The turmoil began with a sudden acceleration in the depreciation of the offshore-traded yuan. It has lost 2% since January 4. On the same day, PMI data was released. Official numbers were satisfactory, particularly the non-manufacturing one, which rose to 54.4, its highest level in 16 months. The private sector PMI on the other hand disappointed. Its composite has dropped below 50, reaching 49.4, which compares to 50.5 in the previous month.

  • Investor nervousness is fueled by the adoption last August of a new foreign exchange regime, which since then has been based on the level of the previous day’s close and the objective of narrowing the differential between the offshore and the onshore yuan.

  • The activation of circuit breakers on the day of their introduction served only to increase the flow of selling orders. Concomitantly, investors began anticipating the end to bans on share sales by major stakeholders from January 8.

  • Rising geopolitical tensions in the Middle East and North Korea’s test of a hydrogen bomb are adding to market stress.


Fuzzy logic applies


  • On the one hand, investors want authorities to let markets define levels of equilibrium. On the other, they are disturbed that authorities do not intervene convincingly to defend the currency or at least smooth the slide. The concern is that authorities have become more tolerant of currency depreciation because the domestic economic situation is worse than they had thought.

  • That would indeed be a worrying situation, with significant negative implications also for other countries, not only in the developing sphere. We do not think that the situation is as dire. First of all, the positive impact of previous rate cuts and other stimulative measures are yet to be seen. Secondly, authorities still have a lot of room to limit downside risks to growth. We retain our view that a soft landing is the most likely scenario.


Fundamentals should progressively reassert themselves  


  • The message of leading indicators, such as those of the OECD or from PMI surveys, is that the global economy is poised to keep growing. The pace of expansion can only be sub-par because of strong secular headwinds such as deleveraging or population ageing. What counts, is that the global economy keeps growing. This will feed sales growth, earnings progression and, in the end, stock price gains. Improving fundamentals should also allow oil prices to rebound from the new 12-year lows that have just been reached.

  • We do not expect strong price gains in stock markets over 2016 because we see earnings growth as the main price driver and that is expected to be single digit. Hence the importance for investors to focus on total returns, i.e. not to neglect the importance of dividends.

  • Because fundamentals are slow moving, the ride is likely to remain bumpy.