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‘Wall of worry’ keeps investors on edge

Grim start: stock markets have plunged so far in January 2016

For the week ending January 15, 2016

For the first two weeks of the New Year, stocks are down around the world: the S&P Global 1200 Index was down 8.64 per cent; the S&P US 500 was down 8 per cent; whilst the Nasdaq was down 10.36 per cent. Last year was disappointing enough! If the first two weeks of the year indicate how 2016 is going to be, let’s stuff it back in the box and return to 2015.

Actually a review of the performance of these indices over the last seven years shows that there is no correlation between the performance of the first month of the year and the performance of the year as a whole. Encouraging is the fact that despite negative performance in January, February generally provides good performance. But we are playing with statistics here and nothing assures us that the trend of the last seven years will repeat in 2016.

As I have said before, fundamentals eventually rule. This does not preclude, however, a three- to six-month sell off where the market gets revalued at cheaper levels. Such a revaluation would be healthy over the long term, although unwelcome by investors frustrated by disappointing investment returns in the near term.

Here’s the “wall of worry” keeping stock markets on edge:

• China: an attempt by the Chinese government to manage a soft landing of its overinflated stock market last summer failed forcing them to eventually capitulate in favour of devaluing the yuan. China’s chief securities regulator has offered to resign as a result of the mishandling of this.

• Iran: with Iran coming online after several decades of sanctions, oil supplies could spike driving oil prices even lower. Perhaps the current price of oil around $30 already prices this new supply in. In any event, the stock market and the price of oil appear to have some correlation over the long term, so it is possible that stock prices will not recover until oil prices find a bottom.

• Higher interest rates/Fed tightening: in an effort to impress the market that the US economy is strengthening, various Fed governors have spoken hawkishly about raising interest rates. Higher interest rates force a revaluation of stocks. They would have done better to keep their mouths shut and let the economy speak for itself. Until markets are settled, further rate hikes are unlikely. Perhaps we will see none during 2016. (Before the December move, I argued for a maximum one-eighth point hike because the Fed has not reached its inflation target of 2 per cent.)

• Politics: the global political environment is worrisome enough with IS in the Middle East, millions fleeing to Europe, China constructing a militarised island in the South China Sea; but additionally within various countries the political opinion is so polarised that no one can guess the outcome of almost any election. Most interesting is the rise of Bernie Sanders in the US and Jeremy Corbyn in the UK — both avowed Socialists. This creates a lot of uncertainty for businesses in those countries. Business does not like uncertainty — Bermuda has experienced the results of its own efforts to get tough on business and lost dozens of companies with thousands of jobs disappearing as a consequence.

So this “wall of worry” encourages investors to sit on the sides. Money is plentiful but investors are reserved, waiting for lower levels. A revaluation would be healthy but the time to reach valuations that investors are pleased with may be long in coming ... or just around the corner, depending on how quickly the market falls.

In any event, lower stock valuations mean greater opportunities for investors in the future. For this reason we have raised 10 per cent cash in client portfolios before the year end as markets rallied and have raised another 5 to 10 per cent in client portfolios since the year end. This will allow us to seize opportunities in the market when they present themselves in the coming year.

Robert Pires is the chief executive officer of Bermuda Investment Advisory Services Ltd. He can be contacted at rpires@bias.bm