Investors will be relieved to see the back of a tough third quarter, reports Chief Investment Officer Chris Ralph.
Volatility in the third quarter reached heights not seen since 2011 as markets shifted their focus from eurozone troubles to slowing Chinese growth and the timing of a US Federal Reserve interest rate rise.
The quarter opened with a more familiar story, as a Greek referendum was held on 5 July to vote on the European Union’s bailout package. The Greek people voted to reject the package, but European stocks suffered only temporarily. After that, markets turned to new fears.
Stocks in China had begun to drop rapidly from 12 June, in great part due to slowing Chinese growth. Dips on 27 July and 24 August were exceptionally severe – the latter was dubbed ‘Black Monday’ in China. Between mid-June and the end of September, the Shanghai Composite Index lost more than 40% of its value.
Fears for China were particularly focused on headline economic growth. GDP growth was 7% in the first two quarters of the year, significantly down from the double-digit returns of recent decades but hardly a downturn. But declining GDP figures were sufficient to burst what now looks to have been a Chinese bubble – the Shanghai Composite traded in a far narrower band in September, as volatility began to subside.
The Chinese government reaction to slowing growth and falling share prices was reckoned to contribute to the ongoing panic selling of Chinese stocks, largely by local investors who had been sucked in at the top of the market. China surprised markets by devaluing its currency on 11 August by around 2% against the dollar. As manufacturing figures continued to disappoint, investors worried about a far deeper slowdown in China – and that true GDP growth was much lower than quoted. There was a sharp sell-off in global markets as a result.
Against this context, it is notable that correlations between stock markets rose significantly in 2015, signalling that many market participants globally were reacting as one to macroeconomic worries rather than doing the harder – and more profitable – work of picking stocks and bonds carefully for the long-term.
Thus, as attention in late August began to turn to the timing of a Federal Reserve rate rise in September, markets fretted together that global growth could be compromised and stocks continued to dip. By the end of September, the S&P 500 had lost 5.7% of its value. Yields on 10-year US Treasuries duly dropped from 2.35% to 2.04% as investors headed for safety.
As poor growth figures continued to drip in from emerging markets, the World Bank warned that the Federal Reserve would put global growth at risk if it raised rates on 17 September. In the event, it left rates on hold, although later in the week Janet Yellen signalled that a rise was on the cards before the end of the year.
Markets were relieved that rates were not raised, but uncertainty over the timing of the next rise contributed to volatility. By the end of the month, markets were not pricing in a rate rise until 2016. US equities suffered a further drop late in September when Hillary Clinton criticised pharmaceutical companies for “profiteering” in their pricing policies. Until that point, the healthcare sector had been one of the few summer bright spots on the S&P 500.
Although European politics stayed largely out of the markets through the quarter, corporate concerns began to tell late in September, as news was published of Volkswagen’s widespread emissions cover-up. Eurozone equities were already down since the start of the quarter on global growth worries, but the trouble at VW put German stocks in particular under extra pressure. The DAX was one of the weakest indices during the quarter, falling almost 13%.
Bunds and gilts both saw yields tighten over the period, as investors looked for security. Nevertheless, there were positive signs in some peripheral economies, as growth picked up in Italy, Spain and Ireland.
In the UK, the FTSE 100 dropped 5.7% over the quarter, hit especially by worries over China and commodities. The quarter opened with the first Conservative-only Budget in two decades – a tapering of tax breaks on pensions was to be expected and companies welcomed the drop in Corporation Tax. Despite disappointing UK results in the services sector and the trade deficit, it was heartening to see positive signs on both productivity and pay growth.
East of China
Japan’s Nikkei 225 fell more than 14% over the period, hitting a nine-month low on 29 September. Stocks in Taiwan and Hong Kong also fell. Corporate results in Japan were solid but the country is especially susceptible to any dip in Chinese growth, and questions were raised over the effectiveness of Shinzo Abe’s reform programme. Core inflation fell for the first time in two years, and markets are always sensitive to any hint of deflation in Japan. More fundamentally, Japan suffered negative growth in the second quarter and initial monthly data for July and August showed only marginal growth.
The third quarter provided investors with a salutary reminder that short-term volatility is an inherent feature of equity markets. With the support of very accommodative monetary policy worldwide, markets have marched higher for four years without much volatility, which perhaps makes recent events more unsettling.
As we always remind our investors, markets never go up in a straight line. Market volatility should not be viewed as an ‘if’ but as a ‘when’. Successful long-term investors are likely to be those who can tune out to this short-term market noise and accept volatility as the inevitable bumps along the road on the journey towards meeting their objectives.
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