The start of 2016 was the worst ever for equities worldwide as global equity valuation plummeted by an enormous 5.7 trillion USD in the first nine trading days of 2016, according to Bank of America Merill Lynch. The MSCI All-Country World Index is down 9% year-to-date and has almost entered official bear market territory with an 18.8% drop from its April 2015 high. A drop of 20% or more is considered a bear market and many individual stock markets worldwide have already passed this threshold. As a result, many investors worry we are on the precipice of another 2008, though the analysis suggests these fears are unfounded. “If a financial meltdown is not on the horizon, what is causing such a drastic sell-off?” explains Nordea Savings experts in Baltic countries.
“Nordea believes this is to a large extent investor psychology, not a reflection of a change in the fundamental picture. Given the past 7 years of consistent market growth, investors are starting to worry that the bull market has matured and are looking for reasons for the market to drop. As a result, all kinds of investor worries have caused increased market volatility. However, at the current stage, increased volatility is normal and investors have to cope with it,” says Anželika Dobrovoļska, Team leader of investment products development department in Latvia.
“Renewed fears about the state of the Chinese economy and doubts over the government’s ability to manage the slowing economy ignited the selloff in Chinese equities in the first days of January, which later transformed into a global market rout. Due to ambiguous communication by the Peoples Bank of China, the shift to a trade-weighted exchange rate and resulting depreciation of the yuan against the dollar was perceived as a desperate step to boost economic growth through currency devaluation. Chinese economic growth is indeed slowing based on the 2015 GDP growth rate reported this week, which declined to 6.9%, its slowest level in 25 years. Still, Beijing has plenty of options left to continue supporting the economy and Nordea believes more emphasis will be put on fiscal easing this year.
A continued slide in oil prices is also affecting investor confidence. Both Brent and WTI oil prices dropped below 30 USD per barrel to their lowest levels since 2003. The unwillingness of OPEC members to cut production and the addition of Iran oil to the market once sanctions were lifted is keeping supply at elevated levels. Together with slowing demand from China, this is causing an oversupply of around 1 million barrels per day. However, supply from the US is slowly decreasing and a drop in demand may not be as big as feared. Moreover, current price levels are clearly the result of overreaction and extremely bearish sentiment.
Given all these facts, the current market decline seems largely the result of psychological factors and does not reflect a change in the fundamental picture. The global economy is still expected to grow in the coming years, while massive stimulus programs put into place by European and Japanese central banks are expected to provide additional support.
Corrections and bear markets are actually very common in the markets and should not be feared. In the last 100 years there have been 123 corrections (10%+ declines) and 32 official bear markets (20%+). That means an official bear happens once every 3 years or so and corrections occur more than once a year. This is why equities are called risky assets and this risk is what provides returns for equity investors, as they are being compensated for taking said risk. History seems to suggest that for disciplined long-term investors, corrections are not cause for worry but a buying opportunity,” says Nordea expert.
“So what conclusions should long-term investors draw from such market behaviour and how should they react? The most important advice is to stick to the plan and follow it despite recent price action. Additionally, Nordea analysts believe this is still just a correction. Taking into account all the negativity that is currently priced in, any surprises are likely to be positive going forward. However, investors need to be prepared for increased volatility in the near future, so sticking to suitable risk limits is of particular importance,” says Nordea Savings expert.
*This publication has been prepared Nordea Baltic Savings unit. The publication is intended only to provide general and preliminary information to investors and shall not be construed as the basis for any investment decision.