Posted on: 18 December 2015 by James Humphreys
Investors reach the end of 2015 having weathered some tough markets. Portfolio returns have been impacted by three broad themes that tell us a great deal about the health of the global economy and the investor nervousness that set in during the summer: oil, the Chinese economy and US interest rates.
At the top of the list is the fall in the oil price. The sudden collapse in oil prices in 2014, from around $110 to $45 was one of the most seismic economic events of recent years. The fall itself took just six months, but the enormous aftershocks are only now becoming evident – some 12 months later.
The price fall was so sudden that it was almost inevitable that during the first half of the year prices would rebound. However, since the summer it has become apparent that the world is increasingly awash with oil and the price has fallen to new lows. This is partly due to slower global demand, but mainly to excess supply. Years of high oil prices have encouraged enormous investment in oil production, particularly inUSshale oil. In response, Saudi Arabia's attempting to safeguard its dominant market position and has forced prices lower.
The first order effect has been to reduce inflation, which has been beneficial for Western consumers and, in response, UK and US consumer confidence has improved.
However, oil's boom years had created some significant global winners who are now suffering the pain of a ‘lower for longer’ oil price. Industrial companies that supply the industry are seeing falling orders and weaker pricing. A number of economies in the emerging world have become increasingly dependent on oil and other commodities, and face recession. Perhaps less obviously, a number of countries established sovereign wealth funds on oil profits and have had to scale back investment in a myriad of asset classes.
The second major influence on portfolio returns is the slowdown in the Chinese economy, which has been an ongoing theme for some years, but which entered a new stage with more global implications.
If one was to point to a single event that summed up 2015 for investors, China’s devaluation of its currency in August might be that event. It seemed to highlight the stresses being felt in the Chinese economy, which has been slowing down as it adjusts its economic model from one driven by investment and industrialisation, to one led by consumer spending. In addition, China is gradually dealing with a large debt bubble that it inflated in an attempt to safeguard the economy after the financial crisis.
In such an environment, the authorities have struggled to maintain the dollar peg of the renminbi, which effectively imports US monetary policy. At a time when the US is moving to tightening mode, China needs to stimulate its economy.
However, the picture in China is complex. Certain regions and areas of the economy are booming, while others are mired in recession. The authorities are sensibly trying to slow the economy down, work off the excess debt that has been built up and transition the economy without causing a recession.
The main losers from this are not in China, but overseas. Again, commodity-led economies have struggled, as have companies supplying the Chinese economy with industrial goods. Companies supplying consumer goods are actually performing well, so we are seeing a change in the way that China interacts with the global economy, rather than something more worrying. Nonetheless, China has been the main contributor to global growth for the last 20 years and its slowdown has certainly taken the wind out of the sails of the global economy.
US interest rates
Lastly, we end the year with the US Federal Reserve (Fed) finally lifting interest rates after a seven year hiatus. The road to this point has been long and arduous and this year has seen expectations of a rate rise wax and wane, leading to some sharp moves in markets.
Back in January, the European Central Bank (ECB) was the central bank grabbing investor attention as it embarked on an enormous quantitative easing (QE) programme to stimulate the European economy after the recessions caused by the euro crisis. However, the Fed was soon guiding the market to expect an increase in interest rates in September. Then, when the date finally arrived, the volatility caused by events in China and a poor run of global economic data gave the Fed cold feet and the rate rise never came. The ’will they/won’t they’ toing and froing caused significant volatility in bond and equity markets, despite having the opposite objective in mind.
The final quarter of the year has been spent preparing the markets for the inevitable lift-off in interest rates. Now that this has taken place, attention has quickly turned to the pace at which interest rates are raised. We expect the Fed will move very cautiously to reassure markets that this is not the start of a period of big rate increases. However, we think monetary policy will continue to be a dominant theme in 2016.
Equity markets have had their toughest year since the euro crisis in 2011 and the global economy is as unstable and vulnerable to shocks as it was then. It remains to be seen whether confidence can be restored or if 2015 is merely a sign of things to come.
All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.
The comments and figures in this document are generally applicable but you should always take specific advice to suit your individual circumstances before taking any action. Errors and omissions excepted.
The value of investments and income generated may fall as well as rise, and investors may not get back the amount invested. Past performance is not a reliable indicator of future results.