China shocks global markets
Just over one year ago in August 2015, the People’s Bank of China shocked the global markets by announcing a sudden devaluation of the renminbi against the US dollar. What followed over the next six months was a perfect storm for emerging-market assets, with accompanying shock waves that also dragged down equities and bond yields in developed nations.
Yet in February 2016, the tide suddenly appeared to turn and markets began to rebound across the board—in all likelihood because pessimism had gone too far and contrarian investors saw an opportunity to step in.
Upward trend in 2016
This overall upward trend has continued for all asset classes for much of 2016, even factoring in a brief post-Brexit plunge:
- Worldwide, equities have recovered almost 20% since earlier this year, with the US outperforming Europe and Japan (the latter by a wide margin); these regions are now standing at roughly the same market levels as one year ago.
- Emerging-market assets—equities, bonds and currencies—have done particularly well this year and have also recovered their losses from last August.
- Global bond prices, which move in the opposite direction to bond yields, have resumed their upward trend as well. Yet to some market watchers, this rebound defies belief. How can risk assets (such as equities and spread products) and “safe” assets (such as sovereign bonds) all do well at the same time? We believe two forces are at work:
- First, economic data have started to stabilize in all major regions; this has lifted investors’ risk appetites because it implies that economic growth is close to reaching its potential.
- Second, markets are discounting the ongoing and even increasing amounts of global monetary policy stimulus following UK’s Brexit vote.
Economic changes abound
Yet although this sounds like a perfect environment for both risk assets and safe assets to continue their upward climbs, there are several reasons why this environment is unlikely to last much beyond the short term.
For starters, if economic data continue improving, investors will begin discounting a more hawkish US Federal Reserve—so far, the market is pricing in only one US rate hike before the end of 2016—and anticipating less stimulus by other central banks. In such a scenario, risk assets may continue to do well, particularly if the earnings outlook also improves, but sovereign bond markets are likely to weaken in price, especially in the US.
If, on the other hand, economic or earnings data start to weaken again, or if political risks come back to the fore—just think of Italy’s upcoming referendum or the US presidential election—prices for risk assets might retreat and investors could switch to safe sovereign bonds again.
Either way, something has to give: the high prices of risk assets or the high prices of sovereign bonds. Given our medium-term growth outlook, we tend to believe it’s the latter: safe assets are more likely to lose out in the medium to long term.
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Important Information
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.
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