Maths on wallLike many others, here at Logic we follow press reports on investment markets with avid interest. Much has been made recently about potential market turmoil and many attention-grabbing headlines and column inches devoted to the subject.

So we thought we’d ask an investment house to share their thoughts with us on the latest situation. Here’s what Tom Becket of Psigma had to say…..

“It could hardly have been a worse opening fortnight for global markets, with both records and investors’ nerves similarly smashed. It will come as no surprise when we state that we have been surprised by how badly markets have started the year, as I am not sure that anyone could have predicted the speed and ferocity of the year-opening falls. Whilst some of the factors driving markets are not major surprises, certainly the reaction that there has been is. There are a number of different issues that investors are confronting at the same time, and as a wise old(ish) man in the office said this week “there is a lot of bad stuff going on”.

Amongst the things concerning markets, the two things that we are most worried about are the potential for what we mostly see as primarily a market issue affecting the real economy and the impact of deleveraging from newly cash-strapped sovereign wealth funds, particularly in the Middle East, due to lower oil prices. Whilst these might not be the key issues that others are discussing, we feel that they deserve the greatest focus at this time.

Positive Things to Consider
Before I go on to discuss the negative stories that are very much en vogue, I think it is important that we consider some of the positives that are being ignored.

  • Economic growth might be lower than some would like, but it is still positive.
  • Monetary policy globally is still very loose by historical standards. In many places policy is being loosened.
  • The actions that China is taking are leading to short term issues. Once dealt with, the economic tomorrow for China should be better balanced.
  • While falling oil prices are a major issue for oil producing nations and there is evidence of Sovereign Wealth Funds selling assets and impacting markets, it should be supporting consumption across the world.
  • The global banking system has been purged of much of the excess of the last crisis and should not be at risk.
  • It is hard to argue that many markets are wildly expensive. Some bonds, some defensive equities and some companies in the developed markets are richly valued, but widespread excessive valuation is not obvious.
  • Investor sentiment is appalling and at levels that normally heralds market recoveries.

Issue 1: Global Growth
There is no doubt that the economy has once again shifted back to sluggish from solid in the last month or so. At best, one could say that economic data has been satisfactory but inconclusive, but at worst one could say it has been outright poor. The US has obviously slowed in the last few months of 2015, despite some extraordinarily clement weather. We need to see evidence that the US is merely suffering a slower patch, rather than a turn in the cycle before we can get more positive on markets. So far, Europe, Japan and the UK are showing signs of stability. There are good points in most of the developed world, such as consumption and consumer confidence, helped by good employment figures, while there are some obvious negatives, particularly in the manufacturing sector. The worry in places like the US is that the manufacturing sector leads consumption lower. The other growth issue surrounds China, which has been treated as the epicentre of the recent sell-off. Our view remains that Chinese growth is stabilising and the impact of monetary and fiscal stimuli will be evident towards the end of Q1. Indeed, China’s economic data this week was actually moderately pleasing, but utterly ignored by markets.

  • Psigma View: We stand by our “solid, but unspectacular” growth view for the year ahead. Yes, more recent economic evidence is hinting at a softer growth path, but as long as market conditions do not impact upon economic confidence, growth should be ok through the year and a steadier Chinese economy by the end of Q1 ’16 should help our global growth forecast to come through. For us to get very worried about the economic outlook, we would need to see markets continue their woeful opening start of the year, the US to lose steam in Q1 or evidence that China is worsening to start to appear.

Issue 2: China and Regional Markets
As stated above, China is being blamed for the worst elements of the dire market conditions since the summer of 2016. Some of this blame has been rightly apportioned and the Chinese are justifiably now apologising for the issues they have caused in the domestic equity market. More importantly by far, the fluctuations in the FX markets have been a major negative impact upon skittish investors and the Chinese appear to have learned their lesson there. In the last few days, the Chinese have acted decisively in the offshore Yuan markets, as they look to clear out negative speculation. This has worked in the short term and hedge funds will be scared by the arsenal the Chinese have to deploy. It is therefore possible that the Chinese have drawn a line under this problem. Now we need to see further confirmation of ongoing policy and hope for the better economic news that I discussed above.

  • Psigma View: A managed moderate decline of the Chinese Yuan this year seems appropriate and the most likely outcome. Markets expect this, so, as long as the Chinese do not act rashly, then there should be less concern as the year develops. We expect there to be imminent reforms concerning the financial markets in China and the growth path should stabilise.

Issue 3: Commodities
The commodity rout has persisted and accelerated in the first few weeks of 2016, with the Bloomberg Commodity Index now back to levels it was in 1991 (not a mis-type). Commodity markets are perilously over-supplied and, despite evidence of efforts to move supply in to equilibrium with demand, this will not happen immediately. There are some tentative signs of an improvement in the supply-side, bit nothing in the short term that convincing to blast away the extraordinary speculation against commodity prices in financial markets. We would note interesting comments from the “luminaries” at Goldman Sachs, who suggested this week that oil prices might well fall further, but the low current prices are setting the scene for the next major bull market, which could start later this year. As long as there is some supply-side discipline and the economic environment does not worsen considerably, thereby impacting demand, we would agree.

  • Psigma View: It is totally pointless trying to call a bottom in commodity markets and the predictions of $10 oil could come true. We would note, however, that the geniuses now falling over themselves to predict the lowest price are the same analysts who were predicting a quick rebound at the start of 2015. It is simply a case of “nobody knows”. However, we have two simple views; firstly, until the oversupply issues are addressed, prices will be lower for longer and, secondly, we expect prices to end 2016 higher than where they started the year. With oil prices staying depressed, it could well dampen inflation expectations and actual headline rates of inflation, but we view this as a temporary factor and ultimately our view that headline inflation rates will rise back towards central bankers’ targets remain, even if they take longer to eventuate. Evidence that some of the Sovereign Wealth Funds, who have been powerful drivers behind markets in recent years, are behind some of the recent fire-sales is obvious and we need to continue to think about this important “second derivative” effect upon markets.

Issue 4: Global Monetary Policy
It seems highly unlikely that the Fed wants to raise rates in Q1, given the mix of global growth concerns, China-specific issues, volatile markets and depressed inflation expectations. Although the Fed might believe that “steady as she goes” commentary will soothe markets, it appears obvious that investors are worried about imminent rate hikes with dark clouds lingering. It strikes us as currently infeasible that the Fed will be able to raise rates four times this year, as they have suggested, unless many of the factors worrying markets right now start to clear. Elsewhere, we learned this week that the decision not to be even more aggressive with QE in Europe late last year was a close call. It would seem likely that the Europeans, like the Japanese could be tempted to put the foot down further on the accelerator in the coming quarters.

  • Psigma View: Markets would respond very positively to any change in tone from a Federal Reserve that has appeared hawkish over the last few months. Further hawkish commentary could easily keep markets suppressed until the Fed was proved right and the economy shows it can take higher rates. Europe and Japan have performed poorly in recent months and proactive central bank activity would help steady the ship and reverse the negativity.

What do Psigma think will happen next in the markets?
I think it is fairly obvious that markets are now very oversold on a short term view and investor sentiment is probably as negative as it can get. I have never known there to be such grim prophecies both from the investment bank research departments and the common press, both of which are often contrarian signs. Having spent much of the week speaking with contacts and fund managers across the world, I can confirm that there doesn’t appear to have been a huge amount of panic selling, but rather a buyers’ strike. Many managers I have spoken to have suggested that much of the industry is cash-rich and any move to put cash to work could have a powerful upside impact. Our view is that the first six months of the year will be volatile, but ultimately markets should make headway later this year. It would be irresponsible and naïve to suggest that markets have fallen as far as they can this year and are a “screaming buy”, but we are expecting conditions to calm and consider the potential medium term upside from many of our investments as extremely attractive. A short term rally could easily be started by helpful comments from central bankers, confirmation that earnings are not as bad as markets are suggesting or better news in the commodity markets. In truth, markets have performed so badly, so quickly that anything could trigger a rebound.

What do recent events mean for Psigma’s strategy?
As you will know, we believed that we had the seen the high points for this cycle for both the UK FTSE 100 and the US S&P 500 in the second quarter of 2015. Our view had shifted, in the face of rampant investor optimism, to a strategy of selling the rallies in many developed markets. However, more recently we believed that equity markets were likely to perform satisfactorily around the turn of the year, after a very poor period over the summer. If our view of a “relief rally” described above takes place, we might well consider taking equity levels down and funding some lower risk investments that we have researched.

Ultimately the key thing that we have to appraise as investors is “am I paying the right price” and “is the timing sensible”. The latter part of an investor’s equation is extremely difficult and recent events have shown that ascertaining entry points is fraught with difficulty. With regards to valuations, as long as there is not a global economic recession, then valuations across most asset markets are compensatory for the risks facing investors on a medium term view. In both equity and credit markets we have more conservative views on earnings and default rates (we only expect moderate earnings growth and defaults to be higher than analysts expect), but even with these beliefs we feel that returns will be positive and, in some cases, excellent in the years ahead. Judging when markets will take a more positive view of macro and microeconomic events is almost impossible, but we certainly do not feel that we are in a situation where market valuations are excessive.”