The start of 2016 has seen market volatility increase with the ASX200 pulling back to levels last seen in 2013.
What has caused the pull back?
Soft Chinese manufacturing data and a devaluation of the yuan has sent shock waves through global markets with fears that the Chinese economy may be in a much weaker state than previously thought. These fears have flowed through to equity and commodity markets with steep falls across the board. Compounding the size of the moves has been the lack of market activity given January is traditionally a low month for volumes.
While the soft manufacturing data has direct implications for the Chinese economy, the decision to devalue the yuan has more global implications. By devaluing their domestic currency the Chinese government is trying to stimulate the manufacturing sector. Such currency adjustments impact all of China’s trading partners. Given the importance of the Chinese economy to global trade, the concern is that this has the potential to drag on the economic growth of China’s trading partners.
Since the initial falls we have seen concerns spread into other sectors/countries. Bond yields have fallen as investors place bets that interest rates will stay lower for longer than previously expected and credit spreads have increased as more risk is priced into debt markets.
What are the Implications the Australian Economy?
China is a significant trading partner to Australian and so any weakness will impact the Australian economy and in particular, the commodity sector. Major miners such as BHP are trading at 10 year lows reflecting the expectation that commodity demand and prices will remain lower for longer. More generally, stocks with any direct exposure to China have also been sold off as investors look to offload any China exposure they can.
Domestically the economic data has actually been quite strong with retail sales over Christmas looking reasonable and recent unemployment data continuing to show positive signs (Unemployment under 6%). Job creation in the services sector continues to be a standout with the falling A$ stimulating tourism and manufacturing. The housing market has definitely cooled in the last 6 months, however approvals are still well above average and there has been no signs of significant price weakness or settlements not being completed.
Overall, while global issues will impact the Australian economy, we are generally still seeing solid economic data suggesting that the outlook remains positive. In the event external forces do start to impact the Australian economy, the RBA is one of the few central banks globally that does have room to stimulate via cutting rates. The Australian fiscal position is also robust and the new coalition leadership team does seem more open to fiscal stimulus in the event the economy softens meaningfully.
How are we responding to the Volatility?
We have been encouraging clients to underweight portfolios to commodities for some time and have only bought those companies with strong balance sheets with high quality projects that are low on the cost curve. While these companies have not been immune to the selloff we continue to see value in the medium to long term and are reluctant to join the exodus when current prices are already reflecting very bearish scenarios.
Outside of the commodity related stocks, we have for certain clients using the volatility to selectively increase exposure to some high quality businesses which have been sold down along with the rest of the market. We will continue to search the market trying to find more opportunities to buy quality businesses that are over sold. At the same time we recognise that the global environment is volatile and we will continue to monitor the situation and should our assessment of the situation change we will look to advise clients to adjust portfolios accordingly.