Current Market Volatility
Some of you may be feeling uneasy with the heightened volatility in the financial markets recently. After a much longer than normal period of rising markets and an unusually extended period of relative calm, investors have become more sensitive to volatility. With much of the world on vacation, markets are typically slow during the summer; however, reduced trading volume can exaggerate otherwise modest market moves. Headlines over the summer have been reporting a growing list of concerns with renewed weakness in oil and commodity prices, lingering fears about Greece, and political and military tensions in various regions of the globe. However, the main catalysts for the recent market upheaval are threefold:
1) Uncertainty around central bank policy and the US Federal Reserve’s decision on whether or not to raise interest rates
2) News of China’s slowing economy
3) Reaction to China’s “Casino” stock market
Our need for certainty can cause us to jump to conclusions about the outcome and meaning of events that have yet to fully play out, which often exacerbates the situation unnecessarily. Financial markets do not like uncertainty, and with the proliferation of Exchange Traded Funds (ETFs) and High Frequency computerized trading models, the speed and magnitude of market volatility can be significant.
China’s economy has grown at an accelerated rate over the past few decades to where it is now the world’s second largest economy behind the U.S. However, it is slowing down as it matures and transitions to a service and consumption-driven economy, which is having an impact on other economies around the world. That said, the Chinese government is expected to remain in control of its transition with significant policy flexibility to respond as it deems appropriate. While China’s economic growth has slowed, its growth rate still remains the envy of the world relative to the other developed economies. As the global economy evolves, countries must and will adapt in order to survive and thrive.
China’s stock market has often been called a casino with share prices bearing little connection to underlying economic conditions. Hoping to promote more stock market investment, a couple of years ago the government relaxed its previously stringent rules around margin trading making the stock market more accessible to the masses. In a country where gambling, though illegal, is part of the culture, this proved irresistible as both unsophisticated small investors and opportunistic wealthy ones entered the stock market in droves. According to Bloomberg, more than 40 million new stock accounts were opened between June 2014 and May 2015. The influx of “hot” money from novice retail investors helped push the Shanghai stock market up by 150% in less than a year. Fearing stock prices were rising too fast, Chinese authorities announced new restrictions on margin trading in June of this year, causing the stock market to fall prompting retail investors to flee the market faster than they rushed in. The result? A 43% drop in less than 3 months. That said, only an estimated 5% of households in China have active accounts, so despite the large absolute numbers of retail investors, the market affects a small segment of the overall population and is less systemic than many fear.
While news around China’s stock market, its slowing economy, and its sudden currency devaluation may have contributed to the recent wild volatility in global financial markets, it’s helpful to keep in mind that downturns are fairly common and are a normal function of financial markets. Throughout history markets have climbed a “wall of worry” with intermittent setbacks and they will continue to do so over time. It’s a law of nature that to gain something we must give up something. Over the 20 year period ending June 2014, the cumulative returns of the Canadian Government Bond Index were 3.22 times more than the 91-Day T-bill Index, and the cumulative returns of the Canadian Stock Market Index were 5.67 times more than the 91-Day T-bill Index. While we gain certainty with T-bills, we give up returns and while we give up certainty with bonds and stocks (in the short term), we gain higher returns in the long term.
Market fluctuations (up and down) provide opportunities for actively-managed, globally diversified portfolios. The key to realizing the benefit of these opportunities is to remain invested and allow the portfolio managers to do the job they were hired to do. While we should expect to see continued volatility, it is important that we remain patient as various markets will present attractive entry points for portfolio managers to enhance future returns.