4 Reasons for Recent Market Volatility
4 Reasons for Recent Market Volatility

4 Reasons for Recent Market Volatility



J. Reed Murphy
J. Reed Murphy

Chief Investment Officer

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4 Reasons for Recent Market Volatility

Market Commentary, January 18, 2016

As we recently communicated, we expect volatility to return to the markets. We are amidst this as equity markets experienced a very tough first week of the New Year with a better second week, albeit still volatile and negative for the S&P 500. Here are some thoughts to keep this in perspective.

  • While we have experienced a 7.9% negative return year-to-date for the S&P 500, very few, including us, expect the recent correction to turn into a bear market.
  • Other areas are actually posting positive returns during this period, including several bond and muni funds that we employ. This is why we diversify.
  • Investors should understand reasons for volatility.
  • Investors should get accustomed to volatility, review their long-term strategic goals and resist the urge to buy and sell based on short term movements.

We will be posting our quarterly market commentary within 24 to 48 hours. This commentary reviews 2015, discusses the first part of January and highlights major themes that we believe will dictate market behavior for 2016 and beyond. We also end with implications for portfolios.

In the meantime, here are a few more highlights on the reasons for recent market behavior.

  • Economic Growth Rates – Investors are concerned about Chinese economic growth rates and their consequences on global growth. Estimates are that Chinese manufacturing is flat (i.e., no growth) year-over-year, but that the service sector may grow 10%. Take a balance of these issues and others and estimates are for the overall economy to grow around 6%. That is a far cry from 10% in years past, but certainly not a recession. Being that the Chinese economy is the second largest in the world, investors are warranted in their concern about slower growth globally. However, this is not a new phenomenon. In its January 2016 release, the World Bank notes that global growth will increase to 2.9% in 2016 from the 2015 level of 2.4%, albeit these figures have come down from 6 months prior. The World Bank also expects global GDP growth to climb to 3.1% in 2017.
  • Chinese Currency Rates – The Chinese currency has been declining, which the market does not like. In actuality, the Chinese economy would benefit from some decline in their currency, however a precipitous drop has other negative economic ramifications. Therefore, we doubt that China will allow a currency free fall as it could result in other non-productive measures, such as currency retaliations from other nations.
  • Oil Prices – Oil prices have declined in the New Year with prices falling below $30 this past week. With global growth concerns impacting expectations for demand and supplies growing due to huge increases in U.S. oil production and no expectation for OPEC to pull back on their production, then markets are struggling to determine the right price for the commodity. Many indicators are suggesting that we are nearing a bottom. In the meantime, this is creating strain on several economies, companies and investors.
  • Debt Levels – Since worries are hitting an inflection point in this New Year, concerns are now expanding to Chinese and global debt levels. There is no doubt that higher debt levels hamper growth rates. This is why we expect U.S. and global growth to be subpar for some time. However, these debt concerns now have some speculating of another financial crisis.

While it is healthy to review potential positive and negative scenarios, the vast majority of economic strategists believe that the recent market sell-off is overdone. They also believe that a global and U.S. recession are low likelihood events. We tend to relate with the camp that believes in a 60% Goldilocks scenario for the U.S. (economy isn’t too hot, nor too cold), a 20% chance of slowing growth from here and a similar 20% chance of upside surprises in 2016. In summary, fundamentals such as valuation levels and growth rates aren’t as bad as the current sentiment is suggesting.

We continue to rigorously monitor economic developments and will provide updates as warranted.

Volatility – A Historical Perspective

Exhibit 1 illustrates that the historical average level of volatility has been higher than in recent years. The author of this chart, First Trust, also points out that volatility may lead investors to ‘sit on the sidelines’ when volatility picks up. However, doing so creates more problems, such as determining when to get back in and missing a potential rebound, which can occur swiftly when economies are not in recessions.

Exhibit 1 – Staying the Course

Volatility – A Historical Perspective

Source: First Trust. S&P 500 index returns.

Tags:  2016 Economy, Bonds, China, Chinese Currency Rates, Opec, Economic Forecast, Economy, Global Economy, Global Stocks, Investment, Market Returns, Market Volatility, PBoC, People Bank of China, Stock Market, Stocks

Note:  The content of this article is for guidance and information purposes only and is not intended to be construed as advice. Information provided is not intended to provide investment, tax, or legal advice.