Thursday, January 14, 2016

Global Stock Market Turbulence: An Excess of Anxiety?


The world’s equity markets are off to a rocky start in 2016. The basic problem, in our view, is a rising fear that a slowing global economy will ultimately lead to recession, disappointing corporate earnings, and bear markets in many countries, including the U.S. What are the sources of these fears and are they justified?

In our January 8, 2016 Outlook, we expressed cautious optimism: “our most probable scenario for 2016 is substandard global GDP growth, modest advances for most key stock markets, very low returns for bonds and money-market funds, and a continuation of challenging conditions for commodities, including oil.” We also identified four issues (the Chinese economy, Federal Reserve policy, the dollar, and commodity prices) where fears of a surprising negative development could damage investor sentiment. Rising concerns in all four issues have created a crescendo of pessimism thus far in 2016, which in our view has become excessive and unwarranted.

  • Many investors are convinced that the Chinese economy is collapsing. We acknowledge that there is a slowdown, particularly in infrastructure investment and exports. However, we continue to see signs that the policymakers’ determination to stimulate consumer spending and stabilize the economy is succeeding. Many large U.S. corporations, including General Motors, Starbucks, Apple, and Yum Brands, have recently emphasized that sales into China remain strong and the future is bright. Although we acknowledge that China’s policymakers have introduced ill-advised, clumsy measures to stabilize their stock market, we do think they are taking effective steps to address their capital flight and currency devaluation issues.

  • Pessimists argue that the Fed will raise short-term rates too aggressively throughout the year, which will damage an already fragile economy. They support this view with the observation that the Fed is keying on employment gains, which were running very strong at the end of 2015. In other words, these pessimists view good economic news as bad news for the market. We disagree. The Fed has stated definitively that they are highly sensitive to any negative consequences of their interest rate policy. We are convinced that the Fed will proceed in a very cautious manner and will not raise rates if international and U.S. economic fundamentals deteriorate and threaten recession. Investors should not fear the Fed.

  • Third, the concern that Fed rate hikes will lead to a stronger dollar has amplified fears of a bear market. The argument posits that a stronger dollar will weaken international economies, diminish the competitiveness of U.S. exporters, and reduce corporate profits. We may see a rise in the dollar, but this is far from certain. The reality is that it has stabilized against a basket of international currencies since last March. In particular, the Japanese Yen and the Euro have actually strengthened modestly against the dollar over the past 10 months. We do not think Fed rate hikes will necessarily result in a stronger dollar, and there is a plausible possibility that a fall in the dollar will provide a boost to the U.S. stock market.

  • A further plunge in the price of oil is projected by some market forecasters who believe that U.S. and international stock markets will follow oil prices lower. They are convinced that this decline will signal a slowdown in global demand and that any economic benefit to consumers and businesses will be more than offset by reductions in investments and jobs by energy companies. In contrast, we think supply issues are causing the decline and that another drop in oil prices will provide additional net stimulus for the U.S. economy.


Of paramount concern to investors is that a combination of overly aggressive Fed rate hikes, a collapsing Chinese economy, a surge in the dollar, and falling commodity prices will push the global economy, including the U.S., into recession. We are not convinced that any of these fears are justified, much less that a perfect storm of all these negative developments will hit simultaneously.

We maintain our Outlook that a U.S. recession and bear market is unlikely. If we are correct, it will still take time for excessively negative sentiment to subside, and thus we anticipate further volatility in global markets. We also emphasize our commitment to monitor closely future economic and financial market developments for indications that our current viewpoint is too propitious and investment adjustments may prove necessary.

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