The fireworks of New Year’s Eve heralded the arrival of 2016 and, as far as financial markets are concerned, those fireworks have continued well into this week.
In an action-packed few days, news from China has been met with a spectacular reaction by the markets, trumping significant geopolitical issues in the Middle East and Asia. Saudi Arabia’s execution of Shia cleric, Sheikh Nimr al-Nimr, caused a swift deterioration in relations with Iran, which resulted in a brief jump in the oil and gold prices. North Korea’s reports of nuclear tests have heightened anxiety amongst its neighbours, but China’s actions have completely overshadowed both of these situations, with markets reeling around the world.
On Thursday, trading was suspended on the Shanghai stock exchange within half an hour of the bourse opening, as traders flooded the market with sell orders. China’s “circuit breaker” rules require the exchange to suspend trading for the rest of day if the market moves up or down by more than 7% in the course of the day; and this was the second time this week the exchange had been forced to close.
The enforced cooling off period evidently did not seem to take the heat out of the selling and some commentators argued it may be making the situation worse as it gave traders time to line up a large number of sell instructions, which were placed within moments of trading commencing. An announcement followed later in the day that the “circuit breaker” rule would be suspended on Friday, which seemed to calm equity markets. Further restrictions on selling, which were announced six months ago and due to expire this week, prompted some small investors to try to get their sell orders in first. Authorities have acted to curb this with fresh restrictions coming into effect, stemming the ability of large shareholders to place redemptions.
The effects have been felt throughout markets with investors fleeing risk assets for traditional safe havens such as the US Dollar and government bonds. In what has already been a difficult week, equity markets were down around 2-3% on average during Thursday with mining and commodity-linked stocks taking a battering, as Brent crude fell to below $33 per barrel. Sterling hit a 5-year low of $1.456 against the Dollar and also lost ground against the Euro, as investors hunkered down and a summer interest rate rise in the UK seemed more remote. Improvements in the Eurozone economy reported this week, with inflation at 0.2% and economic growth indicators gaining strength, were completely ignored and European equities were punished along with their counterparts in other parts of the globe.
The Chinese central bank lit the touch paper last Thursday as it began to devalue the Yuan. The Yuan is pegged to the US Dollar and allowed some latitude to float against the peg rate. The bank has lowered the peg over eight consecutive days so far, which should support China’s struggling manufacturing and export businesses, making their goods cheaper outside China. It has also been interpreted as an indication that problems in the Chinese economy might be more widespread, with faltering domestic demand also a possibility. China has also announced foreign exchange reserves fell by $107bn in December, the largest month-on-month drop on record, as it attempted to support the Yuan and stem the flow of money out of China. It is reported China spent an incredible $512.7bn supporting the Yuan in 2015, although it is also worth remembering reserves currently stand at $3.3trn.
Slowing growth in China has been well-recognised in markets for some time as China’s economy matures and transitions from being a low cost manufacturing hub for the world, to an economy with increasing focus on domestic demand from its middle classes. In our view the panic has been caused by surprise and uncertainty around 1. the strength of China’s domestic economy, which would have ongoing implications for commodity and oil demand levels; and 2. the devaluation of the Yuan, which increases the pressure on other Asian countries to follow suit. The situation has undoubtedly been compounded by China’s famously tight-lipped stance. Unlike almost any other nation, actions are not accompanied by any form of comment or explanation and a lack of transparency adds to this, leaving investors to fear the worst. We may see further announcements today, but as the situation currently stands, we anticipate significant volatility could persist well into next week.
This commentary was written by Jo Benson, Senior Analyst, at one of our Investment Managers, Wellian Investment Solutions