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13th January 2016
Market Commentary January 2016

financial market commentary

2016 has started in a similar way to the way in which 2015 played out: heightened geo-political uncertainty and stock markets faltering due to weaker global economics. The latest issues that have caused this increased volatility are the ever-familiar stories of a slowing Chinese economy and political unrest in the Middle East. Whilst it is difficult to assess what damage these factors may cause to individual company fundamentals, it is not hard to see the effect they have on investor confidence.

The UK market finished 2015 down 5% in price terms but only 1.5% down when income is included. This is a relatively strong return when it is considered in the wider context of sharply falling commodity prices, another Greek showdown with the Europeans, a slowdown in emerging markets and the horrific terror attacks that shook various areas of the world. None of these issues seemingly affected the UK economy and thus it proved to be a positive arena for investment in 2015.

The biggest beneficiaries were smaller companies, and housebuilding. Smaller companies had the benefit of being on relatively undemanding valuations and having a more domestic earnings bias, which meant that earnings were largely unaffected by global economic headwinds. Housebuilders were also in strong demand due to a solid year of 9% average house price inflation and the persistent, decades-old problem of a chronic lack of new housebuilding. The annual deficit is running at about 100,000 homes and this inevitably leads to too few houses being chased by too many buyers, a problem of home affordability that will continue to store up for the next generation.

Whilst these two areas delivered strong performance, it is worth noting that there was a stark increase in the amount and the scale of profit warnings by companies. In the third quarter, 79 UK quoted companies issued profits warnings, the highest third quarter since the credit crisis. These warnings led to sharp downwards movements in share prices as investors took fright at high valuations and negative earnings growth. Whilst data for the final months of the year is not yet out, it feels as though the third quarter figure will be surpassed.

Across the Atlantic, the American economy was finally deemed strong enough to withstand a quarter of a percent interest rate increase, the first rise in nearly 10 years. It would be a worrying development if policy makers thought that an American economy growing at over 2% and with 5% unemployment could not cope with such a small and well highlighted rate increase. The area that does not seem to be coping so well is the $40 trillion ($40,000,000,000,000) US bond market. Many companies have been issuing cheap debt to engage in financial engineering to increase returns for equity investors. When this is combined with a slower global economy and less ability by investors to sell this debt easily, it leads to bigger movements in the price to the downside. This is a risk that we are acutely aware of for 2016.

What is particularly interesting is the number of respected, seasoned financial commentators who have never seen this level of uncertainty across the globe. It is political, with the rise of extreme politicians, the entrenchment of the so-called Islamic State in the Middle East and the subsequent refugee crisis that this has created. It is economic, with a slowing Chinese economy, an uncertain path for interest rates and a fragile bond market. It is even the weather, with the warmest and wettest December on record, El Nino playing havoc with climates and the potential La Nina leading to future unpredictable weather. It is all cause for concern.

It has been nearly 8 years since the financial crisis brought the world to a halt and it is pleasing that America has taken another step towards economic normality. But whilst America takes a step forward, it seems that China and Emerging Markets are taking two steps backwards. Bright spots still exist for investment; but the current storm clouds do seem more prevalent than they have been for the past few years. The volatility that will inevitably ensue allows long-term, pragmatic investors to deploy capital into good quality companies at good prices. Caution needs to be taken with investment decisions and it is advised to carry an umbrella, just in case the storm clouds do open.