Crisis of confidence grips financial markets

By Janice Roberts


Given the likelihood that market volatility will increase against the background of global growth and monetary policy divergences and uncertainties, it will be important for investors to stick with their investment horizons and not be influenced by short-term noise.

Commenting in Novare Investments’ economic report for the fourth quarter of 2015, Francois van der Merwe, Head of Macro Research, said: “Strong deleveraging forces have kept aggregate global growth subdued and 2016 is not expected to be materially different.

“Regional economies are desynchronised and unorthodox policy measures by some central banks will result in ample liquidity at a time when the US Fed is withdrawing liquidity. The key swing factor for the global outlook over the next 12 months will be the Chinese economy.”

Van der Merwe said the panic gripping financial markets reflects a crisis of confidence, rather than clear signs that global economic fundamentals are rapidly deteriorating.

Investors are increasingly shorter-term orientated, fixated by the latest data releases instead of the broader trend. Predictions of an imminent global recession have echoed. However, there is little evidence of the economic excesses that typically act as recession warning signs.

Concern over China seems to have been overdone given that economic data signalled a stabilisation in growth, rather than an abrupt slowdown. In addition, the low oil price reflects excessive levels of supply rather than a looming recession.

“Navigating financial markets this year will not be easy. The stage of the business cycle is important for determining asset class exposures. Stronger global growth will be important for extending the business cycle and investors will need to perceive that growth is durable to sustain the next leg of the equity rally. Company fundamentals will be significant for equity returns as further valuation expansion is likely to be moderate,” said van der Merwe.

“We believe that global economic activity will slowly improve, led by the US and Europe and stability in China. Global equities are likely to recover from current oversold levels and provide decent returns.”

In contrast, on the domestic economic front there is no catalyst in sight to turn the situation around. In addition to economic uncertainty, political uncertainty will persist amidst a looming credit rating downgrade. Socio unrest is a growing risk in this environment.

Household consumption will remain vulnerable to higher interest rates this year and will slow materially. Despite years of low rates, household balance sheets are over-leveraged. The inflation outlook has deteriorated alongside the depreciation in the rand, and drought-induced food price increases pose a significant risk.

While Finance Minister Pravin Gordhan looks committed to fiscal consolidation, South Africa’s vulnerability to capital flows will remain high as the US Fed embarks on monetary policy tightening and the risk of a sub-investment grade rating beckons. This will continue to put pressure on the rand.

“Where domestic equities are concerned, rand hedges will benefit from currency weakness. Those companies that are dependent on domestic growth for earnings will struggle in the current environment.

“While a reduced underweight position in domestic equities may be justified given recent share price weakness, offshore equity exposure offers a much wider opportunity set of companies to choose from.”

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