Global equity market sell off : the worst start to the year in decades

Peter Brooke, Head of Old Mutual Investment Group’s MacroSolutions boutique,

The sharp decline of global stock markets during the first week of the year, after Chinese market events sent them into a tailspin, proved to be the worst start to the year for the US in the past three decades and the All Share Index in at least two decades. According to Peter Brooke, Head of Old Mutual Investment Group’s MacroSolutions boutique, the implications of this selloff for SA include a weaker rand, more inflation, additional rate hikes, fiscal tightening and weaker economic growth. However, it is difficult to gauge the extent to which the local economic environment will deteriorate this year.

Investors took fright when the Chinese stock market shut down for two days last week after circuit breakers were triggered by a 7% decline in shares on the stock exchange. The global backdrop to last week’s event was the weak global growth situation, US policy tightening and China’s unexpected weakening of the yuan.

Brooke explains that these global headwinds took hold in 2015 and, importantly, started to create new ones. These include China slowing, emerging markets coming under pressure from lower commodity prices, the US not actually growing that strongly (little more than 2%) and slowing global trade volumes.

Markets are now becoming increasingly worried that the deliberate yuan weakening caused the market panic as it was seen as the People’s Bank of China sending a message to investors that China’s economy is not yet stabilising. “Yuan weakness is imparting a powerful deflationary force upon the rest of Asia and all other exporters to China,” says Brooke. “Investors are constantly being reminded that the huge yuan devaluation in 1994 was one of the key underlying drivers of the Asian crisis of 1998. While the same kind of fallout is not expected this time, yuan weakness does undermine prospects for all trading with China.”

Brooke points to market concerns that also include commodity price weakness starting to undermine upstream and downstream industries around the world, as well as the currency weakness of a number of countries around the world sharply escalating local currency costs of US dollar-denominated debts – a very deflationary local economic force. “Currency weakness may set off a greater inflation/rate cycle in some countries, further harming growth,” says Brooke. “Market weakness may also set off a ‘negative feedback loop’ in real economies, with market weakness diminishing household wealth; potentially leading to less spending and thus reinforcing the slowdown.”

As far as SA is concerned, the direction of the macro environment is not hard to judge, according to Brooke. Investors can expect a weaker rand; more inflation; additional rate hikes than expected up to this point; fiscal tightening, following the step-up in local bond yields and worsening growth prospects; and likely higher taxes. Weaker economic growth is also on the cards, as a result of a weaker world economic backdrop, tighter policy and drought.

“At this stage, however, it is difficult to gauge the extent to which the local economic environment will deteriorate this year,” he says. “The one positive is that the current account deficit should narrow sharply as the combination of a weak rand, slowing economy, falling oil price and policy tightening will cause a sustained import slump – even though this improvement will take some time to show up in the numbers.”

Brooke explains that one of his team’s investment themes, ‘SA suffers’, paints a bleak picture of South Africa’s growth and profit prospects and thus their portfolios have been underweight to SA equity and overweight to offshore equity. “This has protected clients somewhat from the poor returns in local equity and bond markets, as they had about 25% direct global exposure; a position that has benefited from the weak currency,” he says.

“Within South Africa, we prefer globally diversified companies with attractive growth prospects and where we owned locally-orientated shares, we are invested in defensive options, including South African banks, which we consider attractively valued.

“We remain focused on protecting our clients’ portfolios from inflation by delivering a decent real return. The current stagflationary environment will make this more difficult to deliver and our funds are thus running with a bit more cash and less South African equity than usual. However, there is always an opportunity to find a decent investment and we will continue to focus on doing so in 2016.”

Brooke believes that given these global and local headwinds and heightened market jitters, investors can expect ongoing market volatility this year. “As always, the best way to navigate these turbulent times is to stick to time-tested investment principles. So as long as you have a sound financial plan that is geared to delivering on your long-term financial needs and aspirations and your investment portfolio is diversified across asset classes, with an appropriate exposure to equities, there’s no need to panic,” he explains. “Trying to time the market, or disinvesting from the stock market in response to a panicked sell off, can be an extremely costly exercise in the long-term.”