“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
It takes a range of views to make a market, even when stocks decline rapidly and news headlines fan the flames of investor fear. While this range of views has undoubtedly deteriorated in recent weeks, and there are several contributing risks that market participants should continue to watch closely, all is certainly not wrong in the world. In fact some factors support a more optimistic view than is currently reflected in the global markets so we thought it would be worthwhile to put some of the risks driving markets into context, and to examine whether now could be one of those fearful times in which Mr. Buffet and other contrarians might want to consider being greedy.
It is natural to be concerned that weakness in equity markets may signal a coming decline in the economy and this fear is most evident in China where a 45% meltdown in the domestic A-share market since June 2015 paints a potentially grim outlook for the country. The Chinese economy was the major contributor to global growth during the post-crisis recovery so a ‘hard-landing’ scenario has potentially far-reaching consequences. However what this decline doesn’t highlight is that the preceding year saw the same Chinese shares rise by 148% on the back of rampant speculation, and that those stocks still remain higher than they were for nearly all of 2014. What has also gone unnoticed is that residential real estate indicators – an important barometer for domestic growth and credit conditions – continue to improve as the economy rebalances to reflect a greater contribution from the emerging consumer and service sectors. The Chinese economy is still growing; yes at a slower pace, but having doubled in just the last seven years, the broader base and greater diversification should continue to have a positive impact.
Low Oil Prices
Another factor cited in the headlines has been the significant decline in oil prices caused primarily by supplies outstripping demand as OPEC defends their market share against competition from higher-cost producers. Certainly this poses direct challenges for oil-producing businesses with potential credit issues shaking the high yield fixed income market; there are broader macroeconomic implications as oil producers curtail spending to the order of $300 billion; and there is also the fiscal strain placed on government budgets that are dependent on oil revenues. What may be missed though, are the potential benefits of cheaper oil because there are many countries like Barbados which gain from lower costs. U.S. consumers contribute nearly 70% of economic output in that county and the savings at the gas pump, combined with their stronger financial position after years of reducing debt, and high sentiment measures, could well become a boon for consumer companies as people spend the money they save.
Broader Economic Fundamentals
There are economic factors that challenge an optimistic viewpoint beyond just the weak performance of stock markets and commodities: there has been a decline in the Baltic Dry Index which measures cargo shipping costs and could reflect slowing global trade; the strength in the U.S. Dollar is posing a headwind to both domestic manufacturers and the country’s global firms which are booking lower foreign revenues, and weakness has been seen in sales of domestically made cars and in measures of business and manufacturing sector sentiment; and the Federal Reserve’s own forecast suggest additional interest rate hikes this year which some fear could choke a fragile recovery. But fragility is not a certainty; in fact the U.S. labour market has proven resilient with a net two and a half million jobs added in 2015; the prospects for 2016 also seem bright as the number of job openings remain at extremely high levels. And while currency strength may be a challenge for some, foreign firms exporting goods and services into the U.S. are in stronger competitive positions, creating potential opportunities for investors to diversify into other countries and currencies.
We believe that a recession is unlikely in 2016. It is certainly not impossible, and if recent global market deterioration accelerates it could have broader negative consequences, but the factors that generally precede a recession are not prevalent now. Continued vigilance is required, particularly in the vulnerable areas of energy, U.S. manufacturing and in China and the broader emerging markets, but opportunities to be greedy are being created as investors indiscriminately sell into market weakness on the basis of uncertainty and sensationalism. It is in times like these that working with an Investment Advisor can help instill objectivity and discipline, maintain alignment with long-term investment objectives, and identify those opportunities that may be created when fear takes firm grip of markets. Investors should always consult a professional before investing in risky market.
This article is intended for information purposes only and based on information that is believed to be accurate at the time of writing, and is subject to change. All opinions are solely of the authors, may not reflect the opinions of RBC Dominion Securities Global Limited, are subject to change without notice and are provided in good faith but without legal responsibility. Interest rates, market conditions and other investment factors are subject to change and past performance may not be repeated. RBC Dominion Securities Global Limited is a foreign affiliate of RBC Dominion Securities Inc., both member companies of RBC Wealth Management, a business segment of Royal Bank of Canada. The member companies and Royal Bank of Canada are separate corporate entities which are affiliated. RBC Dominion Securities Global Limited is regulated by the Financial Services Commission Barbados. ®Registered trademarks of Royal Bank of Canada. Used under licence. ©RBC Dominion Securities Inc. 2015. All rights reserved.