A version of this article first appeared in the Financial Times.
Markets in the first weeks of 2016 were unexpectedly violent. After one of the worst starts for equities on record, I remain pessimistic that things will meaningfully improve soon.
One of the most disturbing aspects of the global selloff in equities and commodities is the virtual lack of panic or fear. Despite a period of relentless selling in U.S. equities, market volume has failed to increase and measures of fear, such as the CBOE Volatility Index (VIX), are not near the levels witnessed during the global financial crisis, the euro zone crisis, or even last August’s market selloff.
Panic is a key indicator of a market bottom. Panic is associated with sharp increases in trading volumes as investors fearing further declines seek to liquidate positions. That kind of selling causes volatility to spike, as price movements accelerate to the downside. None of this has been associated with the decline to start 2016, which tells me we have more downside before we see bottom.
A number of analysts are currently painting a bleak picture for the global economy. Candidly, I don’t see it. Despite the Federal Reserve’s recent actions, monetary conditions remain highly supportive for global economic growth. In the U.S., the index of leading economic indicators shows no warning signs of recession.
LEI Shows No Warning Signs of Recession
The index of leading economic indicators, comprised of 10 components whose changes typically precede changes in the U.S. economy, remains in positive territory and shows no warning signs of recession.
Source: Bloomberg. Data as of 1.19.2016.
Many analysts point to widening credit spreads and falling equities as foreshadowing a recession. I remind folks that we had a similar scenario after the market crash of October 1987, and the U.S. recession was still two years away. For those of us who remember, that time became a great buying opportunity. I could say the same for 1994 and 1998.
Meanwhile, the persistent weakness in oil continues to exert its negative influence on all markets, especially corporate credit. Oil prices likely have further to fall: not until it reaches approximately $25 per barrel will we begin to see oil production shuttered, which should then set the stage to stabilize the energy sector.
Additionally, if market turmoil continues as I expect it will, and lower oil prices damp headline inflation, the Fed is likely to delay further rate increases. Given strong employment growth and continued wage growth, along with a stimulative fiscal policy now in place, the U.S. economy is likely to thrive in 2016.
What about China? The Chinese have locked themselves in a vise. The currency needs to depreciate to help keep their economy competitive with other nations— like Japan and Korea—that have allowed their currencies to depreciate.
Chinese Competitiveness Has Eroded
The renminbi needs to weaken to help keep the Chinese economy competitive with other nations that have allowed their currencies to depreciate.
Source: Bloomberg, Haver. Data as of 1.19.2016.
As it becomes apparent that the renminbi (RMB) will depreciate, pressure mounts on capital flows out of China. This causes asset liquidation, which drives their stock market lower as investors attempt to avoid the losses associated with currency devaluation.
Somehow, the world had become convinced that the Chinese would be able to maintain the value of their currency despite competitive pressures from its neighboring nations.
China Needs a Weaker Currency to Boost Waning Growth
The relationship between the renminbi exchange rate and gross domestic product illustrates the importance of foreign exchange values to growth in an export-driven economy like China’s.
Source: Bloomberg, Haver. Data as of 1.19.2016.
Once again, investors are learning that market forces will win in the end. While the RMB could be propped up for a time, imbalances ultimately build to extremes that overwhelm artificial prices.
When the dam finally breaks, market moves are violent. This is what we are seeing in China. Chinese stocks are down 20 percent from recent highs, but there is more pain to come. Markets do not move in straight lines; any pause in the selloff should not be viewed as a trend reversal.
The good news is that I do not believe the volatility in Chinese equity markets will have any meaningful impact on the U.S. economy. In the short run, however, selling pressures in China will continue to spill over into other equity markets including the U.S. This is the product of global capital flows. Eventually, the capital leaving China must find a new home. The U.S. and Europe will eventually benefit.
As I look at the markets so far this year, I am reminded that “cooler heads will prevail.” While the market will remain volatile and likely lead to a period of outright panic, that is when having a “cool head” will pay off. Those who are prepared will find exceptional opportunities for investment.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"). Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
Read a prospectus and summary prospectus (if available) carefully before investing. It contains the investment objective, risks charges, expenses and the other information, which should be considered carefully before investing. To obtain a prospectus and summary prospectus (if available) click here or call 800.820.0888.
Investing involves risk, including the possible loss of principal.
*Assets under management is as of 12.31.2019 and includes leverage of $11.8bn. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
Guggenheim Investments. All rights reserved.
Research our firm with FINRA Broker Check.
• Not FDIC Insured • No Bank Guarantee • May Lose Value
This website is directed to and intended for use by citizens or residents of the United States of America only. The material provided on this website is not intended as a recommendation or as investment advice of any kind, including in connection with rollovers, transfers, and distributions. Such material is not provided in a fiduciary capacity, may not be relied upon for or in connection with the making of investment decisions, and does not constitute a solicitation of an offer to buy or sell securities. All content has been provided for informational or educational purposes only and is not intended to be and should not be construed as legal or tax advice and/or a legal opinion. Always consult a financial, tax and/or legal professional regarding your specific situation. Investing involves risk, including the possible loss of principal.